The Fed’s future path still seems more bullish than the European Central Bank. If so, the yiel...
Risk on/Risk off See-Saw Continues in Forex Markets
07/20/2009 11:03 am EST
After a couple of weeks of "risk-off" trading that started the month of July, risk appetites bounced back this past week largely due to better-than-expected earnings reports in the US. The rebound, however, follows a similar pattern extant over the last few months: Investor sentiment improving on the back of data/news that on its surface suggests recovery, but on closer inspection is riddled with holes. Take bank earnings, for example. Off the top, we would observe that bank profitability in the current environment does not necessarily translate into improvement in the underlying real economy. In fact, those banking lines serving the real economy continued to post multi-billion dollar losses and loss reserves for future write downs were increased significantly. Where did the profits come from? Mostly from trading profits and investment banking fees, which reflect successful market calls and overall financial market stabilization, rather than any concrete improvement in the real economy. And in the case of the two weakest large US banks, which reported surprising earnings on Friday, profits would have been multi-billion dollar losses were it not for one-off asset sales.
On the data front, European sentiment as seen in the July ZEW survey slipped back more than expected, while in the US, both the Philadelphia Fed and IBD/TIPP Economic Optimism indexes saw unexpected declines. An unprecedented drop in US continuing jobless claims and a sharp decline in first time filings were also a mirage, as seasonal adjustments look to have skewed the reports more positively. As the seasonal factors adjust in coming weeks, we expect to see further backsliding in weekly claims data before a more sustainable decline in the rate of job shedding takes hold. More ominously, 15 US states this past week reported unemployment rates above 10% and the Fed forecast the national unemployment rate will hit 10% later this year. The rising tide of unemployment keeps the outlook for any rapid recovery extremely dim. The bright spots, such as they are, are mostly emanating from emerging markets, while the best that can be said of the mature economies is that the worst is past. The current situation, then, remains one where sentiment continues to dominate, as opposed to tangible improvement in real economies.
In this environment, we expect intermarket correlations to persist, where stronger risk appetites will drive the USD and Treasuries lower and push riskier assets like stocks, commodities, and carry trades (long cross JPY) higher. Should data disappoint, including the week's heavy slate of 2Q earnings reports, risk aversion is likely to resurface quickly, leading the USD and Treasuries to strengthen and riskier assets to decline. We'll continue to focus on stocks as the key indicator of risk sentiment, closely mirrored by moves in JPY crosses. The past week saw risky assets finish out stronger overall, but the week closed out with inconclusive daily candles. In particular, the JPY crosses posted double-doji patterns, suggesting indecision over the move higher and foreshadowing a potentially explosive resolution on Monday.
Important Price Levels to Watch
In these fickle summertime markets, we'll be watching the following key price levels:
S&P 500: All eyes are on the 950/955 recent highs. Strength above will likely ignite talk of a move up to 1000 initially, while an inverted head-and-shoulders pattern would suggest gains back to 1230 on a multi-month basis. The upside looks to be in play while above the 900/910 level.
Gold: Upside potential remains while above 927/928 cloud base, but the 940/950 area is formidable resistance. Strength above that would likely see gains try for the mythical $1,000 again.
EUR/USD: Broad 1.3750/1.4200 sideways range. Bias is higher while above the cloud top at 1.3950/60. Strength over 1.4200 will initially target recent highs at 1.4330/40, then bring 1.4500 into focus.
GBP/USD: Similarly broad 1.6000/1.6500 range. Overall, the bias is higher while above the cloud top at 1.6024. Above 1.6500, we'll need to clear rejection highs at 1.6630 to see sustained gains.
USD/JPY: The 94.50/95.00 area stands out as key resistance zone. Strength above is likely to move to the 96.90 cloud base initially, and weakness below 93.50/60 may see a re-test of recent lows at 91.70/80.
EUR/JPY: Recovered to inside the cloud while above 131.80. Cloud top is at 135.20 to start the week, but falls to 134.50 by the end of the week. Major trend line resistance from recent 139.20 highs is at 135.30.
USD/CAD: Downside potential while below the cloud bottom at 1.1171, but a daily close back above threatens a reversal higher toward the 1.1500 area initially, then to the cloud top at 1.1650/1700 area.
WTI Crude Oil: Trading inside the cloud, holding just below the 55-day SMA at 63.97, then Kijun line and cloud top at 65.85 and 66.24 are key resistance. Upside potential remains while above the cloud base at 58.50.
Expecting Verbal Intervention at BOC meeting
The Bank of Canada is scheduled to meet on rates this Tuesday and the press release is due to hit the tapes at 0900ET/1300GMT. The market is unanimous in looking for no change to the target rate of 0.25% and the bank has explicitly noted that it does not see a change to the rate until June 2010 at the earliest. So we can safely assume that no change to rates is baked in the cake. The focus will be on the press statement, however, and the bank is likely to report a more constructive outlook on the economy.
Employment, housing, and several business surveys suggest fundamental improvement of late and the members are likely to reference this. That said, they will probably remain cautiously optimistic and borrow a line from their previous statement that the recovery will be more muted than usual. The tone on inflation is likely to see little change as headline consumer prices, which lie at a -0.3% annual rate, remain well below the 2% mid-point target.
