Brave New World

FX Update 19/05/2009

News

EUR: German ZEW, which measures investor and analyst confidence rose to 31.1 in May from 13 in April; highest in 3 years

GBP: UK Consumer Price Index was 2.3%y/y vs 2.4% consensus forecast

AUD: Minutes from the RBA meeting, “economic stimulus has been applied by supporting demand”, likely to keep rates at 3% in 2009

Commentary

Risk has made a full fledged return to the market, as positive market friendly news in the US at the end of Monday helped drive equity markets higher. The MSCI Asia Index closed up 2.75%. Given the strong inverted correlation between the USD and JPY, the currency market took its cue and by early European trading the market witnessed a sell-off, particularly against Sterling. GBPUSD reached new highs, trading above the 1.54 handle. Sterling even rallied against the USD following weaker than expected CPI figures. Despite the pair trading around its Purchasing Power Parity level the market is, according to flow data, still oversold in Sterling. More positive economic data out of the UK, crucially Retail Sales figures later this week, could see Sterling reaching new levels against the USD, perhaps aiming towards the 1.60 level. This will certainly be in play if GBPUSD breaks a key 200 SMA resistance level of 1.5586. The EUR also rallied against the USD, but has been the less favoured currency. Economic data from the Eurozone is a real cause for concern and the feeling is that EURUSD is gaining not only from a weakening USD but as a result of FX reserve diversification; the rally in commodities and pick up in activity in China is allowing emerging market economies to once again build up their economies. Although green shoots indicators are increasingly apparent around world, optimistic indicators in the Eurozone come from solely from sentiment surveys. The Germany ZEW is a perfect example. The survey measures investor and analyst sentiment; in other words not participants in the ‘real’ economy. Today it posted a sharply higher reading for May, from April. This was mostly due to renewed confidence in the banking sector. It is unlikely that this confidence will continue to keep on the same trajectory, particularly given that European banks are in a much weaker position than was previously thought and no US style stress test has been agreed on in principle, let alone implemented. Given that the Eurozone is so dependent on exports, rather than domestic demand, for governments in the region will be concerned about much more appreciation in EURUSD. Nevertheless, the pair is likely to grind, cautiously, higher as improved market sentiment and the beginnings of a momentum away from the reserve status of the Dollar will weaken the US currency more than European authorities can manage. After all, the ECB will be extremely reluctant to outdo the Fed in aggressive monetary easing.

Currency Review 15/05/2009

News

• EUR: German GDP grew by -3.8% q/q (-6.9% y/y) in Q1, vs expected -3.0% (-6.0 y/y)
• EUR: European GDP grew -2.5% q/q (-4.6%y/y) in Q1 vs expected -2.0% vs (-4.1% y/y) 
• EUR:  Consumer Price Index for April was 0.6% y/y
• JPY: Wholesale prices fell 3.8% y/y vs expected -3.0%
• CNY: FDI fell 22.5% y/y in April

Commentary

Headline GDP figures tend not to create much of an impression in the markets, given that the components of the figures tend to be factored in in the months leading up to the figure. As a result, it is also rare for the headline figure to be much outside the consensus forecast. It is therefore quite a shock that q1 German and Eurozone GDP figures were so much worse than expected. The most important component, German GDP posted a dismal -3.8% fall in output in the first quarter alone; the worst reading since 1945. It is perhaps surprising therefore that the currency market response was not more dramatic. EURUSD initially fell to just below the 1.3600 level from an overnight high of 1.3650. Enough green shoots appear to have emerged for the market to be more focused on forward looking data, consigning the first quarter of this year to the rubbish bin. Important US data out later today- including Industrial production, Empire State Manufacturing Index and the University of Michigan survey will determine how much longer the good news story seizes market sentiment. As I have stated before the wheels will come off this recent rally. When that happens the USD and increasingly the JPY will benefit.

