Weekly Review and Outlook
Euro Soared on LTRO News as JPY, CAD, AUD Dived
Euro finally broke out of recent range last week and ended as the strongest currency on improvement in the banking system as well as confidence. Meanwhile, Canadian dollar was the weakest one following BoC statement that dented any hope for rate hike and deeper selling was seen after tame inflation reading. Aussie and Sterling were both weighed down by disappointing economic data. And in spite of strong risk appetite as seen in rally in stock markets, CAD, AUD and GBP were not supported. Some recovery seen in the Japanese yen after BoJ meeting as markets were disappointed but selloff quickly resumed and sent USD/JPY and EUR/JPY through 90 and 120 psychological levels respectively. Dollar was mixed in general.
While USD/JPY and EUR/JPY extended recent uptrend last week, both pairs looked a bit stretched. And indeed, AUD/JPY struggled to get rid of 90 psychological level clearly and GBP/JPY and CAD/JPY were both limited below recent highs. Maintaining yen short positions is favorable but it's not time to initiate new yen shorts. Sterling would likely stay soft and remain the weakest European major in near term. Long EUR/GBP could be maintained but GBP/USD and GBP/JPY should be avoided. Our strategy of long USD/CAD and AUD/USD short last week was correct even though long EUR/CAD was the most profitable. We'd maintain our bearish view in Canadian dollar and Australian dollar this week. Also, note that S&P 500 is in a dangerous zone above 1500 and reversal risk is very high. Should stocks reverse, deeper selloff could be seen in Aussie and Loonie. For current positions, USD/CAD long and AUD/USD shorts could be maintained. But for new positions, EUR/CAD and EUR/AUD longs could be considered.
In US, House of Representatives approved the bill to suspend the borrowing limit by a 285-144 vote, lifting the government's borrowing limit of US$ 16.4T until May 19. IMF chief Lagarde warned that US officials have to "consider that the leading role played by the U.S. economy in the world is at stake". And she urged Congress to settle the debt ceiling issue asap rather than "kick the can down the road a little bit longer, a little bit farther". Lagarde said that "if they take the time to really sit down, rationally, sensibly, putting a little bit of their respective ideology on the side to really focus on what is good for the economy and what is going to be good for the rest of the world, that’s great."
In Eurozone, the news that boosted EUR/USD out from recent range was that ECB said on Friday that 278 banks would repay EUR 13.7b, or 30% of the long-term refinancing operation LTRO loan on January 30. That's significantly higher than markets' expectation of around EUR 100b and was seen as a sign of better than expected improvements in the long-troubled Eurozone banking system. In addition, economic data also supported Euro. The German Ifo business climate index rose for the third month to 104.2 in January, up from 102.4 in December. Also, that's the highest level since last June and beat expectation of 103.0. Current assessment rose to 108.0 while expectations gauge rose to 100.5. Both beat market expectations. German ZEW economic sentiment rose from 6.9 to 31.5 in January versus expectation of 12. That's also the highest level since May 2010. Current situation gauge also improved from 5.7 to 7.1 versus consensus of 6.2. Eurozone ZEW economic sentiment also jumped sharply from 7.6 to 31.2 versus consensus of 12.2. Eurozone PMI indices improved more than expected in January even though they're still staying in contraction region. Manufacturing PMI rose from 46.1 to 47.5 versus consensus of 46.6. Services PMI rose from 47.8 to 48.3 versus consensus of 48.0. German PMI manufacturing rose form 46.0 to 48.8 versus expectation of 46.8 while services PMI jumped sharply from 52 to 55.3 versus expectation of 52. French PMI indices disappointed though and deteriorated.
Sterling was sold off sharply against Euro as Q4 GDP disappointed. The UK economy contracted by -0.3% qoq in Q4, comparing to expectation of -0.1% qoq and 0.9% growth in Q3. The data showed some evidence of fall back fro the boost by Olympic Games in Q3. And it raised concern that UK is heading to a triple dip recession. UK treasury said that the figures reflect that "Britain, like many European countries, faces a very difficult economic situation." Chancellor of the Exchequer Osborne said that the problems UK is facing were "many years in the making and there’s no magic solution," and it takes "hard work and perseverance" to bring a lasting recovery. BOE minutes unveiled that policymakers voted unanimously to leave the Bank rate unchanged at 0.5% and 8-1 to leave the bond purchase plan unchanged at 375B pound. David Miles favored expanding the stimulus amid concerns that rise of the pound would be detrimental to economic growth. The majority of the MPC members believed that economic developments in December were 'modestly positive' and it was not necessary to cut interest rates further or increase the size of bond purchases at that moment. More in BOE Voted 8-1 To Leave Bond Purchases At 375B Pound.
