Has the Risk Rally Finally Turned?
10/05/2009 10:53 am EST
The short answer to that is a definitive, unequivocal "maybe." The first day
of October saw risk assets take a beating for apparently no good reason. True,
weekly US jobless claims rose and the ISM manufacturing index disappointed, but
we knew from the Chicago PMI that ISM was likely to be weaker, and the jobless
claims was not a major jump. Complicating matters further, we had
month/quarter-end to contend with the day before and September NFP the day after
October 1. Overall, though, we are left with the impression that October has
begun on an inauspicious note for risk appetites and risky assets, such as
stocks and commodities. If so, we could see further USD strength and potential
signal that a multi-week USD low was seen a few weeks ago.
The primary reason for our hesitation is the price action on Friday, and here we run the risk of attaching too much significance to post-NFP market reaction, which frequently reverses itself in the ensuing days. But Friday's price action generated a number of hammers on daily candlesticks, frequently a sign of a bullish reversal after a decline. Hammers are evident in daily EUR/USD, AUD/USD, GBP/USD, and to a lesser extent, in the S&P 500, XAU/USD (gold) and XAG/USD (silver). Ten-year US Treasury yields also posted a daily hammer, suggesting yields have hit bottom, which would normally be USD supportive, most so against the JPY. Spinning tops and doji, both signs of indecision and a potential early signal of a directional reversal, are evident in the USD index, USD/JPY, NZD/USD, and USD/CAD. If correct, those candles would suggest that the recent risk pullback may be at an end. But if Friday's price action was nothing more than an NFP chop-fest, then we may be looking at a more significant decline ahead in risk assets and a further rebound in the USD. Another encouraging sign for the USD is that several key pairs closed below the 21-day simple moving averages (SMA) (EUR/USD, AUD/USD, and GBP/USD), which hasn't happened since the dollar broke down around September 8.
In terms of restraining our risk bearishness, it's also important to note that important range levels were tested and held this past week. Until they do break, we have to reckon with additional range-bound consolidation and continued choppy trading. To highlight potential risk breakdown levels, in EUR/USD, we and the market are keenly watching the 1.4450/4500 support, in GBP/USD 1.5750/80, AUD/USD 0.8550/70, S&P 500 1000/1010, gold 980/990, silver 15.70/80, and BCO/USD $64.00/bbl. In other pairs, the risk breakdown triggers are key resistance levels: USD/CAD 1.1000, USD/JPY 90.50/91.00, and USD/CHF 1.0450/1.0500. Should those levels break on a daily closing basis, we will become much more convinced of a deeper pullback in risk markets and a general move higher in the USD. Since we believe it's a USD-driven move at the moment, we would be cautious on trading the JPY crosses to express a "risk-off" view.
Finally, to symbolize our frustration with the lack of clarity in markets at the moment, we'll leave you with a favorite riddle to ponder. "When is a hat not a hat?" Answer next week.
Weekend Event Risk: G7 Meeting/Irish EU Vote Update Coming
This Saturday sees two key events that may unleash sharp moves in FX, mostly for the EUR and USD. The first is the G7 finance ministers meeting taking place in Istanbul, where the group is expected to issue its communique on Saturday afternoon. USD weakness is a concern for many in the group, with the European contingent leading the way in vocalizing opposition to EUR strength/USD weakness (Trichet, Lagarde, Almunia, and Juncker). Canadian finance minister Flaherty has also openly expressed worries over USD weakness/CAD strength, and indicated that the Australians, though not in the G, are concerned too. However, as of late Friday afternoon, the latest word from G7 sources is that the G7 communique will contain only the standard FX language, like "excessive currency volatility is undesirable for growth." If true, the market could interpret that as meaning the US tacitly favors a weaker USD and there is no consensus to act in the market, giving dollar bears another reason to pounce on the greenback. We would expect recent USD lows to subsequently be tested. On the other hand, if the G7 modifies the FX statement at all, it could very well signal a significant turning point for the USD, and we would expect the key range levels outlined above to be broken and a sharp USD rally to ensue.
NEXT: Market-Moving News Coming Soon in Euro Zone?
EU Referendum Could See Significant EUR/USD Volatility
On Friday, the Irish are voting on whether to ratify the EU constitution, known as the Treaty of Lisbon, with results expected to be released on Saturday. In June of last year, just over 50% of Irish voters rejected the Lisbon Treaty (which would increase the clout of the European Parliament in legal matters and make way for an EU presidency). The market is probably priced for ratification as recent opinion polls suggest that this time around, Ireland will vote "yes." Thus, the upside to EUR/USD is likely a bit more limited than the downside from a "no" vote. However, at this point, the polls also suggest that the results are too close to call (most recent polls show between 48% and 55% of Irish voters favor approval of the treaty), so it's impossible to rule out that the referendum will get voted down again. The "no" vote in 2008 was worth about -200 pips in EUR/USD, but given the high expectations this time for the referendum to pass, we have to think we could see more downside than that. If the referendum is rejected, it will be as much a protest vote against the Cowan government as it would be against greater union with Europe.
