The Fed’s future path still seems more bullish than the European Central Bank. If so, the yiel...
The Week Ahead in Forex Trading
09/08/2009 10:36 am EST
In a nutshell, we're looking for the intermarket correlations that have prevailed throughout 2009, but broke down into the latter part of the summer, to resume. We saw some of this in the first week of September, with higher EUR correlating with higher stocks and commodity currencies. The market seems to be in the process of putting in a short-term top as better-than-expected economic data of late have failed to elicit any material extension in equities. The more than 50% rally off the lows in the S&P is unsustainable, in our view, and we would expect a China-like correction in US stocks in the weeks ahead. If past is prescient, developed equity marts will follow Chinese equities much in the same fashion as the prior leg down from the 2007 highs-when China was ahead of other marts by about five months. China has dropped about -20% from the August highs and the recent government-induced pop notwithstanding, this translates to about a -10% correction in US marts, or about 930 on the S&P.
With this in mind, we expect the US dollar to be the main beneficiary of the unwind in risk as per the strong negative correlation the buck has enjoyed with stocks all year. Our near-term caution stems from the fact that we believe the budding recovery in the US will not be as robust as many expect. Until we get the employment situation under control (the four-week moving average in claims just ticked up last week), we will not be able to drive consumer spending or the economy in any sustainable fashion. Given that consumer spending accounts for about 70% of the US economy and is the driver of corporate earnings, the ramifications for stock valuations could be detrimental indeed. Should analysts begin to ratchet down earnings estimates, stock prices will undoubtedly follow lower. On the currency front, this translates into weaker yen crosses and commodity currencies. In other words, selling AUD/USD, EUR/USD, and the yen crosses on strength, while buying USD/CAD on weakness is a strategy that makes sense in the short term.
Long-Term CAD Fundamentals Positive
Long term, we remain cautious about the robustness of the US economic recovery and think Canada will be on much better footing than the States. US growth right now is being supported in a big way by government largesse in the form of first-time homebuyer rebates, cash for clunkers, and the slow drip from the $787 billion fiscal stimulus that should see more projects come on line as the year closes out. Canada has seen nowhere near the government intervention the US has, and the economy there has pretty much held its own throughout the crisis. This was very evident in the booming Canadian employment and PMI numbers out last week. We think once these long-term shortcomings in the US economy become more evident, Canada will be an even stronger relative investment choice and we would not be surprised to see the USD/CAD pair trade back at parity sometime in early 2010. For the longer-term players, any short-term reversal up into the 1.15/1.20 area looks like a good opportunity to establish shorts, in our view.
G-20 Likely to See More Talk Than Action
We expect the meeting of the G-20 finance ministers to be mostly a non-event over the weekend and would advise that any knee-jerk reaction to headlines when markets open Sunday should be taken with a grain of salt. First of all, currencies are very unlikely to be discussed and many officials have said as much. In the midst of a nascent global economic recovery, officials will be hard-pressed to pick winners and losers in the currency space given the risk of potentially destabilizing the system. Talk-and indeed action-with regards to diversifying away from the US dollar will only commence in earnest once the global economy is on good footing, which we think is still a ways away.
The topic du jour is likely to be pay restrictions for financial institutions. European leaders have recently noted their intention to discuss pay regulations and sanctions against banks that refuse to take part. While consensus on this front would be a potential negative for stocks (especially financials) and the yen crosses, it looks as if it will be more political grandstanding than anything. The US and Canada have both voiced reservations with regards to such policies and Treasury secretary Geithner himself said that this confab will not establish any new initiatives.
Talk about exit strategies has also been rife, but we expect little traction on this front as well. While commentary from UK officials that the G-20 will seek a coordinated stimulus exit, recent musings suggest most of the world believes it is too soon. Most recently, ECB president Trichet stated it is way too early to discuss exit strategies, and many other officials have echoed this viewpoint. Overall, we expect the meeting to be a non-event and look for any potential knee-jerk moves to be quickly unwound.
NEXT: BOE Policy Meeting, Important Euro Zone Data |pagebreak|
Bank of England Set to Stay Cautious
It should surprise no one if the overwhelming tone of the Bank of England's September policy meeting is steeped in caution. Last month's decision by the Bank to increase the size of the asset purchase program by GBP 50 billion came as a surprise, but the market has subsequently become more resigned to cautious rhetoric from most other central banks. Despite recognizing the improvements in the global economic backdrop, central bankers continue to foresee a number of substantial risks.
Not only that, but disappointing UK GDP data have enhanced the view that the recovery in the UK is lagging that in North America and in the euro zone. Even though Germany and France both managed to grow by +0.3% q/q in Q2, ECB president Trichet has warned that the recovery could be bumpy. Also, the minutes of the August 12 FOMC have highlighted that the Fed remains concerned with the negative impact of rising joblessness on household consumption. Even the RBA (where growth reached +0.6% q/q in Q2) has disappointed the hawks by underpinning the view that rates are still seen as appropriate.
While it will be interesting to see to what degree the Bank recognizes the improvement in the economic backdrop, there is little chance that it will signal anything other than accommodative policy over the coming months. Providing additional color to the UK economic backdrop in the week ahead will be production and trade data, the BRC retail survey and RICS and Halifax house price surveys. Given that sterling is still generally viewed as undervalued versus the EUR, good economic data should provide some incentive for EUR/GBP to push lower. Below 0.8700, initial target is 0.8670. Very strong support waits at 0.8500.
German Export Data Should Show Signs of Improvement
The German trade data will be one of the most interesting pieces of economic news released in the euro zone in the week ahead. The German economy is heavily export-dependent. Relative to last year, both exports and the foreign trade balance remain significantly lower. While there has been some moderation in the pace of these y/y declines, there is still sufficient weakness in these data to question the sustainability of Germany's economic recovery going forward. While stronger-than-expected data may help support the EUR, any gains should be moderated by the fact that the ECB has made it clear that there is unlikely to be any change in its loose policy in the months ahead.
By Brian Dolan, chief currency strategist, FOREX.com
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