Weekly Review and Outlook
Euro Selloff to Resume after Indecisive Week, Spain Weighs
Traders have been indecisive in deciding whether to sell dollar or euro last week. Disappointing job market data from US reignited the talk of QE3 from Fed and triggered some pull back in the greenback. But it's the situation in Spain that should have finally pushed traders to make up their mind to dump euro and risk assets. Late Friday's selloff in European majors suggests that the pull back in greenback is over. Yen is also having admirable resilience last month's rebound. Meanwhile, we saw DOW faced strong resistance from 13000 despite a solid rebound attempt. It looks like markets are back in risk averse mode where odds now favor more upside in dollar and yen in near term.
Spanish bond yield is back pressing 6% last week despite interim dip following ECB's talk of resuming SMP bond purchase. CDS on Spain also rose to record high near to 500 bps. A major concern was on Spain's ability to meet the deficit target as recession in the country worsens. More importantly, the impact of ECB's three year LTRO has faded rapidly and it's uncertain whether ECB will restart buying bonds after stopping in back in February. Data from Bank of Spain showed that Spanish banks borrowed a record EUR 316.3b from ECB in March, almost doubling the EUR 169.8b in February and a new record high. And the data argues that ECB's second LTRO was dominated by Spanish banks which tapped over 30% of the EUR 529.5b cheap funds offered. There were also talks that ECB's liquidity measures has boosted the correlations between the debt crisis and bank risks as banks used the fund to buy government bonds. In any case, and for whatever reason, risk selloff would accelerate should Spain's yield break through 6% this week.
Recent renewed worry in Eurozone debt crisis triggered a breach in 1.2 in EUR/CHF this month on thin holiday trading. SNB interim president Jordan ensured that the bank will enforce the "minimum exchange rate with all the means at its disposal" and is prepared to buy foreign currency in "unlimited quantities. Jordan emphasized that the bank's policies are "totally unchanged". Jordan played down last week's breach of 1.2 and said the trade occurred in "what is known as a segmented market" and the trade were remedied quickly by "means of arbitrage".
Speeches from Fed officials have been directing market expectations of QE3. The FOMC minutes for the March meeting indicated that policymakers saw less urgency to implement QE3 due to improvement in the economic backdrop. Yet, the Fed Chairman Ben Bernanke's speech regarding stimulus and the job market, and Vice Chairman Janet Yellen's comment that 'a highly accommodative policy stance to be appropriate' have once again sparked speculations on QE3. The current developments suggest that further QE is still likely, but only after completion of Operation Twist and upon rapid deterioration of economic growth. More in The Possibility of Fed's QE3.
China's outlook was not helping sentiments neither. The 8.1% yoy growth in China's Q1 GDP was worse than consensus of 8.3% and Q4's 8.9%. That's indeed the slowest growth since Q1 of 2009. The World Bank said "prospect for a soft landing" in China remained high and lowered its growth forecast to 8.2% this year, down from prior projection of 8.4%. Though, projection for 2013 growth was raised to 8.6%, up from prior estimate of 8.3%, as world trade pickup next year. It said that China's trade surplus could dropped to 3.1% of GDP in 2012, down from 2011's 3.4% and the drop in surplus would result in a slower accumulation of forex reserves and trigger slower appreciation of Yuan. World Bank urged China to be "very flexible and to really look at the data as they come in month by month and be ready to move". Though, it also said that cutting interest rates should be the "last resort" as they're still relatively low and could "sow the seeds for inflationary pressure and speculative activities later on". There were reports that IMF is poised to lower long-term forecast of China's current account surplus sharply in its World Economic Outlook to be published later this month. It's reported that a reduction from 7% of GDP to 5% was discussed and in that case, would markedly weaken the case that the Chinese yuan is undervalued. Back in 20007, China's CA surplus reached as high as 10.1% and formed the basis of argument that yuan was "substantially undervalued". However, the CA surplus then dropped deeply in the following years and was just at 2.8% of GDP in 2011.
