Weekly Review and Outlook

Euro Rebounded Strongly but Sustainability Doubtful, Risk Appetite to Extend

Euro overcame the impact of S&P's massive downgrade of nine Eurozone states and strengthened broadly last week. Investors expressed their confidence in Eurozone sovereign bonds with solid demand seen in debt auctions while yield also dropped significantly. ECB's three year LTRO operation seemed to be working well in reducing stress in the the region's money markets as three-month dollar Libor dropped for consecutive nine days. In the FX markets, European majors outperform commodity currencies as Canada, Australia and New Zealand released some weak data over the week, and also on short covering in respective crosses. In stocks, US is clearly outperforming other regions with DOW extending recent strong rally and closed above 12700 level. Nonetheless, at the time of writing, the negotiation between Greece and private sector on the debt swap deal is not concluded yet and is posting some uncertainty for the week ahead. Also, technically, EUR/USD and EUR/JPY faced strong resistance from 1.3 and 100 psychological level respectively. EUR/GBP and EUR/AUD showed sign of renewed weakness just before the week closed. It's a bit doubtful whether the common currency could extend last week's rebound.

French bond auction was the main focus last week after S&P's downgrade but that went quite well. France successfully sold EUR 7.965b of 2014, 2015 and 2016 bonds today, near to maximum target of EUR 8b. Demand was solid with bid-to-cover ratio of 2014 bond at 2.12, 2015 bond at 3.42 and 2016 bond at 2.12. Yields were at 1.05%, 1.5% and 1.89% respectively, and were lower from similar auction last year. The results suggested that investor confidence towards France was not much affected by S&P's downgrade last week. Spain's bond auction was also seen as successful. Spain sold EUR 6.61b of 2016, 2019, 2022 bonds today, much more than it's target of EUR 4.5b. Yield on benchmark 2022 bond was at 5.403%, significantly lower than the 6.975% in last auction in November. The EFSF bailout fund sold EUR 1.501b of six-month bills today. Bid to cover ratio was at 3.1. Yield was at 2.664% even though the fund was downgraded by S&P from AAA to AA+.

Talking about S&P, the rating agency affirmed EU's long- and short term credit rating of AAA and A-1+ even though some of the member states were downgraded. Outlook is negative for going risk in Eurozone. S&P said that the EU "benefits from multiple layers of debt-service protection sufficient to offset the current deterioration we see in member states' creditworthiness". Though it also warned that if the number of AAA rated member states decreases, or if EU's "headroom decreases compared with its annual debt service" or if member states default, EU's rating could be downgraded.

Greece's negotiation with private creditor on the debt swap deal looks positive even though there is no conclusion yet. IIF said that the "elements" of the voluntary PSI are "coming into place". Greek spokesman said that the "atmosphere of the talks is good". The swap deal targets to lower Greece's debt burden of EUR 350 by EUR 100b as part of the second bailout. Overall target is for Greece to reduce debt to 120% of GDP in 2020. With the deal, private creditors would have the face value of their Greek bonds cut by as much as 50% through swapping existing bonds with ones with longer maturity and lower interest rates. It's reported that the main point of disagreement is on the interest rates of the new bonds and the groups are considering a proposal to set rates of below 4%, which would then increase gradually until 2020. Eurozone ministers might examine the final proposal on Monday and decide whether they'd accept it.

Other news from Europe include talk that the combined capacity of the temporary EFSF and the permanent ESM would be unchanged at EUR 500b. The size of the fund would be reviewed in March and could be raised once it's operational. Also, the bailout fund would made only available to states which signed the EU budget pact. EU finance ministers are expected to approve the treaty for establishing ESM on January 30. The IMF is proposing to raise its lending capacity by EUR 500b.

China was another factor that supported risk appetite last week. The Chinese economy grew 8.9% yoy in 4Q11, down from 9.1% in the prior quarter. Despite the slowdown, the result beat consensus and brought relief to those who worried that growth would have slipped below 8%. Expansion in the fourth quarter was driven by surge in industrial production and retail sales. For full year 2011, GDP growth reached 9.2%, in line with market expectations. The question now comes to how the world's second largest economy would perform in 2012 given external headwinds and domestic slowdown. In our opinion, a soft landing is a likely scenario and the chance of sub-8% growth is quite low as policy easing by the government helps limit the downside risks to growth. We expect GDP will grow by mid-8% in 2012. More in China Watch: Shift To Monetary Easing Should Support Chinese Growth In 2012.

