Forex: “Risk-Off” Trade Is Back on
09/26/2011 11:10 am EST
Currency traders should look to establish strategic “risk-off” positions on the heels of last week’s Fed actions and the numerous downside pressures that continue to plague the US and global economies.
Risk assets crumbled in the past week, with major stock and commodity indices putting in some of their worst weekly performances since late 2008. Greek debt/default headlines continue to dominate market attention, but the underlying cause of the market slump remains the deteriorating global growth outlook.
In particular, the Fed’s statement on Wednesday sent investor confidence reeling, as the central bank noted “significant” downside risks to the US economy in the months ahead. The US dollar (USD) and US Treasuries, along with the Swiss franc (CHF) and Japanese yen (JPY) to a lesser extent, were the main beneficiaries of the risk selloff, which even saw gold and silver get caught up in the collapse.
We think there is more downside to come for risk assets in the weeks ahead, as markets appear to have only just begun pricing in the potential for recessions in the major economies, potentially dragging the global economy into a recession as well.
The Greek drama continues to play out, and here, we think we may get some opportunities to re-sell risk assets/buy USD after some consolidation. After endless foot dragging, European Union (EU) leaders seem most likely to agree to measures that will allow Greece to receive its next installment of EU/International Monetary Fund (IMF) aid, staving off an imminent default/credit event.
On Friday, German Chancellor Angela Merkel repeated that a Greek default is not an option, and with this German backing, we continue to expect an eventual favorable resolution to the current Greek crisis, potentially as soon as this week.
As well, risk sentiment has been damaged by underlying concerns over Eurozone banks’ capitalization, with French banks at the epicenter of doubt. We think there is a strong likelihood that the French government will agree to allocate funds to recapitalize weak French banks in the coming weeks, which could also remove an element of uncertainty in markets and prompt a rebound in risk sentiment.
Ultimately, however, deteriorating growth outlooks and ongoing financial uncertainty, along with the potential for emergency central bank action, is likely to weigh on risk assets again, so we remain strategic sellers of risk/buyers of USD, CHF and JPY.
In concrete terms, we would look to use the following levels to establish strategic “risk-off” positions:
- EUR/USD short 1.3630/60 (Tenkan line 1.3661)
- GBP/USD short 1.5550/1.5600 (Tenkan line 1.5599)
- AUD/USD short 1.0000/50 (Tenkan line 1.0034)
- NZD/USD short 0.8000/50 (Tenkan line 0.8033)
- USD/CAD long 1.0040/90 (Tenkan 1.0064/Kijun line 1.0043)
- XAU/USD short 1690/1720 (cloud bottom 1688-1695 next week).
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G20/IMF Unlikely to Deliver a Rescue
This weekend sees the annual meetings of the IMF/World Bank in Washington, with the G-20 having met on Thursday. The G-20 statement was long on supportive language but short on concrete steps.
We are not optimistic that any new action plans will emerge at the IMF/World Bank meetings over the weekend, but risks remain high for a surprise weekend announcement, with market tensions having forced the hands of European leaders, in particular, to take action.
Absent any such announcement, we think risk sentiment and markets are most likely to relapse sooner rather than later. We would also note a planned meeting on Tuesday in Berlin between Germany’s Merkel and Greek Prime Minister Papandreou, which also may see a brief respite in despair if Merkel sounds encouraging on Greek progress.
Lastly, the German Bundestag is set to vote on the European Financial Stability Facility (EFSF) on September 29. The measure is expected to pass, but some coalition defections have made this a closer call.
Fed’s “Operation Twist” Fails to Impress
The Fed went ahead with the expected lengthening of the maturities of its Treasury debt portfolio in what markets have come to call “Operation Twist,” but the reaction was certainly not what they had hoped for.
On top of the ominous notation of the “significant” downside risks to the US outlook, the Fed indicated that it was not planning additional unconventional easing measures in the near future. Operation Twist is set to run through June 2012, where nine months is seen as an eternity and suggests a lack of urgency from the Fed.
Markets seem desperate for another round of asset purchases (QE3) and the lack of any mention of QE3 added to the sense of gloom. Then there are the dissenters. All told, markets drew the conclusion that the Fed has run out of ammunition, leaving the outlook very much in doubt.
With monetary policy essentially exhausted, investors are left looking to Capitol Hill for new fiscal stimulus, possibly in the form of President Obama’s jobs bill. But political dysfunction continues to dominate the US Congress, where the two houses could not even agree on a stop-gap funding bill containing emergency aid to cope with recent natural disasters.
This sets up the prospects for another US government shutdown if funds are not approved by the end of the month. In light of the dramas on both sides of the Atlantic, is it any wonder investors continue to run for cover?
By Brian Dolan, chief currency strategist, FOREX.com