Risk Appetite Looks Poised to Wane Some More

04/20/2009 10:51 am EST

Focus: FOREX

Brian Dolan

Chief Currency Strategist, FOREX.com

The rally in risk lost some thrust last week despite a plethora of improved economic reports and bank earnings. The more prescient US economic indicators showed some signs of bottoming out. The NY and Philly regional indices blew away consensus expectations and suggest things are at least not getting any worse in the manufacturing space. Meanwhile, the homebuilder index (NAHB) popped to its highest level since October, while housing starts and building permits witnessed a sharp downside correction—a good sign in terms of speeding up the return to equilibrium on the home price front.

If that wasn't enough to wet risk appetites, the Fed's Beige Book alluded to some signs of stabilization, while the University of Michigan sentiment index printed its highest result since September—before financial markets really took a spill. Speaking of financials, companies who reported this week from that space beat analyst estimates by 2% on average. Despite all of the rosy news, stocks only managed to eke out a 2% rally for the week, and this is somewhat ominous. The S&P 500 remains just below critical 880/900 resistance and there are multiple events this week that could see the rally peter out in earnest.

On the US data front, we will find out just how real that decline in weekly jobless claims to 610K from 663K was. The Department of Labor admitted that seasonally adjusting the number around the Easter holiday was a challenge, and this makes the low-ball number seem rather dubious. Indeed, it would not be a surprise to see a 700K print in claims as the seasonal adjustment problems skew the number to the upside this time.

Company earnings will continue to impact markets as well, and the action really picks up in the financial space with 32 major companies slated to report. These will include recently troubled investment banks and credit card companies. One of the main takeaways in the recent earnings reports was that credit card defaults and commercial real estate are likely to be the next shoes to drop. The market will be looking for signs that these two areas continue to pose a risk to the overall economy. The more prevalent they seem, the more risky assets are likely to be sold.

Last but not least, we are likely to see multiple market-moving headlines out of the US Treasury on Friday. They are set to announce the underlying assumptions behind the bank stress tests, it is the application deadline for the PPIP program, and Treasury secretary Geithner will host the G-7 finance ministers. The stress test assumptions will be scrutinized for their rigor, and if the market perceives them to be lax, the implications for the market could be detrimental. In terms of the PPIP, traders will be looking to whether participation was enough to really create a market for the toxic mortgage assets. The fact that the government already extended the application deadline suggests demand has been rather weak. The G-7 is really a toss-up, but could ultimately be a positive for markets if the countries involved show willingness to act in coordinated fashion in an effort to end the financial crisis.

If the news flow proves to be on the negative side, we would expect equities to slip, gold to rebound, and the US dollar to extend gains. Gold remains on the heavy side, but we would expect buying interest to emerge into 865/850. Back above 900 should shift the medium-term focus higher here. The USD would likely be better bid against most of the majors except the yen. We would expect significant retracements in AUD/USD and USD/CAD, specifically as weaker equity markets should see the commodity complex head lower as well—which would weigh heavily on AUD and CAD. The yen crosses would come under pressure and we would not be surprised to see EUR/JPY test back to the 127/126 area and USD/JPY towards 98/97 on the follow.

By Brian Dolan, chief currency strategist, FOREX.com

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