Rally to continue? 18/04/2009
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Risk appetite has been the most important driver of currency markets in the last few months. This is has been due to universally low interest rates, poor economic growth prospects for all the main economies and extremely high volatility. With the rate of economic decline appearing to level off – the “second derivative” as Morgan Stanley economists have recently taken to calling it- and declining levels of volatility, as so much bad news has been priced into the market there is little left to surprise, the panic and flight to risk aversion that had until recently gripped the market, has weakened. More encouraging economic numbers and better than expected corporate earnings from the financial sector have gone some way towards convincing the market that the downturn does indeed have a bottom.
The recent equity market rally has been driven by short term money. Real money investors remain on the sidelines until they are sure that there has been a real sea change in sentiment. Unfortunately, there are significant reasons to suspect that risk appetite is already stumbling and, given the that the rally is about to enter its seventh week- there could be a significant correction. The market rally is tailing off, with a small gain this week could signify that the market is running out of steam; a negative “second derivative” in itself. Economic data from the US this week was indeed better than expected, but the S&P gained only 1% a week.
Equity market performance suggests that the real economy should expect a strong upturn un the future. US economic data released earlier this week suggest that economic deterioration is slowing. Bulls point to the New York and Philly regional indices which both surprised to the upside and the University of Michigan sentiment index which gave its best reading since September. This is indeed cause for hope, but the data merely suggests that expectations for further deterioration have lessened, not that expectations for an improvement have increased. The equity market is behaving as if the problems which have created the financial and economic crisis have been solved; namely the toxic assets on banks’ balance sheets, a sharp reduction in (primarily) US domestic consumption as a direct result of lower household wealth and a return to savings linked to a steadily falling housing market. In fact, none of these problems has been adequately addressed. Continuing signs of a decline in US consumption will bear heavily on the world economy and equity markets until a suitable replacement engine can be found. Similarly, the market will become increasingly nervous in the run up to the results of the US stress test for banks due in early May. If all banks pass, markets will believe the test was too lenient. If some banks fail to pass the test, without immediate government support bankruptcy will ensue. In both cases, stress on the world financial system is likely to resume.
In the meantime, the week ahead should provide important direction for global markets with the meeting of G7/G20 finance ministers at the end of the week. The growing game of currency politics being played between the US and Chinese authorities will be a particular driver. Company earnings season gets into full swing with 33 major companies in the US due to report, including banks and credit card companies. There are risks next week, but the real risks lie in the weeks ahead.
FX Weekly View 18/04/2009
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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……..
Daily Currency Outlook 16/04/2009
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EURUSD: Bearish Sell at 1.3148. Target 1.3080.
GBPUSD: Bullish. Buy at 1.4880*(current spot rate). Target 1.50
USDJPY: Bullish: Buy on dips below 99
Risk aversion has been creeping back into the market in the last couple of hours, as poor economic data from China and the Eurozone has dampened sentiment from an earlier rally in equities in New York and Asia. China showed slightly worse than expected GDP figures- an annualised 6.1% in Q1- while the Eurozone showed continued signs of weakness, with CPI and industrial production data giving their weakest readings since records began at 0.6% and -18.4% year on year respectively. Earlier, equity markets were bolstered by the US Beige Book survey which revealed signs that the financial turmoil may be easing, and data from American Express showing that bad loans had increased at a slower rate in March than in previous months. The JPY has been the chief beneficiary from this bearish sentiment, with EURJPY reaching 129.36, its lowest level since March 31st. The JPY also strengthened earlier against the USD, following the poor Chinese GDP figures. In the UK, the BRC Retail Sales Monitor showed a decline in transactions of 1.2% y/y in March, following a drop of 1.8% in February. Total sales rose 0.6% after a rise of 0.1% in the previous month.
As has been the theme in recent weeks, much depends on risk sentiment which in turn depends on the market’s confidence that the financial system is beginning to function properly again. Figures out from JP Morgan later this morning will be a very important pivot.
FX Update- Few signs of flattening-back to safety 15/04/2009
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The market has taken an indecisive turn with recent economic and corporate indicators. Surprises abound, with Goldman Sachs reporting better than expected Q1 earnings, while US retail sales data took the wind out of the markets sales, showing a worse than expected decline of 1.1% in March. News this morning that UBS was planning a further cut of 7,500 jobs added to the unease, although most investors are clearly cautious about calling a bottom to the market. In this climate of uncertainty, the EUR has be the currency to take the greatest punishment. After a bearish night in Asia the single currency has suffered at the hands of both Sterling and the Dollar. A story in today’s Daily Telegraph reported that one third of European junk bond credits could default on debt given that there was no prospect for pick up in demand for exports. The EUR had earlier reached a high of 1.33 against the USD before comments from the ECB’s Weber that indicated the central bank would announce a package of non-standard measures (read quantitative easing) in May; valid for the rest of the year and into next year. At the same time he said that cutting the benchamark refinancing rate below 1% would risk paralysing the money markets.
