Weekly Review and Outlook

Drastic Turn in Sterling, ECB, BoE, RBA, NFP, ISM... Featured This Week

There was an 180 degrees turn on the sentiment on Sterling last week as the pound rebounded strongly across the board. There are a couple of reasons behind the strength in Sterling ahead of BoE meeting, including comments from George Soros that he's not betting against the pound anyway, as well ass rebound in bank stocks following unexpected rise in UK mortgage approvals. But after all, the reasons were not too fundamentally sound as the UK economy is still in deepening recession. IMF forecasts the UK economy to contract by -2.6% this year, worst in G7. BoE is also widely expected to cut rates again by 50bps this week to 1.00%, closer to ZIRP.

So what's behind the strength in Sterling and could it last? It's indeed believed to be driven by position adjustments in Sterling crosses as traders are taking profits on Sterling shorts as well as turning to short EUR and AUD. Indeed, that could be seen with GBP/AUD and EUR/GBP topping the top movers chart last week. Looking at the following chart, we can see that Sterling topped out at around the same time as Canadian dollar in Nov 07 while Aussie and Euro topped much later in around Jul 08. Decline in Sterling was much deeper, as driven by cross selling too. Euro, Aussie and Canadian dollar all made a medium term bottom in Oct 08 but Sterling continued the down trend until Jan 09. The pound was indeed not that strong last week if we look at the bigger picture and the markets were merely readjusting the deeply oversold Sterling back to a more 'normal' level comparing with other major currencies. Indeed, Sterling is still way below last Oct's low of 1.5262, which corresponds to the medium term bottom in Euro, Aussie and Canadian dollar.

Nevertheless, considering that EUR/GBP has topped out at 0.9799 and GBP/AUD has bottomed at 0.2031, we're expecting the pound to rebound further against both currencies and thus, would likely be supported against dollar and yen in near term too. However, 1.5722 in GBP/USD and 141.52 in GBP/JPY should represent significant resistance.

Another important development last week was the return of risk aversion towards the end of the week. DOW failed to sustain above key near term resistance of 8367 and is back pressing 8000 level again. AUD/USD has resumed recent fall while EUR/USD is also pressing recent low of 1.2764. Now to be bigger victim of risk aversion, Euro and Aussie are expected to retest medium term low against dollar and yen as DOW finally takes out 8000 level decisively this week.

Dollar, on the other hand, survived test of another round of poor data from US. Q4 GDP contracted most since 1982, by -3.8% annualized rate even though it's better than expectation of -5.4%. New home sales plunged to new record low of 0.33m annualized rate even though existing home sales unexpectedly rebounded to 4.74M. Durable goods orders fell the third consecutive months by -2.6% in Dec, worse than expectation of -1.8%. Ex auto orders also dropped much more than expected by -3.6% while ex-defense orders dropped by -4.9%. Consumer confidence dropped further to 37.7 in Jan.

Fed left rates unchanged at 0-0.25% target range as widely expected. Fed didn't sound too panic in the statement despite recent deterioration in economic data. Indeed, the Fed was slightly more optimistic on economic recovery than in the Dec statement as the Fed affirms that it "anticipates" a "gradual recovery later this year" even though downside risks are still "significant. In December, recovery was not even mentioned. Also, Fed will not start purchasing treasuries yet as it's only "prepared" to do so " if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets." While Fed is concerned that "inflation could persist for a time below rates that best foster economic growth and price stability in the longer term," there is no specific mentioning of inflation targeting.

Technically speaking, dollar index dollar index is still trading well within inner rising channel and thus, rise from 77.69 is still in progress to retest 88.46 high. Though, note again that a break of 83.58 support will invalidate this case and suggests that correction from 88.46 is going to resume, with the third leg down to 77.69 and below before completion.

Euro's recovery against dollar and yen was short lived. Not much support was received from unexpected unexpected recovery in Germany Ifo. The common currencies' strength is built on speculation that ECB will be on hold this week. But markets are starting to doubt if ECB would indeed cut considering that Jan CPI estimate released on Friday showed much faster slowing in inflation to 1.1% yoy, way below ECB's definition of price stability of "below 2%, close to 2%". Eurozone unemployment rate also climbed further to 8.0% in Dec.

Much volatility was seen in the Swiss Franc after markets are flip-flopped by SNB comments on intervention. Swiss KOF dropped much more than expected to -0.87 in Jan.

Canadian dollar survived poor GDP data which showed -0.7% mom contraction in Dec. The Loonie is so far still resilient, probably on anticipation of a rebound in crude oil.

Inflation in Australian slowed less than expected, with CPI dropped -0.3% qoq in Q4, yoy rate down to 3.7%. RBNZ surprised the markets by cutting 150bps to 3.50% this week. NZD/USD has resumed medium term down trend by taking out 0.5186 low last week and should be heading to 0.5 psychological support next.

