The Fed’s future path still seems more bullish than the European Central Bank. If so, the yiel...
The Forex Trading Week Ahead
07/12/2010 11:03 am EST
After dropping to recent lows at the end June, risk assets have regained most of that lost ground, but there are some noteworthy differentiations that suggest caution and a lack of conviction continue to dominate. In terms of recoveries, the S&P 500 has effectively recovered all its losses since the end of June and is now re-testing the key 1075/1080 breakdown area, now resistance. In bonds, US Treasury yields are up off their lows but still below the key technical resistance (prior lows for the year) between 3.05/3.10%. For stocks and bonds, those resistance levels remain the triggers to a further risk rebound. In commodities, the recovery has been more muted, with the CRB Index having regained only about two-thirds of its losses since the end of June, which is potentially suggestive of a correction rather than a rebound. More fundamentally, a lesser rebound in commodities suggests ongoing concern that the global recovery is stalling. Declines in the Baltic Dry Index to lows not seen since May 2009 underscore the outlook for weakness in commodity demand.
In currencies, the notable shift is more pronounced USD weakness, with the USD index having fallen for the last five weeks straight. Weakness in the buck is due to consistently disappointing US data over that period, which highlighted concerns that the US recovery is stumbling. An increasingly likely US slowdown, in turn, jeopardizes the broader global recovery, which explains the back and forth in risk assets over the last few weeks. In the JPY crosses, the rebounds closely mirror those seen in US shares, with losses since the end of June simply being recouped rather than surpassed. Clearly, conviction is lacking across all asset classes, and that suggests that short-term flexibility in positioning remains essential.
In terms of shorter-term trading direction, we are clearly at a crossroads, where recoveries above risk resistance levels cited above could trigger additional follow through. In FX, strength in EUR/USD above the 1.2720/1.2730 area is the equivalent trigger and represents a break of the entire downtrend from November 2009 and a likely new phase of USD weakness. In the bigger picture, though, risks remain tilted toward further weakness as the developed economies remain burdened by high unemployment and impending austerity measures/fadeout of stimulus. In that sense, we view the rebounds of the past week as more of a correction and continue to see gains in risk assets as selling opportunities. However, we are mindful of still-heavy risk-averse positioning (e.g. short EUR, long USD, short JPY crosses), and with it the potential for a further squeeze higher. Thus, we would suggest relatively tight stop losses just above the past week's highs.
Stress Tests Dominate Attention in Europe
Initial enthusiasm that most banks would pass the stress tests outlined by the Committee of European Banking Supervisors (CEBS) on July 7 quickly dwindled as fears rose that non-stringent tests would fail to bring sufficient transparency into the banking sector. The banks will be tested against macroeconomic scenarios, the most adverse of which will assume a 3% deviation in GDP from the EC’s forecast over a two-year horizon. A shock on interest rates to reflect a possible deterioration in the EU government bond market will also be included. However, there is plenty of debate on whether the haircuts made to government bond holdings will sufficiently reflect potential risks. Some investors are unhappy that the CEBS has apparently ignored the possibility of sovereign default. EU officials have moved quickly to offset concerns over the credibility of these tests, but doubts are likely to persist at least until the publications of the test results on July 23 and possibly beyond. The fact that German Landesbanken and Spanish savings banks are on the list of banks that will be tested suggests that the authorities are not deliberately avoiding the institutions considered to be among Europe’s weakest. By implications, however, the market will be expecting some of these banks to fail if the tests are to be perceived as sufficiently credible. The EC has reassured the markets that the EU is well prepared to deal with this situation, but uncertainty over the results could leave the EUR unsettled in the coming weeks.
NEXT: Chances for Double-Dip Recession; Key Data to Watch This Week|pagebreak|
Double Dip a Done Deal?
Earlier last week, the S&P 500 was down 15% from its April 2010 high. The ongoing debate on whether the US economy is poised for a double-dip recession can be linked with these falls. At present, there is insufficient evidence to conclude that the US economy will fall back into recession, though there are signs that the recovery could be losing momentum. A key question is whether the adjustment in asset prices seen since the end of April has been appropriate. Proponents of a double-dip recession imply that asset prices may have further to fall. In contrast, die-hard bulls suggest that equity valuations are looking cheap. In the past few sessions, the bulls have been gaining the upper hand.
