The Fed’s future path still seems more bullish than the European Central Bank. If so, the yiel...
The Forex Trading Week Ahead
06/28/2010 10:20 am EST
US housing data in the past week revealed the extent of the artificial and temporary support provided to the US housing market by the homebuyer tax credits. The data had been expected to show decent gains on a final flurry of home closings before the end of the June deadline to close, but the sharp declines showed that many homebuyers were unable to secure financing. Housing data is only expected to deteriorate from here on out, as an extension of the tax incentive program seems highly unlikely in the current deficit-reduction environment. Given the still-high levels of foreclosures and underwater mortgages, as well as a large “shadow inventory” (homes that would be on the market if conditions were better), it appears US housing is about to see a double-dip decline. The implications for household spending are quite ominous, as the wealth effect of deflated home values and still-depressed stock market portfolios generate a negative feedback loop to consumption. Add in still-high unemployment levels (and the failure to extend unemployment benefits due to deficit concerns), and we have another negative feedback loop undermining US consumption. Together, these threaten to see the US recovery falter sooner than we expected, which has also altered our view on the broader global recovery.
Up until about a month ago, two of the three global economic regions (North America and Asia) were experiencing solid improvement (Europe is the laggard third), enabling the global recovery to continue. Now that the US appears set to slow more severely into the end of the year, two of the three pillars of the global recovery are now set to underperform, suggesting a more serious headwind to the global rebound. Looking ahead, G20 economies are moving more resolutely toward fiscal austerity measures. Despite anticipated lame proclamations out of Toronto's G20 conclave this weekend that governments will seek to balance growth with fiscal restraint, the outlook for 2011 just got more anemic. Coupled with ongoing credit/debt concerns out of Europe (see below), risk sentiment may be set for a more severe decline in the weeks ahead.
Looking for Another Slide in Risk Assets
Safe-haven assets are clearly showing signs of these strains, with US Treasuries at their highs/yields at their lows for the year, gold on its highs, and LIBOR elevated. But several anomalies appear as well, most obviously that the US dollar is not stronger and that commodities are not weaker. We expect that to change in coming weeks and will continue to look for opportunities to buy USD on weakness, sell AUD, CAD, EUR, and GBP on strength, as well as looking to sell JPY crosses on rebounds. As to why the USD is not stronger in this environment, it appears to be the result of core “risk-on” positioning being forced out. For example, this past week saw major short squeezes in core short EUR and GBP positions against AUD and CAD, in particular. These were the “no-brainer” trades of the year and were consequently heavily populated. We last saw such a short squeeze phenomenon back in mid May as stocks' declines accelerated, and we think it augurs poorly for risk trades ahead. Lastly, we would note a bearish engulfing line on the weekly S&P 500 candlestick charts, which suggest the June rebound has just ended. We will be monitoring shares for an eventual return to the 1035/1040 S&P lows and anticipate a break lower in the weeks ahead.
This week brings month end and quarter end, along with the usual volatility and chaotic price action, which may only be aggravated by World Cup distractions. In terms of data, US June employment will be the focal point at the end of the week (and if private payrolls come in around the weak +110K, it should not be pretty), but the Chicago PMI, ISM, and consumer confidence will also be important.
Sterling Reacts Well to Budget
Sterling reacted well to the austere budget profiled by the new coalition government. The budget deficit is forecast to fall from 10.1% of GDP this year to 1.1% of GDP in the full year 2015-2016. Credit rating companies were quick to reaffirm the UK's rating on this news; last year's threat from S&P of a potential downgrade having been sunk by these projections. This has re-inspired investor confidence in the UK markets, although it remains to be seen how accurate the government's projections will be and whether or not the threat of austerity will result in widespread labour unrest, which could tarnish the outlook for the pound. The debate as to whether the budget will send the UK economy back into recession continues to rage, but given that many of the budget measures do not come into force until 2011, the full impact of the budget will not be known for years. The forthcoming release of UK June PMI manufacturing and Gfk consumer confidence will provide an interesting gauge on economic conditions at present. Some disappointments this week in European confidence indices have reined in expectations with respect to this release, and poor data could weigh on the pound. That said, fears about the level of non-performing debt in European banks threatens to underpin risk aversion will could undermine the EUR and lead to further downside in EUR/GBP. Assuming the EUR/GBP 0.8275 area continues to cap, technical bias remains on the downside towards the recent low near 0.8175, with a break below that level targeting further weakness toward 0.8000.
Banking Sector Fears Set to Keep the EUR Nervous
Investors continue to smart over fears that further non-performing loans could be uncovered in the European banking sector in the months ahead. Banking sector stress tests for some countries may be published in September, though Austria has now announced that it will not be issuing the results of any stress tests on its banks. Earlier this week, the President of the Banque de France, Noyer, warned that some banks (in Europe) were already having difficulties raising capital. This was followed by reports suggesting that some banks in Greece, Ireland, Portugal, and Spain were particularly reliant on the ECB for capital. Given that the ECB's 12-month EUR442 billion loan is due to expire, nervousness may rise some more.
Tension in the interbank market continues to be described by the elevated position of LIBOR. More broad-based concerns surrounding debt defaults have been reflected in further widening in the sovereign yield spreads of Spanish, Portuguese, and Greek bonds versus German. Faced with the uncertainty over potential defaults, the EUR is likely to remain on the back foot through the summer months. We think EUR/USD in the 1.24/1.26 area offers an attractive level to enter shorts.
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