The BOC expectedly paused in January, keeping the overnight rate at 1% for an 11th consecutive meeting. While policymakers believed economic growth will be "more modest" than previously anticipated, they preferred to stand on the sideline for the time being as historically low interest rates and the well-functioning financial system have been providing stimulus to the economy. Yet, the central bank pledged to monitor the market situation carefully so that it could act swiftly with the aim of keeping inflation at the 2% target in the medium-term. More in BOC Extended the Longest Pause since Adoption of Overnight Rate.

Technical Highlights

DOW extended recent rally and broke 12500 last week as expected. The index is building up momentum again with daily MACD moving away from the signal line. We'll stay near term bullish as long as 12311 support holds and expect a test on 12876 high in near term, likely within the next two weeks. In the larger picture, firstly, while up trend from 6469.95 is still in progress for sure and it's looking likely that DOW would have a test on the 14198.1 high set back in 2007. It's a bit early but we're starting to look at the prospect of reaching 61.8% projection of 6469.95 to 12876 from 10404.49 at 14363.

Dollar index's sharp decline last week indicates that a short term top is formed at 81.78, inch below mentioned 100% projection of 72.69 to 79.84 from 74.72 at 81.86. Focus is turned back on 79.51 near term support. Break there will be the first signal for completion of whole rebound from 72.69, on bearish divergence condition in daily MACD and would bring deeper fall back towards 74.72 support. Though, strong support fro 79.51 will retain the near term bullish outlook and extend such rebound to 61.8% retracement of 88.70 to 72.69 at 82.58.

The Week Ahead

China will be on Chinese new year holiday next week and Asian session would possibly be slow in the early part. Main focus will be on reaction to any news on Greece PSI deal. Three central banks will meet this week including BoJ, Fed and RBNZ. No change is expected. But Fed would start to release forecasts of its benchmark interest rate after the meeting. Fed released two templates of the charts to be provided in this meeting, which should show when FOMC members expect to have the first rate hike, and expectation of the target rate of at the end of the next three years and the longer run. BoE will also release meeting minutes. In addition, the economic indicator is jam-packed with market moving data, including Australian inflation, UK and US GDP advanced readings.

Monday: Australia PPI; Canada leading indicator, Eurozone consumer confidence
Tuesday: BoJ rate decision; Swiss UBS consumption indicator; Eurozone PMIs; UK public sector net borrowing; Canada retail sales
Wednesday: Japan trade balance; Australia CPI; German Ifo; BoE minutes, GDP; US pending home sales, FOMC rate decision;
Thursday: RBNZ rate decision; US durable goods, jobless claims, new home sales;
Friday: New Zealand trade balance; Japan CPI, retail sales, BoJ minutes; Eurozone M3; Swiss KOF; US GDP

EUR/GBP Weekly Outlook

EUR/GBP's consolidation from 0.8221short term bottom continued last week and edged higher to 0.8378, but failed to sustain gain there. After all, more consolidative trading could be seen in near term first. But rebound attempt should be limited by 38.2% retracement of 0.8830 to 0.8221 at 0.8454. We'd anticipate resumption of the larger decline from 0.9083 after the current consolidation. Below 0.8254 will be the first signal of fall resumption and should send EUR/GBP through 0.8221 low to 0.8067 key support.

In the bigger picture, price actions from 0.9799 are treated as a consolidation pattern in the long term up trend. Fall from 0.9083 is viewed as the third leg and should head to 61.8% projection of 0.9799 to 0.8067 from 0.9083 at 0.8013 (which is close to 0.8 psychological level). We'd expect strong support inside 0.7693/8186 support zone, possibly near to 61.8% retracement of 0.6535 to 0.9799 at 0.7782) to contain downside to finish off the consolidation. On the upside, though, break of 0.9083 resistance is needed to indicate completion of the whole pattern from 0.9799. Otherwise, there will also be risk of another fall even in case of rebound.

In the long term picture, long term up trend from 2000 low of 0.5680 shouldn't be over yet and the choppy fall from 2008 high of 0.9799 should be a correction only. We'd expect such correction to be contained by 0.7963/0.8186 support zone and bring up trend resumption. Rise from 0.5680 is still expected to extend beyond 0.9799 high eventually.

EUR/GBP 4 Hours Chart