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Potential Breakout in FX Building, but...
05/04/2009 11:50 am EST
After an initial setback on news of the swine flu outbreak, risk appetites bounced back sharply, sending the USD lower and the JPY crosses higher this past week. The short-term price action in the JPY crosses was especially persistent, suggesting the potential for further gains in the weeks ahead, as markets increasingly conclude that the worst has been seen in the global downturn. As we have noted repeatedly in recent weeks, however, the data points that are showing improvement have mainly been sentiment gauges (e.g. ZEW, IFO, PMI's, ISM manufacturing, Conf. Bd. consumer confidence), which have bounced back, in most cases, from record lows. In contrast, economic outlooks for the year as a whole have been repeatedly downgraded (German government, BOJ, RBNZ, Fed staff, and the IMF) suggesting a significant disconnect. While it is not surprising that sentiment should rebound from extreme lows, the issue comes down to sustainability. In that sense, the improvement in risk appetites remains exceptionally fragile.
While the S&P 500 and other stock indexes saw sizeable gains during April, key currency risk indicators were largely unchanged in April. For the month: EUR/JPY finished -60 pips; GBP/JPY +400 pips; AUD/JPY +300 pips; NZD/JPY +30 pips; USD/JPY-30 pips; and EUR/USD -20 pips; gold -$33 (-3.6%). To the extent that there was movement in risky FX, it was in favor of risk-seeking trades, but FX risk appetites clearly lagged gains in other asset markets. The one FX area where we can see some differentiation is between the core G7 economies and the commodity currencies (AUD and CAD primarily, GBP also stands out-see below). The lack of appreciable movement in the USD, EUR, JPY, and CHF suggests markets are appropriately cautious on the mature economies' outlooks, while gains in the commodity currencies likely reflect the optimism that a corner has been turned in the global recession. However, the CRB index of commodities, while showing signs of leveling off since February, gained less than 1% in April, undermining the notion of a significant rebound in commodity demand. More likely, the relative strength of CAD and AUD mirror the relatively healthier state of economic and financial affairs in those countries, with both central banks abstaining from quantitative easing and likely at the end of interest rate easing cycles.
In the short run, though, this past week's rebound in JPY crosses may have more room to run. The major JPY crosses are all above their Ichimoku clouds and above both the Tenkan and Kijun lines, suggesting an overall bullish stance. In terms of chart patterns, the move down in JPY crosses during most of April formed bull flag consolidations of the move higher from lows seen in January, and the strength seen this past week broke above the top of the flag, suggesting that gains are resuming. The last remaining hurdle to the upside is the recent high seen in early April (more below). JPY weakness is also highly correlated to gains in US Treasury yields, and the recent surge in ten-year yields should be closely monitored for signs of any retreat, especially in light of Fed Treasury buying plans. As well, there are multiple news events which could upset the apple cart of the current sentiment rebound, most notably because the Fed is set to release the results of the banking sector stress tests on Thursday, May 7. We would also note that the KBW banking index failed to sustain gains seen in the S&P 500, which is a break from its role as a leading indicator for stocks overall (Or is it?).
Market holiday advisory: This week, Monday will see UK banks shut for the spring bank holiday, and Japanese financial markets will be closed until Friday for the Golden Week holidays. Reduced liquidity conditions could result in heightened overall volatility.
Important Price Levels to Watch
In view of the strong move up in JPY crosses, our attention will be fixed on them next week. In particular, we will be watching:
GBP/JPY: Resistance: 150.00 (4/16 high) and 151.50 (4/6 high, highest since the low).
Support: Tenkan and Kijun lines are key support at 143.50/70.
AUD/JPY: 72.76 (4/20 high) and 73.50 (4/14 high and highest since the low). 200-day SMA is at 71.18; Tenkan line is at 69.90 and Kijun line is at 69.24.
CAD/JPY: 200-day SMA is at 83.74 (potentially closed above on Friday); 85.24 (11/10 high). Tenkan line is at 81.04; Kijun line at 80.30.
USD/JPY: 100.00 and 101.50 (4/6 high and highest since low). 200-day SMA is at 98.40; Kijun line is at 98.54 and Tenkan line is at 97.61.
USD/CAD: 200-day SMA is at 1.1857 (potentially closed below on Friday); 1.1762 (1/10 low). Tenkan is at 1.2169 and Kijun line is at 1.2274.
MORE: UK Economic Update and GBP Outlook|pagebreak|
Sterling found support on Friday on the release of better than expected manufacturing April PMI data (42.9 vs. 39.1 in March). Earlier in the week, a smaller than expected fall in the nationwide UK housing price index (-0.4% m/m) also lifted the pound. Months of bad news on the UK economy and on the outlook for the national debt appeared to have left the market short of the pound. This would explain why sterling is sensitive to good news. However, while better than expected, last week's UK economic data provide very little reason for celebration. The PMI data is not overtly good news insofar as any number below 50 is still hinting at contraction in the sector. Similarly, the releases of lending and mortgage approvals data from the BoE highlight continued weakness in lending to individuals in March. At GBP0.9 billion, the overall figure was below that printed in February. That number is driven by lending on dwellings, which at GBP 0.8 billion, was also below the February figure and the previous six-month average. Better news was provided by the number of loans approved for house purchases, which at 39K in March, rose modestly on the month to hold above the six-month average. Put together, the data suggest that although the housing market in the UK is showing tentative signs of stabilization, it could bump along the bottom for many months to come. For the broader economy, it seems that the pace of the contraction may be moderating, but signs of growth remain elusive.
