The markets have given back some of their weekly gains as we move towards the market close in what has been a fairly lacklustre session so far. Tight ranges persist – EURUSD has traded between 1.3035 and 1.3075, although it is still expected to end the week 1% higher. The European peripheral bond markets have had a mixed day: after an initial drop some comments from Eurozone officials, earlier who are embarking on the second day of the EU summit, saw yields reverse course. However, Spanish bond yields are still down 50 basis points on the week. European stock markets have also retreated today partly after US markets suffered yesterday amidst the confusion of Google’s disappointing Q3 earnings release (complete with half written press release), which was released hours early by mistake. No doubt a PR person’s head has rolled this morning, but it doesn’t change the bottom line– tech companies are struggling.
Taking the lead from Tech
IBM, Intel and Microsoft all had lacklustre third quarter results. The tech sector is a good lead economic indicator so what do the results of Google, IBM and co tell us? 1, Companies may not be investing potentially due to the heightened political uncertainty in the US and the threat of the fiscal cliff. 2, If the US manages to avoid the cliff edge then investment in tech could bounce back next year. The Nasdaq in the US tends to be a lead indicator for US markets and its failure to get over the 3,200 mark looks worrying. Good support lies at 3,000, if we can’t bounce from here in the next few days then it could signal broader concern that may dampen market sentiment in the medium term.
While tech giants report weak earnings, this week may well be remembered as one where fears about the strength of the US economy were finally put to bed. Stunning retail sales and good industrial production data along with home sales suggest that QE3’s life span could be cut short. Although stocks are weaker, US Treasury yields are moving more in line with the broader macroeconomic outlook. They continue to test the 200-day sma at 1.8%. If they can stay above this level into the weekly close then it could point to a move to 2% - the highest level since April. Since USDJPY follows the trajectory of US yields closely we need to see them remain at this level for USDJPY to have a fighting chance of extending gains above the 200-day sma at 79.40. (See chart below).
The dollar has strengthened today as sentiment has seeped from the markets. The FOMC meets next week, the commitment to QE3 will be watched closely and any signs that Fed officials are starting to wonder whether the economy can stand up by itself could be met with hefty dollar buying. We doubt officials will be that optimistic and while the activation of the ECB’s OMT continues to hang in the balance we see EURUSD range bound between 1.2850 and 1.3175 in near term.
Is gold redundant?
The good economic news is being greeted with further selling of gold. The yellow metal has fallen below the $1,740 level, the next key support is $1,720 – the 50-day sma. Although economic data has been fairly good around the world recently it doesn’t seem to have stoked inflation, which reduces the need for an inflation hedge like gold. The yellow metal may be a bit volatile over the FOMC meeting especially if Fed officials still sound worried about unemployment, but we still think that $1,765 is the top for the medium-term.
Spain wasn’t a topic of discussion at the EU summit that continues today. PM Rajoy said that he doesn’t feel pressured to accept a bailout. That is good as the ECB’s OMT programme cannot be triggered by a country that requests a formal bailout – it needs to ask for a precautionary line of credit instead. There was some positive news – French President Hollande said that Spain would not face more “conditionality” if it seeks help. This could make it more palatable for Madrid to make a request as early as next week once regional elections are over. Expect a knee jerk rally on the back of any activation of the OMT, EURUSD could potentially break above 1.3175, but we are wary of extending gains further from here as next week sees the release of the flash October PMI readings. If they remain sub 50 as the market expects then growth fears could haunt the single currency. We expect 1.2980 then 1.2850 to act as good supports in the event of a sell off.
EU Summit: a damp squib
The EU summit has been fairly market neutral so far. We know 2 things: the EU (presumably without the UK) is pushing for a single banking regulator in the form of the ECB. This is unlikely to be in place by the Jan 2013 deadline and instead could take a year to be implemented. We don’t know any details, for example will be big financial centres like London, Paris and Frankfurt have the same regulation as a small country like Finland or Slovakia. We also don’t know what the UK’s veto to banking regulation actually means and whether it will hold up the process. Banking stocks in Europe were lower along with the overall market, potentially due to the uncertainty this will create. The other main topic of discussion was over allowing the ESM rescue fund to directly re-capitalise banks, German resistance has put that on the back burner, which is bad news for Spain who needs to find EU60bn to re-capitalise its banks after independent stress tests.
Osborne has a good week, for once
The pound has been volatile today. After weakening first thing it has got its groove back this afternoon. Next week is a big one for the UK as the Q3 GDP estimate is released. There are expectations for a big rebound in growth, which may ensure that GBP is bought on any dips as we reach the end of the week. Overall economic data has been good. Retail sales and labour market data were stunning for the UK this week, while public sector borrowing was also a positive surprise. Borrowing in September was the lowest level since November 2008 at GBP12.8bn, added to that net borrowing for 2011/2012 was revised down by GBP4.4bn to GBP121.6bn. Compared to a lot of countries the UK’s debt to GDP looks ok at 67.9% of GDP, but we definitely don’t want to see that number rise any further. However, this has been a fairly good week for George Osborne.
One to watch: USDJPY and 10-year US Treasury yields. 1.8% and 79.40 are key levels to watch