Bank of England and ECB Previews
Both the ECB and the BoE are due to announce policy on October 8. The ECB is expecting to keep policy on hold and make no alterations to its general accommodative stance with respect to "exceptional" policy measures this month. Last week saw the ECB's second 12-month tender. Compared with the first 12-month auction, demand was surprisingly light, resulting in EUR72.2 billion being allotted. President Trichet will likely make reference to improvement in health of the banking sector implied by the muted demand at the 12-month action. He will also likely make reference to the improvement in recent euro zone economic data, but he is set to retain his cautious tone on the outlook for the euro zone recovery. Of particular interest is whether Trichet will make any reference to the relative strength of the EUR. By recently underpinning his support for the US Treasury's strong USD policy, Trichet has hinted that he is worried about the impact of the EUR on the euro zone recovery. Trichet may remain reluctant to make a bolder statement with respect to the EUR, however, he may suggest that EUR strength has acted as a dampener on inflation or export potential. This could inhibit the ability of the EUR to move higher ahead of Thursday's meeting. That said, a "yes" vote in the Irish referendum on the Lisbon Treaty could enhance to perception of coherence within the EU and lend a little support to the EUR.
Sterling could see additional pressure in the run up to the October 8 policy meeting. The market is comfortable with the idea that no firm consideration will be given to QE until November insofar as this will coincide with the next Quarterly Inflation Report. Speculation that October could bring a cut in the interest rate paid by the BoE on commercial bank reserves held at the bank have also been pared back, although remaining rate cut fears coupled with fear that comments from governor King may again batter the pound are likely to keep sterling on the defensive.
The highlight of European data calendar will be the service sector September PMIs. These are generally expected to show further improvement. The UK data will be most keenly watched given the disappointing outcome of the UK manufacturing PMI data. Poor UK PMI or another weak set of data from the manufacturing sector have the potential to knock back sterling again. Technically, EUR/GBP remains in an uptrend. Given the swings in cable caused by changes in risk appetite, EUR/GBP offers a cleaner way to express short GBP position. Alternatively, momentum in the hourly GBP/AUD chart is looking extended suggesting an opportunity for a short GBP position.
MORE: US Job Losses, Key Data to Watch This Week
US Continues to Be Plagued by Job Losses
Not only did payrolls drop a massive -263K for the month of September-which was about -100K below consensus when you tack on the back month revisions-but the real takeaway is that employers also cut hours a further -0.3% on the month. Empirically, hours lead bodies, and for now, the trend remains decidedly lower. The annual rate for aggregate hours worked is at the cycle low -7% and the weakest since data go back-all the way to 1965. This confirms what the initial jobless claims have been telling us (latest print 551K), and that is that jobs continue to bleed at a rapid clip.
The BLS (Bureau of Labor Statistics) also released preliminary results of its annual benchmark revision for the period of April 2008 through March 2009. Total employment was revised down a massive -824K, with -855K coming in the private sector. While true that this is backward-looking data, it highlights just how wrong the initial BLS estimates of monthly employment had been. In other words, the government had been extremely overestimating payrolls. It is not out of the question that they are once again underestimating losses, and the back-month revisions month in and month out certainly suggest that.
The evidence says that we will continue to see significant NFP declines into the end of the year and double-digit unemployment sooner rather than later. From a "risk off" perspective, this is USD positive, as the buck has seen a -94% correlation with stocks all year. However, buyers beware, as this doesn't exactly paint a rosy picture for the US economy going forward! Should Europe not show a similar relapse in economic data over the next few weeks, we would expect EUR to continue to outperform in the near-term.
Key Data and Events to Watch This Week
The action lightens up in the US this week. ISM non-manufacturing kicks off the action on Monday, while consumer credit is up on Wednesday. Thursday is the highlight with the weekly jobless claims and wholesale inventories due. Friday rounds out the week with the trade balance.
The euro zone is touch busier with PMI services and retail sales up on Monday. Euro zone GDP and German factory orders are up Wednesday, while Thursday has French business sentiment, French trade, German industrial production, and the ECB rate meeting. Friday sees German trade, German consumer prices, and French industrial production.
It is also busy in the UK. PMI services start off the week on Monday, while industrial production and consumer confidence are up on Tuesday. The BOE interest rate meeting on Thursday is the highlight for the week, while Friday has producer prices and international trade on deck.
Japan is on the lighter side. The economic leading index, current account, and trade balance all kick it off on Wednesday. Machine tool orders close out the week on Friday.
Canada has some top-tier data lined up. Building permits and the Ivey purchasing managers index are due on Tuesday, while housing starts are scheduled for Thursday. The highlight comes Friday with the all-important employment report and international trade. Look for the BOC senior loan officer survey out on Friday as well.
It is an important week down under too. The RBA rate meeting is Monday, and the market anticipates that the bank is poised to be one of the first to raise interest rates before the year ends. While no change is expected this time, we will be looking for hints on potential future hikes. Monday also sees the New Zealand NZIER business opinion survey. Australian home loan data is up Tuesday, while the Australian employment report is scheduled for Wednesday.
By Brian Dolan, chief currency strategist, FOREX.com