Currency Heat Map

Suggested Readings:

• This Week's Market Outlook
• Weekly Foreign Exchange Insights
• US Dollar Outlook Unfazed by Worst Economic Contraction Since 1982
• Financial Markets Review: Sterling Strengthens ahead of BoE Rate Decision
• Weekly Focus: Is a "Bad Bank" a Good Idea?
• FX Briefing: USD - Strength Through Weakness
• US: How Much Bang for the Obama Buck?

Fed

• FOMC Continues Credit-based Policy of Quantitative Easing
• FOMC: Ready to Scale Up Purchases
• FOMC January Meeting: Exploring New Territory
• FOMC Close But No Cigar For Treasury Buying
• U.S. Dollar Surges Following FOMC Decision
• Lacker Dissents From FOMC Majority
• Federal Reserve Prepared to Use Balance Sheet to Ease Monetary Conditions
• Fed Says It Is "Prepared" To Purchase Treasuries
• Comparison of Current and Dec 16 FOMC Statements
• FOMC More Optimistic About Economic Recovery in January Statement
• FOMC Keeps Rates Unchanged, No New Policies Announced
• (FED) FOMC Statement January 28, 2009

RBNZ

• RBNZ OCR Review: Cut to the Quick
• New Zealand Cash Rate Slashed by Another 150 Basis Points
• New Zealand Dollar Drops as RBNZ Unexpectedly Slashes Rates by 150bps to Record Low
• RBNZ Cuts by 150 Basis Points Blaming Uncertain Outlook for Trading Partners
• (RBNZ) OCR Reduced to 3.5 Percent

The Week Ahead

We're talking about 3 central bank meetings and non farm payroll this week, plus numerous important economic data. BoE is the easier take as it's widely expected to cut 50bps to 1.00%. RBA is widely expected to cut 100bps to 3.25% this week too. Slower than expected drop in Q4 CPI dampened the possibility of a deeper cut. ECB is expected to be on hold as Trichet mentioned in last meeting that "March" is an important meeting. However, markets are starting to reassess whether the word "important" refers to revised economic projections only or does it refer to rate decision. Euro could be heavily sold if ECB surprised by a rate cut.

On the data front, Non Farm payroll from US is expected to show another -500k job loss in Jan with unemployment rate surging from 7.2% to 7.5%. Other important data include US personal spending and income, ISM manufacturing and non-manufacturing , pending home sales, factory orders, Q4 labor costs and productivity; Eurozone PMI manufacturing and services; UK PMI manufacturing and services, industrial and manufacturing production and PP; Swiss SVME PMI, trade balance; Canadian Ivey PMI and job report; Australia Q4 house price, trade balance, retail sales; New Zealand job report.

Also, close attention will be paid on whether DOW would finally take out 8000 level decisively. Be prepared for a roller coaster ride.

Suggested Readings:

• Economic Calendar Summary 2/1 - 2/6
• EMU Economic Indicators Preview
• Forex Outlook Mixed Ahead of RBA, ECB, BOE Rate Decisions, Non-Farm Payrolls
• Weekly Economic and Financial Commentary
• The Weekly Bottom Line
• Australian & New Zealand Weekly: We've Downgraded Our Growth Forecast RBA to Cut by 100bps
• Week Ahead Canada & U.S.: Canadian and U.S. Employment Reports
• Week Ahead UK & Europe: BOE Expected to Cut Rates; ECB Decision Less Certain
• Week Ahead Japan and Australia: RBA Rate Decision, BOJ's Mizuno to Speak

GBP/USD Weekly Outlook

Strong than expected rebound from 1.3503 and the break of 1.4469 support turned resistance mixes up the short term outlook. Also, it opens up the possibility that GBP/USD has indeed bottomed out after failing to sustain below 1.3680 key long term support. Nevertheless, in any case, further rise is now in favor as long as 1.4071 minor support holds. Rally from 1.3503 could extend further towards 1.5722 resistance. On the downside, below 1.4071 will flip intraday bias back to the downside for retesting 1.3503 instead.

In the bigger picture, the failure to sustain below 1.3680 key long term support and stronger than expected rebound from there raises the possibility that fall from 2.0158 has already completed the five wave sequence (1.7445, 1.8668, 1.4557, 1.5722), with fifth wave terminated at 1.3503. This is indeed, slightly in favor now considering bullish convergence conditions in daily MACD and RSI. Touching of 1.5722 will confirm this case and bring larger scale correction before resuming the long term down trend from 2.1161. On the downside though, firm break of 1.3503 will revive that case that medium term down trend is still in progress for 61.8% projection of 1.8668 to 1.4557 from 1.5722 at 1.3186 next.

In the longer term picture, as discussed before, the corrective nature of the multi-decade advance from 1.0463 (85 low) to 2.1161 as well as the impulsive nature of the fall from there suggests that GBP/USD is now in an initial stage of a long term down trend. While some medium term scale of consolidation might be seen in the near future, the long term down trend is expected to resume after completing such consolidation.

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