In the US, talk of a flattening of the downturn (as per Larry Summers and President Obama yesterday) may still prove premature, with much of the data released surprising to the downside. US Capacity Utilisation in March reached a lower than expected 69.3%- a new record- whcihle industrial production came in at -1.5% against an expected 0.9%, and a reading of -1.5% in February. Consumer Price data was -0.4% y/y compared with 0.1%. However, there were some encouraging signs, in the form of the Empire survey, which showed a significant improvement to -14.65, compared with the market expectation of -35. This may indicate that inventory drag is beginning to be worked off and that demand is beginning to stabilise, albeit at significantly lower levels.
In the UK, the RICS house price survey showed the house price balance rising to -73.1 in March; in line with expectations. Sterling performed strongly against the USD, briefly breaking the 1.50 level, and the EUR with EURGBP breaking below 0.88 from over 0.89; a sharp sell-off for a traditionally low volatility currency pair. Sterling looks bid at the moment, with signs that it could break out further against the EUR. A report shows that that options market is the most bullish on sterling for four years. With both technical and fundamental indicators working against the Euro, shorting EURGBP remains the favoured trade. Given that the 0.88 level has been broken, the next key level of 0.8770
No recovery without action 14/04/2009
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UBS’s George Magnus pours cold water on the notion that things will fix themselves. Tories and Republicans should take note.
FX Weekly Outlook-Pt 1: USD, GBP, EUR 14/04/2009
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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.
Foreign Exchange Outlook 07/04/2009
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EURUSD: Bearish. Current spot (1503BST): 1.3261. Targeting 1.3160 (100 day SMA)
- Heightened risk aversion
- Worsening economic outlook in Europe
- Lack of policy response from European policy makers
GBPUSD: Mildly bullish. Current spot (1503BST): 1.4710. Targeting 1.4960 (yesterday’s high)
- Better than expected data
- Limited downside risk from Thursday’s BoE announcement
- Technicals indicate a higher move in Cable
USDJPY: Mildly bearish. Current spot (1503BST): 100.322. Targeting 100
- Heightened risk aversion may see break back through psychologically important level
Comment– Given the market surge at the end of last week on the back of G20, news of a relaxation of the mark-to-market rule for financial services firms, and relief that the US NFP figures showed that less than 700k jobs(!) were lost in March, it is unsurprising that the market has taken time to take stock. Risk appetite has diminished this week, with equity markets displaying nervousness. Reports that the IMF are about to announce that the toxic asset problem is much larger than originally thought have served to refocus minds on the origins of this crisis and the lack of progress made on its resolution. However, we are not quite back to the doom and gloom of six weeks ago.
The AUD is consolidating gains made against the USD, with the RBA effectively announcing earlier this morning that the rate cut cycle is over, following one last cut of 25bps to 3%, a strong current account surplus (unlike Japan, both exports and imports increased). China is showing some renewed signs of confidence, in some of its latest data- although the optimism in official figures should be discounted the data is moving in the right direction.
GBP– The UK economy, while still unofficially the toxic man of Europe, is showing signs that a flattening of the downturn is taking place. Last week’s Nationwide survey showed a surprise rise in house prices, although Halifax showed a drop. Industrial production data out today showed a further fall of 1.0% in February, better than the market expectation and better than January’s fall of 2.7%. Manufacturing output dropped 0.9% in February, following a revised fall of 3.0% in January- making it the smallest monthly fall since August 2008. Authorities in Europe’s second largest economy have been proactive, using every available tool at their disposal. In this context, sterling should be reasonably well supported, although any strong return to risk aversion will bear down on GBPUSD. .
The EUR has benefitted from a return to risk appetite, and a boost to IMF finance from G20 meeting, which reduced the region’s exposure to Eastern European economic implosion reaching a high just short of 1.3590 at the start of the week. Risk aversion, policy inaction and appalling data from the region have served to undermine the single currency this week and with little prospect of those three bearish elements changing EURUSD looks vulnerable for the remainder of the week.
USDJPY has traded in a 60 pip range since the start of European trading, with the BoJ’s announcement or keeping rates on hold at 0.1% having no impact on the market. The accompanying statement highlighted worries about possible deflation, and the dependency the Japanese economy has on global demand. The break of USDJPY over the psychologically important 100 mark has been well supported, but continuing risk aversion will weigh heavily on the pair.
China’s dollar problem 04/04/2009
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Paul Krugman explains China‘s problem of owning so many dollars. The Nobel prize winner argues that the country is in a much weaker position than is commonly thought.
Foreign exchange outlook for Event-Risk Thursday 01/04/2009
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Currency markets have been relatively quiet of late, perhaps in anticipation of tomorrow and Friday’s important market moving announcements and data. Market has jumped around quite a bit in the last few days, often quite independent of economic figures released. Risk appetite has generally been higher than expected given the diminishing likelihood of anything tangible coming out of the G20 meeting, awful European economic data and the wait for a belated interest rate cut from a reactive and overcautious central bank. One of the main reasons for this, of course, has been the month and quarter end flows moving heavily towards risk; boosting equities and keeping a lid on any advance in the US dollar. However, tomorrow should provide a very different trading environment, as a sudden flight away from risk is likely if either the G20 or the ECB fail to provide detailed proposals to tackle the current crisis. And the likelihood of that is very high.