Quantitative easing is likely to get little lip service as the measures implemented thus far seem to be working. Canadian home prices rose 3.6% in June to a new record while credit markets ostensibly loosened, as evidenced by the latest senior loan officer survey. Thus, the main thing to watch for is any commentary on the recent Canadian dollar strength. The Canadian economy's resource-based nature means it needs a competitive currency to keep growth humming along. Thus the Canadian dollar's 5% rally against the US dollar from the July lows is likely to be a major talking point.
In their last communique, the bank noted concern with regards to CAD strength. To wit: "If the unprecedentedly rapid rise in the Canadian dollar proves persistent, it could fully offset these positive factors (i.e., better economic data)." USD/CAD was testing 1.0800 support that day and promptly squeezed to 1.1291 within three days and hit a 1.1639 high one month later. If past is prescient, we could be looking at a USD/CAD back into the 1.14/1.16 zone in short order. Should risk trades unwind on weaker US earnings reports, the decline in the Canadian dollar will intensify further.
MORE: BOE Minutes, UK GDP, Key Data This Week |pagebreak|
BOE Minutes May Shine Further Light on QE Outlook
The minutes of the July MPC meeting, due July 22, may shine fresh light on the BOE's position on quantitative easing (QE). No decision to extend the plan was made at the July MPC, the Bank in effect delaying any decision until August when its current tranche of asset buying will be complete. By not extending the plan in July, it appears more likely that the Bank will not announce a further extension. However, the MPC's Bean has denied that the Bank has paused on QE and has furthered the opinion that August is a more natural month for the MPC to make its next decision on QE given that its new inflation forecasts will then be prepared. UK June CPI, at 1.8% y/y, was in line with market expectation. Finally, CPI is below the BOE's 2.0% y/y inflation target. However, the "stickiness" of UK CPI on the downside could provide a reason for the BOE to be reluctant to extend QE. The release of June retail sales data on July 23 is expected to show a moderate 0.3% m/m increase, consistent with a stabilization in the UK economy during Q2.
UK Q2 GDP Report Due on July 24, Should Confirm Stabilization
The sharp downward revision to the UK Q1 GDP report posted on the last day of June revealed a contraction of -2.4% q/q and confirmed that the trough of the recession in the UK had been far deeper than had been previously been indicated. The performance of the UK economy during Q2 has clearly been better, and the pace of the downturn has apparently moderated. On July 24, the ONS will publish the first estimate of Q2 GDP data. The market consensus stands at -0.3% q/q, though this translates to a hefty -5.2% y/y contraction. Data in line with the median will scupper any lingering hopes that growth may have returned to the UK in the last quarter, but should be sufficiently improved relative to Q1 to keep alive hopes that growth may return by year end. EUR/GBP pushed sharply higher on the Q1 GDP revision on June 30 and sterling has not been able to recover all those losses since. Concerns over the UK's fiscal position, remaining fears that the BOE may yet increase its QE plans next month, and a general lack of risk appetite have left sterling on the back foot. Better-than-expected GDP data could push EUR/GBP back to its recent low in the EUR/GBP0.8530 area, but we would expect EUR buyers to emerge on dips for a move back to the EUR/GBP0.8700 recent high.
Key Data and Events to Watch This Week
The US data calendar is on the light side, but important events loom nonetheless. The highlight of the week comes Tuesday with Fed chairman Bernanke giving his semi-annual economic testimony before the House (same before the Senate on Wednesday). Monday has the index of leading economic indicators, while Wednesday has weekly crude oil inventories. Initial jobless claims and existing home sales are due Thursday, while Friday has the University of Michigan consumer sentiment index. Keep in mind that 147 S&P 500 companies are scheduled to report earnings this week, so despite a relatively light week for data, the price action should still heat up.
It is a modest week in the euro zone as well. Monday kicks it off with German producer prices, Wednesday has euro zone industrial new orders and French consumer spending, and Thursday sees the euro zone current account and French business confidence. Friday rounds out the week with the euro zone PMI composite (manufacturing and services) and the German IFO surveys of business conditions.
The UK sees a pretty typical week. More home price data is on the docket with the Rightmove figures due up on Sunday. Monday sees the Bank of England's "Trends in Lending" report, while Wednesday has the BOE meeting minutes lined up. The highlight Thursday is the retail sales report, while Friday ends the week with GDP and the index of services.
It is very light in Japan. Nationwide department store sales are due up Tuesday. The trade numbers are the highlight for the week on Wednesday, while Friday closes things out with the all industry activity index.
Canada sees a characteristically light, but important week for data. International capital flows and wholesale sales start the action on Monday. The Bank of Canada rate decision is the highlight of the week on Tuesday (analysis above). Wednesday has retail sales on tap, while Thursday brings the Bank of Canada monetary policy report.
It is a relatively quiet one down under. Sunday has the New Zealand performance of services index, Monday brings Australian producer prices, and Tuesday sees the RBA meeting minutes and New Zealand credit card spending. Australian consumer prices close the week out on Wednesday.
By Brian Dolan, chief currency strategist, FOREX.com
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