The Fed’s future path still seems more bullish than the European Central Bank. If so, the yiel...
The Forex Trading Week Ahead
04/26/2010 11:01 am EST
Last Friday's selloff in risky assets suggested this past week might see a broader correction lower in risk, but it only lasted a few hours at the start of this past week. Markets quickly shrugged off the fraud indictment of a US investment bank and took some solace in ongoing US corporate earnings surprises (more below). Greece’s funding concerns weighed on the EUR and risk appetites most of this past week, but news on Friday that Greece has requested access to the EU/IMF loan package has allowed a mild relief rally to unfold. Whereas last week, risky assets (stock, commodities, JPY crosses) finished out at the bottom of recent ranges, this past week sees them closing nearer to recent range highs. The key word here is “range,” and we're still stuck in them. The most puzzling development of this past week is not that we're back at recent range highs, but that we're not above them.
Incoming economic data has mostly been surprising to the upside (e.g. better ZEW, euro zone PMI's, IFO, US durable goods and housing reports) and would seem to suggest the global recovery is gaining momentum, which should have seen risk assets test higher. That's the dog that isn't barking. Perhaps we're just impatient and the market needs more time to digest recent news before the risk rally can extend, but it certainly feels as though markets are at a critical inflection point. In last week's update, we outlined many of the market internals that supported a correction lower in risk, and those factors may still see that downside scenario play out. In light of this week's developments, though, we have to focus on the upside potential for risk trades, and we will be ever mindful of recent range highs (especially USD/JPY 95.00, AUD/JPY 87.50, and S&P 500 1227 61.8% retracement).
Looking ahead to this week, talk is that a deal may be struck as soon as the weekend among US lawmakers hashing out financial regulatory reform. US banks don't seem to be in line for serious punishment, at least not according to the KBW bank index, which is set to close at its highest level yet in the current rally. Details of any financial regulation deal will be important, so we'll stay flexible on this. Also likely over the weekend will be loads of Greece-supportive comments coming from G-20/IMF/World Bank officials meeting in Washington. As of Friday's close, Greek CDS's (and other euro zone peripheral nations) show little sign of buying into the rescue package as the end of the funding concerns, so we're also wary about the bounce in EUR (more below). We don't expect any material changes from the Fed when they release their statement on Wednesday. On Friday, markets seemed to latch onto talk that the Fed might begin selling some balance sheet assets in the near future, sending US Treasuries lower and yields higher, supporting USD/JPY. However, we don't think any asset sales are imminent in light of recent Bernanke comments suggesting he thinks the Fed's balance sheet holdings are appropriate. As always, we'll be alert for any additional credit tightening moves out of China. Lastly, this week will be month end, and we fully expect the usual disjointed moves around the month-end fixings. Overall, with US stocks having gained for the month, USD selling is likely to be dominant as asset managers rebalance currency hedges.
Weaker Q1 GDP May Give the Tory Party and GBP a Short-Term Boost
At just +0.2% q/q, UK Q1 GDP expanded at only half the expected pace. Unsurprisingly, the data knocked sterling lower. It will also have knocked the spirits of the incumbent Labour government, which has been spinning the line that its careful management has helped steer from the worst recession in living memory. Opinion polls released earlier in the week indicated that the preferred election outcome—as far as the market was concerned—was for a majority government of any persuasion. If the poor GDP data help the Tory party extend its lead in the weekend opinion polls, then sterling could regain its losses. Exit polls following the latest televised debate from the leaders of the three main political parties imply that the Tory's Cameron and the Lib Dem's Clegg both performed equally well. Overall, polls suggest while more people appear likely to vote for the Tory party on May 6, the surge in popularity of Clegg over the past week means that the election could be a three-horse race. While a hung parliament would not be a surprise for the market, fears that this would lead to more inter-government bickering, which could delay action on budget deficit reduction, would reduce the chances of a significant and sustained sterling recovery this year.
