The Fed’s future path still seems more bullish than the European Central Bank. If so, the yiel...
Risky Forex Assets May Come Under Increasing Pressure, but...
08/17/2009 10:09 am EST
The USD finished out this past week virtually unchanged from week-ago levels against most other currencies, excluding the JPY. To be sure, there was healthy intra-week volatility in most USD pairs, but the key takeaway is probably that the USD rebound following last Friday's July NFP report was largely sustained, adding further weight to the idea that the USD has made a significant medium-term low. The other prominent result of the week is a more decisive turn lower in many of the so-called risky assets. USD/JPY most clearly surrendered all of its post-NFP gains and continues to trade in near lock-step with US Treasury yields, which also gave back the bulk of their gains from last week. With the USD unchanged against most others, but down sharply against the JPY, the carry trades (JPY crosses) have posted bearish engulfing patterns on the weekly candlestick charts, which typically warns of further losses ahead. Outside of FX, stocks continue to stall below key Fibonacci resistance at 1015/1020 in the S&P 500, while oil also looks to have more decisively given up on attempts to extend gains beyond the year's highs around $73.00/50. The recent strength in gold prices also looks to be losing steam after having topped out below key technical resistance in the $975-$980/oz. area. Overall though, FX and many other assets remain trapped in recent ranges.
Some of the pullback in risk appetites is certainly due to exhaustion, with recent gains unable to extend without a more compelling case of an imminent rebound in economic activity. Increasingly, the view is spreading that all the good news is priced in, and as we've been suggesting over the past few weeks, valuations are getting rich. Faltering economic data, particularly on the consumer front (weaker retail sales, uptick in four-week avg. of initial claims, and the drop in Univ. of Michigan Aug. sentiment), don't help the case for fresh near-term gains. On balance, the risks appear increasingly tilted toward a period of profit taking, potentially leading toward a more serious setback for risky assets. In FX, we think the USD has room to extend gains against all except the JPY, which will likely remain captive to fluctuations in Treasury yields. There, we continue to anticipate that yields will not go much lower than 3.40%-3.45% in ten-year notes, and that suggests USD/JPY is unlikely to see much lower than about 93/94. In anticipation of higher rates in the months ahead, we continue to look for opportunities to buy USD/JPY on weakness in the 92/95 area. In other USD pairs, the USD is still trading in the lower half of recent ranges, and we think there is near-term potential for the buck to trade into the upper half of those ranges. That suggests potential for EUR/USD to drop under 1.40 and move to 1.37; GBP/USD under 1.65 toward 1.60; AUD/USD below 0.82 toward 0.78; and USD/CAD above 1.11 toward 1.15. S&P 500 below 970/980 would be the likely coincident catalyst for such a shift higher in the USD.
That's What We've Been Waiting for
Perhaps ironically, the seemingly impending risk relapse would come just as developments on the ground are about to get appreciably better. The risk here is that we underestimate the degree to which good news is already priced in, and therefore, we might also underestimate the extent of the potential pullback. But for most of the summer we have been suggesting that the massive run-up in risk assets (stocks, commodities, and JPY crosses) was premature, and as it wore on, increasingly overextended. We have consistently been expecting a more substantial improvement in economic activity in the late 3Q/early 4Q and were hopeful we might have a correction lower in risk assets before then to establish long positions at more advantageous levels. Unfortunately, markets have not cooperated with our view and the window of opportunity for a pullback is increasingly narrow. It may be that markets are indeed lagging, responding only now to faltering early 3Q data, and may relapse in time to get long risk before improving late 3Q/early 4Q data begins to hit, most likely initially only in late September and early October. From a longer-term strategic perspective, we will look to exploit such pullbacks to build long risk positions in anticipation of more sustainable economic improvement into the end of the year, which may only materialize in data reports in late September and early October, at the earliest.
BoE Minutes Due August 19; Not Much Room for Surprises
The presentation of the quarterly inflation report on August 12 has sapped the potential for surprises from the minutes of the BoE policy meeting. BoE governor Mervyn King has already made clear the bank's view that the pace of the recovery remains highly uncertain, with inflation more likely to be below the bank's 2% target over the medium term, rather than above it. On this view of inflation, there would appear little chance of any adjustment in interest rates for many months to come. The release of July CPI on August 18 is expected to show a -0.3% m/m fall, bringing the headline rate to 1.5% y/y. This would be only the second consecutive month where inflation has been below target. Nevertheless, data in line with expectations would be in line with the bank's prediction that price pressures will fall significantly in the coming months. Rightmove housing market data and retail sales will be barometers of the general health of the economy and may show further signs of stabilization. By contrast, the July PSNCR data will give a reading on the poor condition of government finances in July. The latter is likely to sour the ability of sterling to benefit from an improvement on consumer-related data.
Germany and France Grow in Q2, but PMI Still Showing Contraction
The EUR has benefitted from the news that both Germany and France managed to grow during Q2. The news is likely to heighten interest in forthcoming PMI data, which to date have remained below the key 50 level for both the manufacturing and services sectors in Germany, France, and the euro zone. Further improvement will be needed to sustain hopes for continued recovery in the latter half of the year. Also due is the German ZEW survey, which can be expected to show an improvement on the recent improved German economic data and following the rallies in stock indices. Euro zone trade data is unlikely to impact the market, but signs of improving export performance could strengthen recovery hopes and the EUR. Barring a negative shock in the PMI, the EUR is likely to remain a better bid. Given the contrasting performance of Q2 GDP data for the UK and euro zone, and barring any negative surprise from the euro zone PMIs, EUR/GBP should maintain an upward bias in the near term. Expect resistance in the 0.8680/90 area. A break above could see gains extended.
NEXT: Key Data and Events to Watch This Week |pagebreak|
It's a relatively light summer data week all around this week.
US data starts off on Monday with the NY Fed's August empire manufacturing index and the June TIC report in the morning, followed by the August NAHB housing market index in the afternoon. Tuesday sees July PPI and housing starts/building permits. Only weekly mortgage applications are out on Wednesday. Thursday sees weekly jobless claims, July leading indicators, and the August Philadelphia Fed index. Friday wraps up with July existing home sales.
Euro zone data begins with the June trade balance, due out on Monday. Tuesday sees the August German and euro zone ZEW sentiment surveys. Wednesday sees July German PPI and June euro zone current account and construction output. Thursday has only Belgian August consumer confidence of note. Friday concludes with August preliminary EC PMI's for the manufacturing and service sectors in France, Germany, and the euro zone as a whole.
UK data begins with August Rightmove house prices at midnight Sunday (local UK time). Tuesday sees July CPI/RPI reports. Wednesday has the release of the BOE MPC minutes and August CBI industrial trends total orders. Thursday ends the UK data week with July retail sales and the July Public Sector Net Borrowing Requirement.
Japanese 2Q GDP data, released on Sunday, may be the highlight for the week in Tokyo. Tuesday afternoon sees the final June leading index and July department store sales. Wednesday will see the June All-Industry Activity Index and final July machine tool orders.
Canadian data starts on Tuesday with June international securities transactions data, followed by July CPI and leading indicators reports on Wednesday, and wraps up with June wholesale sales on Thursday.
Australian economic releases include the RBA minutes on Tuesday afternoon, followed by a speech from RBA assistant governor Edey on Wednesday morning, and the June Westpac leading index that afternoon. NZ data starts with the July Performance of Services Index on Monday morning, 2Q producer prices on Wednesday morning, and July credit card spending on Friday.
By Brian Dolan, chief currency strategist, FOREX.com
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