After its rate setting meeting, BOJ doubled its inflation target to 2% at the January meeting although this decision was dissented by 2 members. Meanwhile, the central bank left the uncollateralized overnight call rate unchanged at 0-0.1%. The BOJ also surprised the market by introducing an open-ended purchase program. After the current asset purchase program, the central bank would purchase a certain amount of financial assets each month without setting a completion date. Yet, the market appeared dissatisfied that the program would commence only in January 2014. The market had anticipated it would extend the current asset buying program. More in BOJ Announces Open-Ended Asset Program And Doubles Inflation Target To 2%. A key fact to consider is that BoJ governor Shirakawa is going to end his term in April. Prime minister Abe is expected to choose a policy dove to succeed Shirakawa and help him implement his Abenomics. Hence, even though yen attempted to recover, that was only brief and up trend in USD/JPY and EUR/JPY quickly resumed after Deputy Economy Minister Yasutoshi Nishimura said that USD/JPY's current level at around 90 "can be said to be a correction of the strong yen, but it isn't over yet". Also, Nishimura said that a level of 110 to 120 might be a concern as that would raise import costs. Markets took that as an indication that USD/JPY at 100 wouldn't be a problem. Also yen was weighed down by inflation data and December BoJ minutes. National CPI core dipped -0.2% yoy in December, down from November's -0.1% yoy. The reading stayed negative in seven out of the past eight months with only a 0% reading back in October. The details were even more worrying as persistent deflation pressure was seen in always every category with the core-core measure, which excludes fresh food and energy, down -0.6% yoy. The data raised expectation that firstly BoJ needs to raise its easing effort and a 2014 plan on open-ended asset purchase is simply not strong enough. Secondly, political pressure on aggressive BoJ easing will certainly be increased in the months ahead. Meanwhile, the December BoJ minutes showed that a few board members "noted that it was necessary for the BOJ to demonstrate its aim to encourage a further decline in short-term interest rates -- thereby narrowing or reversing interest rate differentials between Japan and other economies -- with a view to exerting influence on foreign exchange rates". And, the members also expressed that "purchases of T-bills should be increased substantially" with one member noting that BoJ should also considering additional purchases of JGBs during the further half of 2013. There was a member proposed to lower the interest paid on excess reserves from 0.1% to 0% and cutting the fixed rate fund rate from 0.1% to 0.03% but that was voted down by other eight members.
Canadian dollar was sold off sharply after BoC left its key rate unchanged at 1.00% as expected. Correspondingly, the Bank Rate stayed at 1.25% and the deposit rate at 0.75%. More importantly, the central bank also revised lowered its GDP forecast to 2% in 2013, down from previous estimate of 2.3%. The economy will reach full capacity in the second half of 2014 with GDP accelerating to 2.7% by then end of that year. Inflation is expected to average at +0.9% in 1Q13 and stay below 2% until 3Q14. The BoC forecast inflation would be at 2% by 4Q13. Canadian dollar dived after the report as the central bank saw less urgency to hike interest rates. More in BoC Lowered GDP Forecast, Said Rate Hike Less Imminent. Loonie suffered additional pressure as CPI unexpectedly dropped -0.6% mom in December and slowed was unchanged at 0.8% yoy. That compared expectation of an acceleration to 1.2% yoy. Core CPI dropped -0.1% mom and slowed to 1.1% yoy. That's even worse comparing to expectation of an acceleration from 1.2% yoy to 1.4% yoy. The data affirmed the case that need for rate hike is "less imminent" and without existence of inflation pressure, BoC would very likely stay unchanged for more time.
Aussie was weighed down as CPI rose 0.2% qoq, 2.2% yoy in Q4 versus expectation of 0.4% qoq, 2.4% yoy. Treasurer Wayne Swan said the CPI result was "further evidence that there has been no significant broad-based increase in consumer prices as a result of the carbon price". The data should give RBA room for further rate cut if necessary. So far, interest rate swaps are pricing in less than 50% chance for RBA to cut another 25bps to record low of 2.75% in February. But after all, another 25bps cut is still generally expected within the next 12 months.
