Highlights
- Divergences continue in risk sentiment indicators
- Important price levels to watch
- EUR fails to follow risk trades as quantitative easing looms
- Key data and events to watch next week
The great debate continues: Have we hit bottom in stocks and risk sentiment, or is this just another bear market rally? Currencies continue to give off mixed signals, but largely FX and gold are not buying into the notion that the worst is over. Despite stocks gaining further ground, which recently has been correlated to USD weakness, the USD index posted a solid gain for the week. In technical terms, it posted a bullish engulfing line on weekly candles and rose above the daily Tenkan line, suggesting further gains may lie ahead. But the USD index is heavily weighted toward Europe (77.3%), and USD index strength may just be a reflection of increasing EUR negatives (see below). More broadly, this past week saw general erosion in the G3 currencies (US, Europe/UK, and Japan) against all others. That weakness in turn belies the ongoing nature of the contraction in the leading consumption economies, which quite simply keeps the global trajectory pointed lower. As for gold, price fell sharply over most of March and early April as stocks rose, which is what the risk aversion correlation would suggest. But gold stabilized and recovered in this past week, even as stocks, and ostensibly sentiment, gained further ground.
And what of that rally yesterday in US shares? A strongly positive 1Q earnings pre-release by a major US bank was all it took to send shares soaring. Adding to the enthusiastic reception of that news, investors seemed to reason that if that bank's 1Q earnings were so strong, then other banks 1Q earnings may be similarly positive. While any earnings news from the banking sector with a plus sign in front of it is a good thing, keep in mind billions in toxic securities still pollute banks' balance sheets. The recent FASB rule change allowing for more significant discretion in valuing those assets was downplayed by the bank in question, though that is subject to interpretation. The credit default swaps (CDS) market was not swayed, and prices of CDS's rose on the day, a sign that credit concerns actually increased. I don't doubt that bank earnings next week will likely be positive, potentially beating estimates in some cases, but the risk is that Thursday's gains largely priced in such expectations, leaving shares subject to profit-taking. The real deal will come over the next several weeks as the Treasury PPIP plays out. Applications to participate by investors are due by April 24 and may offer a preliminary indication of the success or failure of the program. But the actual results of the program won't be known for several more weeks until bids are submitted for the toxic securities and banks accept or reject them. As well, the results of the Fed's stress tests of banks' capital adequacy, reported to be generally better than feared, won't be known until sometime in May.
On the economic data front, investors seem to keep cherry-picking data, latching on to those that offer a glimmer of hope and ignoring those that remind of risks to the outlook. A 20K w/w drop in the latest US initial jobless claims is viewed by some as a possible peak in layoffs. Never mind that the 4-week moving average for claims held steady at its highs for the cycle and that continuing claims rose another 95K to 5.840 mio, another new high in the cycle. True, some sentiment gauges have recovered from excessively low levels, but this is to be expected and should be viewed cautiously. In the bigger picture, meanwhile, global trade continues to plunge, as seen in the sharp narrowing in the Feb. US trade deficit, where ex-petroleum imports fell by another -5.5% MoM. China's March trade report purportedly revealed signs of improvement, as Chinese exports were down only -17.1% YoY from February's -25.7% YoY decline. But that YoY number is misleading: a look at the 3 month rolling average of Chinese exports shows a further decline to a -20.1% annual contraction vs. a -15.3% rate in February.
Important price levels to watch
Next week may see the EUR decline further and we will be closely watching the 1.3050/1.3100 area, as a daily close below may see further downside potential to the 1.2700/30 area. Reserve managers have reportedly been buying EUR/USD in the 1.3100/3200 area and if they relent, the bottom may indeed fall out. USD/JPY needs to hold above the 200-day sma at 99.00/05 area or a deeper pullback may ensue, while the 101.50/102.00 seems likely to contain gains. The commodity currencies (AUD, CAD, NZD) have outperformed in recent weeks, but are at risk of stalling as the global growth picture remains weak. However, should USD/CAD fall below 1.2150/80 and AUD/USD rise above 0.7250/80, those currencies could see further strength.
EUR fails to follow risk trades as quantitative easing looms
The failure of EUR to follow the stellar performance in US stocks of late has left many scratching their heads. While equities have managed to jump more than 10% since the last FOMC meeting, EUR/USD has seen its early gains evaporate to a mere 0.9% add over that same time period. So while in the past a rally in risk elicited a run-up in EUR - as the buck was sold on the flight from safe assets - this time around the currency has failed to follow the rising tide in risk appetite. It seems that quantitative easing from the ECB is viewed as a growing possibility and, if past is prescient, this would be detrimental for the euro.
The dilutive implications for currencies whose countries are executing quantitative easing became obvious in the sharp -4% decline in the US dollar index in the days following the Fed's announcement to buy Treasuries last month. Some of the sharp weakness here has reversed and the index is now only about -1% from pre-Fed levels. This has been mostly due to the correction lower in EUR/USD, which is now sitting only about 100 pips above where it was ahead of the Fed announcement. Other currencies such as AUD and NZD, where quantitative easing is quite unlikely, remain more than 9% higher against the buck since that fateful day.
Mere hints of potential quantitative easing coming in the near future have weighed on EUR but the lack of confirmation on this front has prevented the market from abandoning longs in size. ECB members remain coy when discussing the topic and Trichet noted recently that "non-conventional" measures will be discussed at the next meeting on 7 May. We believe that once the ECB is finally forced to implement some form of unconventional easing (on the back of continued economic deterioration) more EUR weakness will emerge. Longs will subsequently run for cover and the correction lower in EUR/USD could be just as messy as the rally on the back of the Fed announcement, when the pair went from 1.3100 to 1.3740 in a blink. In the weeks leading up to the rate meeting, we would remain on alert for any potential comments regarding quantitative easing from ECB officials and still prefer selling EUR on rallies rather than buying it on dips.
Key data and events to watch next week
The US economic calendar is jam-packed next week and the action kicks off on Tuesday with producer prices, retail sales and business inventories all on deck. Wednesday is very busy and sees the usual weekly oil inventories along with consumer prices, NY Empire manufacturing, international capital flows, industrial production and the NAHB homebuilder index. Thursday follows with housing starts/permits, jobless claims and the Philly Fed manufacturing report. Friday rounds out the week with the University of Michigan sentiment index. Look for the Fed's Beige Book report on Wednesday as well and speeches from Fed Chairman Bernanke on Tuesday and Friday.
It is very quiet in the eurozone and UK as the Easter holiday slows things down quite a bit across the pond. Noteworthy data start on Thursday with eurozone consumer prices and industrial production while Friday has the eurozone trade balance. Look for speeches from ECB's Weber on Wednesday and ECB President Trichet on Friday as well. The UK only has home prices and the BRC retail sales monitor, both up on Wednesday.
Japan kicks off the week on Sunday with domestic corporate goods prices. Wednesday we'll see industrial production and Thursday has the tertiary industry index on tap. Friday closes out the week with consumer confidence and department store sales data.
Canada is characteristically light but has some top-tier numbers up nonetheless. Monday starts it off with the business sales outlook survey and the Bank of Canada senior loan officer survey. Motor vehicle sales are up on Wednesday while Thursday has manufacturing shipments lined up. Consumer prices round out the week on Friday.
It is a pretty modest week down under as well. New Zealand retail sales are up on Monday and Tuesday sees Australian business confidence. Wednesday brings the Australian leading economic index. Thursday has New Zealand consumer prices on deck while Friday closes it out with Australian import/export prices.
Brian Dolan, Chief Currency Strategist Jacob Oubina, Currency Strategist Forex.com http://www.forex.com
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