BoJ announced to leave the policy rate unchanged in April, maintaining the uncollateralized overnight call rate at 0-0.1% unanimously. Stimulus of 30 trillion yen asset purchase fund and 35 trillion yen credit lending program remained unchanged .In the policy statement, the BOJ noted that 'overseas economies on the whole still have not emerged from a deceleration phase but US economic conditions have continued to improve moderately and the sluggish European economy has stopped deteriorating'. Domestically, the economy has shown some 'signs of picking up'. BoJ governor Shirakawa later said Japan still faces "critical challenge of overcoming deflation and returning to a sustainable growth path with price stability". He warned that Europe's debt problems could affect Japan through market developments. Shirakawa reiterated his commitment to pursue "powerful monetary easing" to meet the inflation target. Meanwhile, BoJ upgraded it's assessment of two of nine of Japan's districts in its quarterly report. It's speculated BoJ would expand its quantitative easing program at next meeting in April and would boost the government bond purchase by another JPY 5T.
The rejection from 13000 level DOW's recovery attempt last week revealed some near term bearishness. It should now be clear that 13297.11 is at least a short term top and the current fall from there is expected to at least have a test on 38.2% retracement of 10404.49 to 13297.11 at 12192.13. There is no clear sign of larger reversal yet though, and reactions from 12192.13 fibo level would be closely watched for clues. Weakness in equities should support the greenback.
Friday's strong rebound in dollar index suggests that recent choppy retreat was just a correction. Rise from 78.66 and that from 78.09 is still in progress. Further rally is in favor this week and break of this month's high of 80.18 should affirm the bullish case and send dollar index through 80.73 resistance. Current development is also favoring the case that whole medium term rally from 72.69 is still in progress for another high above 81.78.
The Week Ahead
Spanish 10 year yield and CDS will remain the major focus this week. We'd expect worry on Spain to intensify a bit this week and send yield through 6% and in that case, dollar should benefit. Other than that, BoC rate decision and BoE minutes will be watched together with German ZEW and Ifo. US data include retail sales, manufacturing and housing but might not trigger much reactions from markets.
- Monday: Swiss PPI; Eurozone trade balance; US retail sales, empire state manufacturing TIC capital flow, business inventories, NAHB housing market index
- Tuesday: RBA minutes; UK CPI; German ZEW, Eurozone CPI; US new residential construction, industrial production; BoC rate decision
- Wednesday: UK unemployment claims, BoE minutes; Swiss ZEW; BoC monetary policy report
- Thursday: New Zealand CPI; Japan trade balance; US jobless claims, existing home sales, Philly Fed survey
- Friday: German Ifo; UK retail sales; Canada CPI
EUR/USD Weekly Outlook
EUR/USD's rebound from 1.3033 was a bit stronger than expected and mixed up the outlook for a while. But Friday's sharp decline cleared the picture. Recovery from 1.3033 should be a corrective only and is finished and decline from 1.3385 is set to resume this week. Break of 1.3033 will confirm this bearish case. Further break of 1.3003 support will confirm resumption of whole decline from 1.3486 and should target 100% projection of 1.3486 to 1.3003 from 1.3385 at 1.2902 next. More importantly, this should also confirm that rebound from 1.2625 has finished at 1.3486 and larger decline from 1.4939 is resuming for another low. We'll favor this bearish case as long as 1.3212 resistance holds.
In the bigger picture, price actions from 1.6039 (2008 high) are treated as a long term consolidation pattern and there is no clear indication of completion yet. That is, price actions could remain corrective and relatively unpredictable. The falling leg from 1.4939 is not finished yet and break of 1.2625 should pave the way to 1.1875 low. On the upside, we'd prefer to see sustained trading above 55 weeks EMA (now 1.3492) to indicate the start of another rising leg inside the pattern.
In the long term picture, EUR/USD turned into a long term consolidation pattern since reaching 1.6039 in 2008. Such consolidation is still in progress and we'd expect range trading to continue for some time between 1.1639 and 1.6039. The range sounds a bit uselessly large but yes, it's that large. For long term traders, anywhere below 76.4% retracement of 1.1639 to 1.6039 at 1.2677 could be treated as a buy zone while above 23.6% retracement at 1.5001 is a sell zone, until there is clear indication of breakout.
Subscribe to our daily and mid-day newsletter to get this report delivered to your mail box