IMF lowered its global economic forecast. The world lender forecast that world GDP would expand 3.5% in 2013 and then 4.1% in 2014. These were below October's estimates of 3.6% and 4.6% respectively. In the Eurozone, the IMF estimated that the economy would contract -0.2%, down from previous estimate of 0.2%. For the US, growth would ease to 2% this year from 2.1% estimated previously. Chinese economy would grow 8.2% in both 2013 and 2014. IMF noted that "the near-term outlook for the euro area has been revised downward, even though progress in national adjustment and a strengthened EU-wide policy response to the euro area crisis reduced tail risks and improved financial conditions for sovereigns in the periphery". But, "the return to recovery after a protracted contraction is delayed" and "Risks of prolonged stagnation in the euro area as a whole will rise if the momentum for reform is not maintained." It also warned that "adjustment efforts in the periphery countries need to be sustained and must be supported by the center".
The Week ahead
Euro and dollar would remain strong against other major currencies in near term but it's a bit hard to determine which one would be stronger even though Euro is slightly preferred. US economic data to be released next week will be key to determine. Those heavy weight data include durable goods, consumer confidence, Q4 GDP, non-farm payroll and ISM manufacturing. FOMC will also meet this week but would possibly be a non-event. RBNZ is also expected to keep rates unchanged.
Key events to watch:
- Monday: US durable goods, pending home sales
- Tuesday: New Zealand trade balance, German Gfk consumer confidence US consumer confidence
- Wednesday: Swiss KOF, US ADP employment, Q4 GDP, FOMC rate decision
- Thursday: RBNZ rate decision; German unemployment; Canada GDP; US Personal income and spending, Chicago PMI
- Friday: Japan unemployment; Australia PPI; China PMI; Swiss PMI; UK PMI manufacturing; Eurozone CPI and unemployment; US non-farm payroll, ISM manufacturing.
S&P 500 soared for another week and closed above 1500 psychological level at 1502.96. Near term outlook stays bullish. But again, we're staying to get very cautious on reversal. Note again that firstly, upside momentum has been clearly diminishing from medium term point of view, as seen in bearish divergence condition in weekly MACD. Secondly, rise from 1074.77 looks like a terminal triangle with current rally from 1343 as the fifth and final leg. Thirdly, the index is now close to an import projection target of 61.8% projection of 666.79 to 1370.58 from 1074.77 at 1509.71. We're expecting strong resistance between 1509 and 1576 to limit upside and bring medium term reversal. A break below last week's low of 1481.16 will indicate short term topping first and would likely bring pull back to retest 1400 psychological level later in Q1. Overall, while S&P 500 could remain strong in Q1, upside should be relatively limited and reversal risk is very high in Q2.
Dollar index continued to gyrate inside range of 78.60/81.455 last week and overall outlook is unchanged. Firstly medium term rise from 72.69 should have finished at 84.10 already and fall from 84.10 is not over. Secondly, price actions from 78.60 should be a consolidation pattern in the decline from 84.10 only and it should be completing soon. Some more choppy sideway trading would be seen in dollar index this week and we might even see a stronger recovery. But upside should be limited well below 84.155 resistance. Eventually, we'd expect a downside break out within a few weeks that should push dollar index through 78.60 to 61.8% retracement of 72.69 to 84.10 at 77.05 and below.
EUR/CAD jumped sharply to as high as 1.3606 last week and the strong move away from 55 weeks EMA affirmed the case of medium term bottoming at 1.2126, on bullish convergence condition in weekly MACD. It's a bit early to conclude if whole down trend from 1.7511 (2008 high) is finished. But in any case, current rally should extend in medium term to resistance zone of 38.2% retracement of 1.7511 to 1.2126 at 1.4183 and 1.4378. And near term outlook will stay bullish as long as 1.3185 support holds even in case of retreat.
EUR/GBP Weekly Outlook
EUR/GBP jumped to as high as 0.8536 last week and met maintained target of 138.2% projection of 0.7755 to 0.8164 from 0.7959 at 0.8524 already. Initial bias remains on the upside this week for further rally 161.8% projection at 0.8621. On the downside, break of 0.8390 support is needed to indicate short term topping. Otherwise, outlook will stay bullish even in case of retreat.
In the bigger picture, price actions from 0.9799 are treated as a long term consolidation pattern with fall from 0.9083 as the third leg. Current development affirms the case that such correction is completed at 0.7755 already, inside 0.7693/8186 support zone as expected. Further medium term rally should be seen to 0.9083 key resistance level for confirmation. Meanwhile, we's stay bullish as long as 0.8164 support holds even in case of pull back.
In the long term picture, no change in the bullish view that price actions from 0.9799 are merely a consolidation pattern and the up trend from 0.5680 is not finished yet. That is, another high above 0.9799 is anticipated. However, note again that sustained break of 0.7693 will strongly dampen this bullish view and bring deeper fall back to 0.6535/7258 support zone.
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