Brave New World

FX Weekly Outlook-Pt 1: USD, GBP, EUR 14/04/2009

Overview– The titans of economic growth, the US and China, claim their rightful place at the centre of currency markets focus this weeks, releasing a slew of economic news. Risk appetite has been the all-pervasive driver in recent weeks, although the direct correlation with dollar weakness has been blurred somewhat with the yen regaining some of its risk appetite status and EURUSD losing its almost perfect correlation with the S&P 500. News of better than expected earnings in the banking sector has helped drive higher yielding currencies higher, with Sterling and the Aussie being chief beneficiaries over the quiet Easter period. However, given a slew of corporate earnings over the next few weeks, ongoing problems in the financial sector, and important economic data out in the US this week, a correction to the recent rally is highly likely and with a reduction in risk appetite.

USD: Trade: Short EURUSD: Target 1.3190 (100 day- Moving average)

US Dollar– The greenback’s continued role as a safe haven currency should help it maintain its value if market sentiment deteriorates. By the same token, if the much vaunted ‘green shoots’ of recovery emerge, heralding the beginning of the end of the downturn, it is widely expected that these will be seen in the US first. This should whet global investor appetite for US stocks and so prevent any significant fall in the dollar. In any case, the current level of risk appetite is likely to diminish. Last week’s FOMC meeting minutes showed a concern for the ‘very fragile’ credit conditions and renewed concern for the ‘fragile and unsettled’ financial markets. Despite what equity markets may believe, banks are still refusing to open up credit lines and toxic assets remain in the system. There are rumours that the Treasury has instructed the US banks that are subject to the ‘stress test’ not to disclose results during earnings season, so as to prevent a perfect storm of bad news raining on the market. The problems in the financial sector will take time to resolve. In the meantime, data out this week includes notable indicators including housing, production and consumer spending- providing the market with a good picture of conditions.

GBP- Trade: Short EURGBP at 88.45. (Current spot 89.00). Target 87.25 (Feb 24th low)

GBP– Sterling has climbed on the back of the recent rally in equities. The currency is strongly correlated specifically to sentiment on the financial sector. News about Goldman Sachs’ better than expected Q1 results have helped the pound against most G10 currencies. With little in the way of data this week- other than the RICS house price balance out on Tuesday- currency direction will take its cue from risk appetite. In an environment with a sharply lower risk appetite sterling should fall, specifically against the USD. However, a rally in bonds could support see sterling higher if risk appetite remains relatively high. The Bank of England is stepping up its purchase of gilts and corporate bonds, to more than GBP 6.5bn this week, compared with GBP 6bn in previous weeks. EURGBP should be the main long sterling trade in this environment. The pair is already trading close to its six week low of 88.50. A break below that should see a bearish bias.

EUR- Bearish. Short EURGBP– see above

EUR– The single currency was the worst performing G10 currency last week, and has stumbled in European trade this morning. Last week’s ECB monthly bulletin showed clear risks of a Eurozone deflation and implied that the ECB would cut rates further in the near future. Output, consumption, manufacturing and confidence are in dire state across the region and the pessimism in outlook is largely priced in. By contrast, Thursday’s CPI inflation data could provide substantial volatility as expectations differ widely. ECB expectations are for a reading of 2%, compared with a market consensus forecast of 0.6%. Another reason to feel bearish about the Euro is the imminent market correction in equities. EURUSD has lost its correlation with the S&P500 in recent weeks, as the market rally in the US has not been reflected in confidence in the European currency. This could return when the equity market rally correction occurs.