Sunday, March 7, 2010

The Week Ahead : Risk steps back from the brink; may rebound further

  • Risk steps back from the brink; may rebound further
  • On paper it seems that the Greek issue may have come off the boil
  • Happy nonfarm Friday for risk
  • Key data and events to watch next week

Just last week at the end of February, risky assets (stocks, commodities and in FX the JPY-crosses) and the global reflation trade were looking extremely shaky and we cautioned on the potential for another plunge. But a new month has brought some more positive data and apparent crisis resolutions (more detail below), and those risk trades have all seen decent rebounds. Does this mean that risk is back 'on'? First off, we would note that most markets are still trading with an incredibly short-term focus, gyrating on daily data reports.

Secondly, incoming data from the major economies continues to be extremely uneven, with some indicators inspiring confidence and others reminding of the damage wrought. We expect this to continue to be the case in the weeks and months ahead, which suggests that short-term volatility and absence of trend will continue.

Lastly, we remain below recent range levels/highs in many pairs and commodities: e.g. gold below 1040/50; oil below 82.00/50; EUR/USD below 1.3800/50; GBP/USD below 1.5200/50; USD/JPY below 90.50/91.00; USD/CAD above 1.0200/50; and AUD/USD below 90.50/91.00. A number of JPY-crosses are also at key Ichimoku levels, but have yet to decisively break through to the bullish side: EUR/JPY stalled at the daily Kijun line at 123.33; AUD/JPY testing the cloud top at 82.48; and GBP/JPY struggling with the Tenkan line at 136.86. Also, US stock indexes (except Nasdaq) are all still below the highs seen back in January. In short, we're still within recent ranges.

While those ranges persist, we're looking at a potentially more USD-positive scenario across the board, based on a brighter outlook for the US relative to more beleaguered UK and European outlooks. This has been the driving force over the last several weeks, and the less-bad US NFP provides another proximate boost to that theme. However, if risk appetites improve more significantly, we may see a reversion to the dynamic that dominated most of 2009, where the USD is sold against all but the JPY, and commodities and JPY-crosses lead the moves higher in risky assets.

With those reservations noted, we would also observe that the past week was largely spent testing recent risk lows, which held up well, typically suggesting that markets will go for the other side of the range in the near future. The better-than-feared US jobs report provides a fundamental catalyst to view the risk outlook as continuing to improve, while data out of China next week may provide another boost to risk sentiment. In addition to the apparent resolution of the Greek deficit crisis, market talk was rife with reports of quasi-official interest to buy EUR/USD below 1.3550, which meshes with an EU desire to prevent a speculative assault on the single currency. As well, moves by the MOF in Japan to increase the size of its FX fund were taken as a signal additional JPY strength is likely to be resisted by intervention. A look at the weekly candlesticks also shows several significant reversal patterns. In particular, GBP/USD posted a prominent 'hammer,' a bullish reversal pattern after a decline, which was matched in EUR/GBP by a large 'shooting star', a bearish reversal pattern after an advance. As jaded as we are on Sterling, a corrective bounce looks imminent and we would look to buy dips back to the 1.4950/5050 area. EUR/USD has also posted 3 weekly doji/spinning tops in a row, suggesting a volatile resolution in the near future. Given still excessive short-EUR/USD and short-GBP/USD positioning, we think the prospects are ripe for a correction higher, moves which we would not fade for quite some distance. USD/JPY seems on better footing now that it's back inside its cloud, and together with the potential for a rebound in EUR and GBP/fresh gains in AUD and CAD, there is potential for a break higher in the JPY-crosses. We'll need to see a benign/positive news environment for risk appetites to recover, so we will stay nimble and roll with the data/events, but risk may surprise higher.

On paper it seems that the Greek issue may have come off the boil
On paper it seems that the Greek issue may have come off the boil. The Greek government’s 10 yr bond issue was three times oversubscribed and the announcement of additional austerity measures worth EUR4.8 bln broadly met the approval of other EMU officials. On the streets, however, it is a different story with riot police forced to control angry protesters with tear gas. Despite the attempts by the populace to stop proceedings the extra austerity measures were rushed through parliament and passed. This may unlock a support package from the EU for Greece. Controlling Greece’s 12.7% of GDP budget deficit has been made all the more difficult by the rise in yields needed to account for the extra risk of investing in Greek paper.