The US dollar remains the world’s safe haven currency at the moment and could gain strongly against the EUR and GBP if the G20 meeting is seen as a failure. Given the number of substantial issues the meeting is expected to cover- increased funds for the IMF, coordinated fiscal stimulus, supporting world trade and changing regulatory oversight of finance, the outcome is bound to disappoint. This has largely been priced into the market but with increasingly antagonistic noises coming participants, including and increasingly vocal row between the Germans and Japanese over the need for fiscal stimulus, the risk is that the outcome may be something more dramatic than a generic and non-commital communique. Any large scale bust up would lead to a significant retreat from risk and precipitate a sell-off in equities, commodities, Sterling, the Australian dollar, the Euro and a flight to US treasuries and the US dollar. It is difficult to imagine the market not reacting to tomorrow’s announcement and it is almost inconceivable that the result of the meeting will be anything other than disappointing.
The ECB decision tomorrow on interest rates will hopefully provide a clear understanding of the bank’s strategy to provide monetary stimulus and signify how far power has shifted away from the inflation hawks to the doves. The market is expecting a 50bps cut to 1.00%, a new low, although from a record that goes back to 1999 as opposed to 1694. Economic activity has weakened considerably in the region in the last month. Today’s figures show German retail sales falling -0.2% in February (vs the market expectation of +0.3%), the Eurozone Purchasing Managers Index lower and unemployment back up to the levels witnessed three years ago. A rate cut itself will not lead to a move in the market- although in the unlikely event of a 100bp cut, a big jump in the EUR would be expected. Trichet’s press conference, after the announcement, is likely to provide much more scope for currency movements. If the ECB chairman outlines a framework for the introduction of quantitative easing the market is likely to take a sanguine attitude and EURUSD could rise. A statement that strikes a cautious tone or one that lacks clarity will lead to nervousness in the market and a lack of faith that the Eurozone will be able to get itself out of a frighteningly deteriorating situation.
US Dollar Outlook for this week 30/03/2009
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USD BULLISH
Trade: Short GBPUSD, short AUDUSD
Following last week’s impressive return of risk appetite, with rallies witnessed in equities, commodities and high yielding currencies, particularly the Aussie and the Kiwi, it was perhaps inevitable that this week would see a more cautious tone given the event risk surrounding it. The USD started the trading session in Asia, Sunday night UK time, higher against all G10 currencies bar the JPY, which gained 200 pips against the greenback. This signifies not only a flight to risk aversion but the return of the JPY as a safe haven currency. The Australian dollar, by contrast, dropped sharply against the USD, falling from 0.6925 to a low of 0.6769. iFlow data shows a strong turnaround in positioning; with new strong net buying of dollars. The EUR is now among the strongest net sold among G10 currencies. Ahead is an extremely busy remainder of the week, with three very important events; namely G20 on April 2, the ECB rate decision also on the same day, and the Non-Farm Payroll numbers out on Friday the 3rd. All three are potential game changers, although the G20 communique will have the furthest reaching implications. A draft communique obtained by the FT, and of course subject to revision, contains no statement about explicit global coordinated stimulus and no mention of an increase in the SDR- ie no change in the USD’s reserve currency status. These are both dollar positive.
The lack of stimulus:
1) Is seen by the market as a complacent move by policymakers in a world faced with serious deflationary pressures, increasing risk aversion and so buying US dollars
2) Shows a strong determination by European governments not to relent, in spite of records being broken daily in the eurozone for a collapse in confidence, output, exports and members states being downgraded- Ireland being the latest, losing its AAA status today.
The event risk for the USD surrounding the G20 communique concerns the ECB’s decision on Thursday on cutting rates. If the ECB cuts, as many market participants expect, by 100bps there could be a sea change in attitudes towards European policy makers’ ability to be proactive, and could boost appetite. However, the eurozone will still behind the curve in terms of policy response and this could benefit the USD. However, the EURUSD is difficult to call for this reason
Sterling looks particularly weak, with Gordon Brown’s credibility severely damaged. More than other G-20 leaders he badly needs a successful summit. The forced sale of Scotland’s largest building society- Dunfermline- underlines quite how weak the financial sector remains, checking the belief that the worst in the financial services sector is over. The FT reported that another 15,000 jobs could be lost in the sector in the next quarter. GBPUSD is currently 1.4270. Sell. Stop 1.4350. Target 1.4054 (Feb low)
AUDUSD witnessed a sharp sell-off in the opening 24 hours of the trading week. The pair trading as a pure measure of risk appetite and outlook for world trade and demand. I am bearish about the prospects for positive sentiment returning. AUDUSD is currently trading at 0.6820, stop 0.6880. Target 0.6700, then 0.6630
Brave New World 