Currency Review 14/05/2009

News

USD: Producer Price Index for March was up 0.3% versus the 0.1% consensus forecast

USD: Initial jobless claims for the week ending May 2nd was 637k, versus the 610k consensus forecast

Overview

European equity markets closed fractionally up after a day which saw them in mostly negative territory. Lackluster price action has been the dominant them in the foreign exchange markets as little in the way of data has provided momentum. However, initial jobless claims data, which came in worse than expected has helped strengthen the argument that talk of green shoots of recovery is premature. The poor US retail sales data for April was a useful reminder to the exuberant equity markets that there is still no actual recovery taking place. Other concerns about economic growth yesterday came from China, which showed a slowdown in industrial growth and production of electricity in April; raising uncertainty over whether a Chinese recovery is taking place. Similarly,  yesterday’s UK Bank of England quarterly inflation report, gave a surprisingly dovish assessment about the state of the economy. The BOE warned that the lack of lending ability could seriously hamper any recovery of the economy. Mervyn King expressed great uncertainty about the future direction of the UK economy, saying “Judging the balance of influences at the moment is extraordinarily difficult”.  Meanwhile, in the Eurozone industrial production data yesterday showed a 20.2% drop in the year to March, the steepest year on year fall since records began in 1991.

The correction taking place in investor confidence has had little impact on the currency markets, although the USD has regained some of the ground it lost to many of the major currencies. Momentum against the dollar has, for the time being, been halted. The exception to this is the JPY, which has strengthened significantly in the last few days. USDJPY tested a low of 95.10 earlier, the 100 day SMA and yesterday’s low. A breach below would see the currency pair targeting the March low of 93.50. Bank of New York Mellon attribute the JPY’s recent rise to three factors. First, a declining interest by Japanese investors in foreign bonds, as a collapse in yields around the world has made domestic markets relatively more attractive. Second, about a third of Japan’s exports go to China, Korea, Taiwan an Hong Kong; the economy should benefit from a pick up in economic activity in China. Third, the allocation of the JPY in the portfolio of FX managers which has until now been low should rise due to the disappearance in yield differentials- being underweight the yen is less rational than it once was.

FX Weekly View 18/04/2009

FX Commentary– Risk appetite continued to rise this week, but only just. Equity markets have posted their sixth consecutive weekly rise, with the S&P gaining 1% to 867 and the FTSE 100 gaining 2.6% to climb above the 4000 level. The continued buoyancy in the market has been helped by some key Q1 corporate earnings numbers that surprised to the upside and economic data that suggests, in the US at least, that the pace of economic decline is slowing. Currency markets have largely reflected this buoyant mood with cyclical and commodity currencies like the GBP, AUD and CAD performing strongly. Sterling is performing well in this environment. In addition to its strong traditional high beta performance, the currency has benefitted from data showing that the domestic housing market and global financial services may be stabilising. The options market (expressed in risk reversal pricing) shows the strongest market support for the pound in four years.

By contrast the Euro, which has been very closely correlated to US equity market indices and hence risk appetite in the last six months, has been the G10 main under performer in the last week. Investors are not impressed with the continuing uncoordinated fiscal policy response by the various governments, but particularly Germany and France. All other Eurozone countries are being tarred with teh same brush. Moodys announced this week that it was expecting to lower Ireland’s credit rating, despite drastic action taken by the government there to rebalance the economy and tighten its fiscal deficit.  In monetary policy the ECB appears to be showing greater signs of disagreement among its members over the next steps forward with regard to interest rates and quantitative easing. To add to the mix, Trichet implicitly talked down the Euro for the first time.  Currency markets responded accordingly. The EUR ended the week lower against most currencies, breaking its relationship with global risk appetite. Until such time as there is more concerted effort to boost aggregate demand and put inflation worries to one side the Euro looks likely to take Sterling’s place as the weakling.  

The US Dollar looks set to benefit from further recovery in sentiment or a flight to safety. This week’s rally in both equities and the dollar looks set to confirm the market’s expectation that the US will exit recession before other developed nations. Tics data out earlier in the week shows renewed capital inflow into the US markets; away from government debt to equities and credit. In times of crisis the safe haven trade still remains.

USD: Bullish

EUR: Bearish

GBP: Bullish

JPY: Bearish

Technical levels and trade recommendations to follow……..

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.