The only real good news on the UK economy of late has been on consumer activity. The rise in official retail sales data for March at +0.3% y/y was underpinned by the April CBI distributive trades survey, which reported the strongest showing from retailers since January 2008. Lower interest rates may be boosting consumer confidence, though there is little in BoE lending data that leads to the conclusion that quantitative easing is yet having a strong impact. Going forward, the likelihood that UK unemployment will rise to above 3 million into 2010 will continue to restrain consumer optimism, as will the possibility that next year's budget will be built around austerity in order to start plugging the holes in the national accounts. This week, the BoE policy meeting is likely to pass with little fanfare. Rates are expected to remain on hold at 0.5% and the Bank is set to confirm that it is continuing with its program of buying GBP75 billion in gilts (around GBP 40 billion has already been done). Until the UK data starts to hint at economic recovery, sterling rallies versus the EUR could prove to be short-lived.
RBA and ECB: The Market-Moving Meetings This Week
The Reserve Bank of Australia is scheduled to decide on interest rates on Tuesday at 0030ET/0430GMT. The consensus is that they will leave rates on hold at the 49-year low of 3.0%, but there are some economists looking for a -25 basis point cut. The justification to leave rates steady is that more forward looking economic data have "stabilized" while inflation expectations look to be turning higher. NAB business confidence rose to -13 in April from a dire -22 print the prior month and leading economic indicators rebounded recently. Meanwhile, inflation expectations edged to 2.4% in April from 2.2%, and this should give the bank some pause-pun intended. The risk is that the bank does indeed decide to take rates lower. The last communique mentioned the "Scope for a further modest adjustment," and thus the possibility exists that they will reduce the target rate by another -25 basis points. Under this scenario, we would expect that the immediate reaction would be to sell AUD, as the rate cut will undoubtedly be justified through a dovish outlook for the economy. A similar reaction was seen in Kiwi just last week. We would look for any knee-jerk selling of AUD to be reversed, as relatively speaking, the Australian economy continues to outperform. An overreaction to lower rates should open up a good AUD buying opportunity on the follow.
The European Central Bank is up on Thursday and will release their interest rate decision at 0745ET/1145GMT. The market is unanimous in looking for a -25 basis point reduction in the target rate, bringing it to 1.0%. This then shifts the focus to the subsequent press conference at 0830ET/1230GMT, where ECB president Trichet is expected to announce whether the bank plans to engage in QE (quantitative easing). Thus far, the debate within the ECB is ongoing regarding the appropriateness of QE. ECB member Nowotny said just this week that "At the moment, we have certainly the need for an expansionary policy" and the market took his comments and quickly sold EUR. Bini-Smaghi took the other side of that argument and stated that, whatever tools the ECB decides on, they are likely to differ from the Fed's initiative. He went on to add that buying private debt is difficult and that there are "issues" with the ECB buying government bonds. The market quickly bought EUR back. This suggests that the price action in EUR will be dependent on the aggressive nature of the "non-standard" measures that are expected to be announced at the press conference. The risk is that the bank shies away from the QE approach, in which case the EUR would be better bid. We would look to cover any EUR shorts ahead of the ECB press conference in case this very likely outcome comes to fruition.
Key Data and Events to Watch This Week
The US economic calendar is busy with some top-tier events on tap. Monday kicks off the action with pending home sales and construction spending. The ISM services index is up on Tuesday, and ADP employment and crude oil inventories are due Wednesday. Initial jobless claims, productivity, labor costs, and consumer credit make for a busy Thursday, while non-farm payrolls and wholesale inventories round out the week on Friday. There are multiple Fed officials speaking on the economy, and chairman Bernanke's testimony before the Joint Economic Committee is the highlight on Tuesday. Look for the release of the Fed Senior Loan Officer Survey as well this week, which will give an indication as to the health of the credit markets.
It is also on the busy side in the euro zone. Monday starts with euro zone PMI manufacturing, German retail sales, and the European Commission release of its economic forecasts. Tuesday follows with euro zone producer prices, while Wednesday has euro zone PMI services and retail sales. The ECB announces interest rates on Thursday (analysis above) and we also see French trade and German factory orders that day. Friday has German trade and German industrial production on deck.
The UK calendar is light and starts with consumer confidence on Tuesday. PMI services are due up on Wednesday, and the Bank of England rate meeting is Thursday (expected to be a non-event). Friday closes things out with producer prices.
It is Golden Week in Japan, and thus, the action is limited. The Bank of Japan meeting minutes, due up on Wednesday, is the only noteworthy event. Look for extremely thin trading conditions in the Asia sessions early in the week.
Canada is also light. Building permits and the all-important Ivey PMI index are up on Wednesday, while the employment report and housing starts are due Friday. Bank of Canada's Carney is set to speak on Wednesday as well.
It is pretty busy down under. Australian home prices and services index kick off the action on Monday. On Tuesday, we'll see Australian building approvals and the RBA rate meeting (analysis above). Wednesday has Australian retail sales, Australian trade, and New Zealand employment lined up. Australian employment is scheduled for Thursday, and Friday has the RBA's quarterly monetary policy statement.
By Brian Dolan of Forex.com
By Brian Dolan, chief currency strategist, Forex.com
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