Understandably the PM would like reassurances from EU that would lessen funding costs. Comments from the European Commission’s Juncker suggest that this may now be likely. By passing the extra austerity measures Greece has swallowed a bitter pill and taken a huge step forward in the move to control its budget.
The story is far from over with further strike action and the likelihood of a prolonged recession suggestive of a long and rocky road for Greece. That said Greece’s action has strengthened the coherence of EMU suggesting some short-term support for the EUR is possible. Longer term, however, the incidence of stringent budget reform this year in the relative large economy of Spain as well as smaller ones such as Greece, Portugal and Ireland will have economic consequences throughout the EMU. Germany is still reliant on exports for growth suggesting that the impact will be felt broadly throughout the EMU region. Insofar as inflation is extremely subdued in the Eurozone (1.0% y/y) there is very little risk of a rate hike from the ECB well into 2011. The interest rate differential is likely to continue weighing on EUR/USD, suggesting that while EUR/USD may edge a little higher near-term, there is room for further downside on a 3 to 6 mth view.

Happy nonfarm Friday for risk
The US nonfarm payrolls report provided a pleasant surprise to the market as it came in much better than expected at -36K (consensus had -68K baked in) and the prior two months were revised up a net +35K. If that wasn’t enough to whet the appetite for risk, the unemployment rate printed 9.7% and was steady as she goes (market expected an increase to 9.8% or worse).

The details of the report showed an even more constructive outlook for the job market than the headline prints suggested. Temporary help workers saw another 48K increase, the fifth consecutive month of sizeable gains. This is a leading indicator of future employment as temporary help is usually what companies will add first. Aggregate hours fell -0.3% after a 0.3% gain the prior month, but this was much less than we would have expected given the significant weather impact on this report. The three-month trend in this metric remains well in positive terrain for the second consecutive month. To illustrate just how large the seasonal impact was, we look at those people “not at work due to weather” during the month. This number spiked to above 1 million and this is significantly above the 265K average (for the February month) since 2000 – palpable indeed. Extracting the weather effect, the payrolls number would have likely been closer to around +200K.

Key data and events to watch next week
The calendar in the United States lightens up a touch but still has some important top-tier numbers on deck. The NFIB small business optimism index kicks off the action on Tuesday while Wednesday is busy with wholesale inventories, crude oil inventories and the monthly budget statement due up. International trade and the usual weekly initial jobless claims are scheduled for Thursday while Friday rounds out the week with retail sales, business inventories and the University of Michigan consumer sentiment index.

It is a relatively quiet week in the Eurozone. French business confidence and German industrial production are the first data points out the gate on Monday. French industrial production, German trade and German consumer prices are due on Wednesday while French nonfarm payrolls are up on Thursday. German wholesale prices close things out on Friday.

UK data starts on midnight local UK time on Tuesday with Feb. BRC retail sales and the RICS house price survey. The trade balance is up Tuesday morning proper while industrial production and the NIESR GDP estimate are up on Wednesday. The Bank of England releases its inflation attitudes survey on Thursday.
Japan’s week is characteristically slow. The index of leading economic indicators and machine tool orders are both up on Tuesday. Wednesday brings GDP while Friday rounds things out with the industrial production report.

Canada is likewise not very busy. Housing starts lead off the week on Monday while trade data is due Thursday. The all-important employment report should send shockwaves through the market on Friday.
It is busy down under, for a change. Australia has NAB business conditions and consumer confidence on Tuesday and consumer inflation expectations and the employment report of Thursday. New Zealand, meanwhile, has business PMI and the RBNZ rate decision on Wednesday while home sales and retail sales close out the week on Thursday.

Chinese data always has a way of moving markets and there will be some to chew on next week. Trade is due on Wednesday while industrial production and retail sales are the highlights on Thursday.

DISCLAIMER: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase of sale of any currency. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.

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