NEXT: New Phase in Greek Debt Crisis, US Corporate Earnings Continue|pagebreak|
Greece Enters the Next Phase of its Funding Crisis
Greece has entered into the next phase of its funding crisis and admitted that it needs to accept loans from the EU and the IMF in order to avoid default in the coming months. The markets initially warmed to the announcement that the Greek government had given up pretending that it could still sell its debt on the open market. However, since Greek bond yields had several weeks ago risen above levels at which the government could realistically afford to issue, Greece's decision was inevitable. It is also nothing to celebrate. The risk of default this year had been effectively cancelled out earlier in the month when the EU made it clear that funds were on offer. The risk of default next year or after the next recession can only be cancelled out when Greece can prove that it can live within its means. This week, the EU warned that the 2009 budget deficit could be as large as 14% of GDP. With this in mind, the fear of the Greek people is that more austerity measures will be piled on top of those that have already been announced. The civil unrest that has been sparked by these austerity measures suggests that there is still a risk that Greece will be unable to tolerate further budget-slashing measures. This implies that the risk of default may merely be delayed. While official rhetoric continues to suggest that default or an exit from EMU (and a competitive devaluation) are not on the table, the market is likely to stay skeptical until such time that the Greek budget deficit begins to show signs of improvement. Insofar as budget reform is a lengthy process, downside pressure on the EUR could persist for months. Pressure on the EUR may also appear from other parts of the EMU. The Irish government announced a blood-curdling austerity budget at the end of last year that involved 20% pay cuts for some public sector workers. The Irish will now be asked to contribute to the Greek bailout, as will Portugal and Spain. Germany may have an opportunity to express its sentiments on Chancellor Merkel's recent caving in on the topic of EMU bailout at the May 9 regional elections. Given prospects for only weak growth in EMU this year, the risk of disgruntlement on the topic of the Greece aid is high. EUR/USD may still have a long way to fall.
US Corporate Earnings Well Ahead of Expectations
This past week was a busy one for US earnings reports. We have now seen just about 30% of the S&P 500 report 1Q 2010 results and the outcomes remain encouraging. Bottom-line earnings (the well advertised EPS numbers) are coming in 22% above the consensus estimates and 48% higher than 1Q09 to boot. This compares with a beat of roughly 5% for the 4Q 2009 reporting period when earnings rose nearly 100% from the financial crisis-driven 4Q 2008 period.
More importantly is the fact that sales numbers (or top-line results) have come in 3% higher than what the market had anticipated. This includes an 8% beat for the financial sector, where just about half of the 76 companies have reported. This semblance of organic growth dovetails with what we saw in 4Q 2009 when sales beat by about 1.5% after a few very difficult quarters.
The positive earnings results along with what was another very strong durable goods report (the core business spending number that feeds into GDP was up 4% on the month) suggest businesses will continue to add a considerable amount to US economic growth. The better tone to business spending should continue to put downward pressure on the unemployment rate as employers look to add jobs in order to take the pressure off of the current workforce, which has ratcheted up productivity to a near 6% annual rate! In the near term, these trends should continue to drive equity markets and interest rates higher.
The areas investors would do well to be in should 2010 correlations remain intact are long both AUD/JPY and CAD/JPY. Both have moved about 95% of the time with equities and 85% of time with US rates. CAD/JPY looks to have formed a nice inverted head and shoulders on the four-hour charts, and we will look for a break north of 94 to elicit considerable upside here. Meanwhile, AUD/JPY continues to find formidable resistance into 87.50, and thus, we will look for a break through there before becoming overly optimistic.
MORE: Key Data and Events to Watch This Week|pagebreak|
Key Data and Events to Watch This Week
The calendar in the United States kicks off with the Case-Shiller home price index and consumer confidence on Tuesday. Wednesday is the highlight of the week with the FOMC rate decision and press statement. We expect the Fed to stand pat on rates, but the potential for a shift in the statement is non-trivial. The usual initial jobless claims numbers are due Thursday, while the first cut of 1Q GDP, Chicago PMI, and the University of Michigan confidence index are due Friday.
The data flow slows down in the euro zone next week, but keep in mind that headline risk with regards to the Greek bailout could be quite prevalent. Tuesday kicks it off with French consumer confidence, German GfK confidence, and German import prices. German CPI is due on Wednesday, while Thursday brings euro zone consumer confidence and German employment. Euro zone employment and French PPI round out the week on Friday.
It is extremely light in the UK next week with home loans on Tuesday and consumer confidence on Thursday the only noteworthy releases.
Japan has a busier-than-usual week ahead. Tuesday starts the week with retail trade. On Thursday, we'll see manufacturing PMI, employment, consumer prices, and industrial production. Friday closes out the week with the BoJ rate decision and housing starts.
Canada is characteristically light. Home prices are up on Wednesday, while monthly GDP is due Friday. Look for BOC Governor Carney to speak on Thursday as well.
It is pretty busy down under. Australia sees PPI and business confidence on Tuesday, CPI on Wednesday, leading indicators on Thursday, and new home sales on Friday. The highlight in New Zealand is the RBNZ rate decision on Wednesday. The bank is expected to leave rates on hold at 2.5% until its July meeting.
By Brian Dolan, chief currency strategist, FOREX.com
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