Saturday, November 6, 2010

FX market update And Strategy update

Zloty moves back to top of EMEA FX Scorecard
This week has seen key technical levels broken in a number of EMEA currencies, and November PMI numbers in most EMEA countries have surprised nicely on the upside. This is good news for the EMEA currencies and is also reflected in our EMEA FX Scorecard, where the overall picture has now turned positive for the first time since June of this year.

Especially notable is the turnaround on the zloty score. For some time, the EMEA FX Scorecard was sending bearish signals on the zloty, but this week it is pointing towards a stronger zloty on a 1-3 month horizon. The Scorecard is also bullish on the Hungarian forint and the Israeli shekel. The scores on ZAR and TRY remain negative, but they have become less negative, mostly due to move positive technical scores. The main drag on the scores for both ZAR and TRY is the valuation score, as both currencies are fundamentally quite overvalued.

There are three reasons for the reversal in the zloty’s score. First, EUR/PLN started to run into resistance around 4.00 and it has been hard for the pair to move above this level. Second, Polish macro data continue to surprise on the upside – most notably the PMI for October, which was published on Tuesday, increased to 55.6, from 54.7 in September – beating our forecast of 55. Third, the comments from Polish central bankers strongly indicate a Polish rate hike already in November. Hence, the NBP is hiking rates at the same time as the Federal Reserve is stepping in with quantitative easing, which makes the zloty an even more attractive carry play.

These factors also mean that our 3-month forecast for EUR/PLN looks way too pessimistic in terms of the zloty, and we will mostly likely revise it down significantly when we publish our Emerging Markets Briefer in about two weeks’ time. In fact, our EMEA FX Scorecard is pointing to a continuing downward move in EUR/PLN in the coming 1-3 months. Furthermore, a look at the technical picture is supportive of a further decline in EUR/PLN towards the 3.82-3.83 level in the next couple of weeks.

Even though we could see a relatively strong downward move in EUR/PLN, we would caution that such a move could become excessive. Although the zloty is not fundamentally overvalued at present levels, there is a risk that we could be heading towards overvalued territory – especially if the Polish central bank “goes solo” and initiates a monetary tightening cycle, or just if the markets think that this will be the case. However, for now we would recommend investors to ride the wave and be positioned for a further downward move in EUR/PLN, at least until November’s Polish rate decision.

Strategy update
Following the closure of our Polish IRS strategy a week ago, we have in turn discontinued our HUF/PLN strategy as a result of shift in the outlook for the zloty. We maintain a short TRY/BRL position, although the Brazilian policy makers’ reluctance to accept further Brazilian real appreciation is an obvious impediment to our strategy.

The past week has seen mixed fortunes for the Brazilian real: The Presidential elections are now behind us – with the much-anticipated election of Mrs. Dilma Rousseff, who is set to continue her predecessor Luiz Lula’s policies – so this uncertainty factor has now been removed from the political climate. At the same time, the economy has shown some signs of softening, with both industrial production and the capacity utilisation disappointing consensus forecasts and the October Manufacturing PMI dropping to 49.5, below the critical 50.0 level.

However, from the perspective of our strategy, it has been the statements and actions on the part of the Brazilian government, explicitly attempting to stall the rapid BRL appreciation, that have proved to be a significant hindrance to continued downside in TRY/BRL – and these actions continue to provide for greatest risk factor for our position going forward. However, the pair is yet to see a weekly close above the bear channel formation shown below and we maintain our position, while closely observing the currency market’s reaction to the Brazilian government’s interventions.

Strategy discontinued – booking 2% gain on HUF/PLN
On 18 October, we established a long HUF/PLN strategy. The time horizon on the trade was 1-3 months. Having gained 3 figures or over 2% on our long from 1.4200, but we have exited our strategy at 1.4500. We have additionally enjoyed an indicative carry gain of 10 pips for the duration of the holding period.

We had anticipated key resistance in HUF/PLN forming in the 1.4690-1.4710 zone (discussed in our EMEA Weekly publication last week), and the pair's inability to clear this area gave us our technical cue to exit our strategy. At this time, we see no potential for a further upward move in HUF/PLN on a short-term horizon.

Another significant impetus for the discontinuation of our strategy has been a flow of positive numbers on the Polish economy and accompanying momentum for the zloty, which has resulted in the short-term negative correction in the zloty coming to a halt. We would now expect EUR/PLN to be heading down further: having broken the shortterm trend support line earlier this week at 3.9450, the zloty’s advance has seen the pair briefly visit the technical support zone at 3.8900-10. Clearing the 3.89 handle would open the way for the cross towards the 3.8235 level, the 2010 low.
Full report: FX market update And Strategy update

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