The reining in of government fiscal incentives, and in many cases, the implementation of austerity measures, suggest that economic growth in most of the developed world will be constrained for the next few years. The release a month ago of the much-worse-than-expected May US labor report was followed by a bout of poor US housing and confidence data that had the effect of triggering a wide-scale debate about the prospects for double-dip recession in the US. The guts of the June US employment report did little to dissuade this speculation. Average hours worked in June fell and 652K people gave up looking for work. During the early stages of an economic recovery, the labor market usually expands. That said, the data were not bad enough to suggest that double dip is a done deal. Private sector payrolls managed to expand by 83K, and while this was less than expected, an expansion in private sector payrolls tends to be a precursor to economic expansion.
Adding to evidence that the US expansion remains in place is the steady expansion in the US industrial production index from its mid-2009 trough. Retail sales have been more volatile, but the underlying trend in the index also suggests improvement. As it stands, a double dip in the US would seem unlikely. In Germany, sentiment has been affected by concerns over the strength of the European banking sector. That said, German factory orders and industrial production have been on a clear upward trend, pulling in new workers along the way.
The industrialized world is still struggling to fully overthrow the constraints of the financial crisis. The slow to moderate growth in money supply data in many countries continues to illustrate that the banking sector is not yet fully healed and that the process of balance sheet repair continues on both a corporate and consumer level. The US, Spanish, and Irish housing markets are far from recovered, and in the UK, it remains wobbly. The pace of economic growth in 2010 and 2011 for many developed countries will be relatively low compared with their averages of the past decade. That said, growth is likely to be sustained, suggesting that fears over double-dip recession are likely overdone and that equity markets and other risk assets may find support.
GBP Shows a Little Resilience
Relative to the EUR, sterling has now unwound all of its post-June 21 budget gains. These gains had made the pound susceptible to poor economic news, and sterling’s resilience in the face of poor trade data released July 9 suggests there is more investor interest in establishing sterling longs at current levels and that sterling may again become more sensitive to stronger economic data than to bad. Technical resistance lies at EUR/GBP 0.8430. Assuming this holds, EUR/GBP could be poised to resume its downtrend.
Key Data and Events to Watch This Week
The calendar in the US is modestly heavy in the week ahead. No data on Monday, but Tuesday kicks off with the IBD/TIPP Economic Optimism Index. The data slate on Wednesday is the heaviest of the week with the import price index, advance retail sales, business inventories, and the FOMC minutes to wrap up the day. Thursday sees June PPI, weekly jobless claims, July empire manufacturing, industrial production, and the July Philadelphia Fed index. Friday wraps up the week with June CPI, May TIC data, and University of Michigan consumer confidence data.
Euro zone data is relatively light. EZ finance ministers will meet in Brussels on Monday, where they are expected to outline their planned responses to the results of EZ bank stress tests. Tuesday sees the ZEW survey of economic sentiment, and EZ CPI and industrial production are due on Wednesday. Friday caps off euro zone data with EZ trade balance. Tuesday will be the only day with data announcements out of Germany when the wholesale price index and German ZEW survey of economic sentiment will be released.
Data out of Tokyo is moderately busy, kicking off with industrial production, capacity utilization, and consumer confidence all on Tuesday. Wednesday will have the BOJ monetary policy meeting, followed up with the BOJ target rate on Thursday. Additional data on Thursday has June machine tool orders and the May tertiary industry index. Capping off data releases for the week will be June nationwide and Tokyo department sales numbers, both due in on Friday.
The UK starts off a significant week of data with final 1Q GDP, current account, BRC June retail sales monitor, and the RICS house price balance. Tuesday sees CPI, RPI, and DCLG UK house prices. Thursday wraps up the week’s data with the claimant count rate and jobless claims change.
Data out of Canada is light with manufacturing sales and leading indicators to be released on Thursday and Friday, respectively.
The calendar down under begins with NAB business conditions, Westpac consumer confidence, and DEWR skilled vacancies on Tuesday. Wednesday ends the week of data with new motor vehicle sales. New Zealand releases food prices on Monday, followed up with REINZ house sales and retail sales on Tuesday. Business NZ PMI is up on Wednesday, while consumer prices round out the week on Thursday.
China kicks off the data early with June's trade balance report set to be released on Saturday. The rest of the releases are all slated for Tuesday, when we will see 2Q GDP, PPI, money supply, and industrial production.By Brian Dolan, chief currency strategist, FOREX.com
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