FX Market Skittish Before ECB

News and Events:

The rally in risk appetite boosted by strong Chinese and Australian data yesterday was further encouraged after our last article by stronger than expected US ISM numbers. Forex risk correlated currencies, such as the Euro, moved lock-in-step with the data. EURUSD rallied above 1.2800 and the S&P climb above 1080. However, US rates weren’t invited to the party as players remained unsure – 10 yr yields did jump roughly 10 bps, but have since retraced

The divergence between equities and bond yields puts us in the corner that any risk rally may be just a short term correction until we get further information. Perhaps our greatest clarity surrounds the recent CHF strength and reconfirmed by today’s Swiss real GDP, released early this morning which rose 0.9% q/q. Q1 growth was revised up to 1.0% q/q from the 0.4% q/q estimated earlier.

While a majority of the Swiss Franc’s gains have been more on the back of safe-haven flows especially from the EU, the fundamentals of Switzerland will begin to give value to the underlying economics. The decoupling of a European economy from EU contagion fears is giving the CHF further strength. For those paranoid about the SNB, Hildebrand comment that “if deflation risks reappear, we [the SNB] would try to respond…” is not much to worry about in the short term. The slight downward slope in CPI is generally expected and not severe – making deflation not a big issue at this point, which should leave the SNB safely on the sidelines.

If any of our clients are trading the CHFHUF, the long trades driven by the massive borrowing of CHF to fund domestic denominated HUF purchases. Repayments from Hungray will continue to support the CHF, especially in an environment with growth fears and funding problems in Hungary.

Overall markets will continue to be hyper sensitive to data (any) and overreact to deviations, which will give traders plenty of headaches for the remainder of the week.

European session participants will be focused on the ECB rate decision today. Remember it was ultra hawk Axel Weber’s surprise comments that radically shifted the discourse around the ECB monetary policy path. While its universally expected that no change in rates from 1.00% there is the chance that the ECB will extend their extraordinary measures. Trichet’s press conference might provide some answers. We know that bank recapitalizations still remains a concern and while Q2 data was firm, there is serious concerns that the EU will follow the US lower (think German retail sales -0.3% m/m).

While Germany is the clear engine of EU growth, it doesn’t have the strength (or political will) to pull all the peripheral laggards up. The divergence between economic data among EU nations(inflation and growth) is becoming palpable. Today’s ECB press conference markets will be focused on any mention of renewed discussion of QE extension between members and comments on peripheral spread widening in the past month.

Today Key Issues:

• 07:15 CHF Jul retail sales; last +0.9% y/y.
• 07:30 SEK Riksbank policy announcement, some eye 25 bp hike in repo rate to 0.75%
• 07:30 GBP Aug construction PMI, 53.2 eyed; last 58.4.
• 08:00 EUR ITA Jul PPI; last +0.2% m/m, +3.4% y/y.
• 09:00 EUR Q2 GDP - revised, no changes eyed; prelim +1.0% q/q, +1.7% y/y.
• 09:00 EUR Jul PPI, +0.3% m/m eyed; last +0.3% m/m, +3.0% y/y.
• 09:00 EUR ITA Jul trade balance - non-EU; last E1.064 bln deficit.
• 11:45 EUR ECB policy announcement, no change eyed in 1.0% refi rate.
• 12:30 EUR ECB Pres Trichet press conference.
• 12:30 USD Initial jobless claims, thous 473 prior
• 12:30 USD Productivity, -2.0 exp, -0.9 prior
• 13:00 USD FOMC Chair Bernanke testimony before Financial Crisis Inquiry
• 14:00 USD Factory orders, % 1.4 exp, -0.7 prior
• 14:00 USD Pending home sales, -1.0 exp, -2.6 prior

The Risk Today:

EurUsd What a turnaround! After a pretty sluggish day on Tuesday, EURUSD has come roaring back higher in the last 24 hours, managing to surge above its 3-week downtrend, and important resistance at 1.2780 (27 Aug high), touching a high of 1.2822. In the process, we have not only carved out a bullish morning star candlestick on the day chart, but in addition, activated a potential double bottom pattern on the hourly chart. This break higher through 1.2780 is therefore significant; and in our view, warrants a punt on the long side in the very short-term. We therefore go long at current levels (1.2800 –which is also just above the 50-day moving average), setting a stop back down towards 1.2750, and look for a first target around 1.2900. The theoretical target for the double bottom pattern is more accurately in the region of 1.2970, but pretty formidable resistance lies at 1.2930 (back side of former 2-month uptrend and major ceiling of supply from mid-August) which compels us to be a little more conservative in our goal. Our bias over the medium-term will crucially depend on the outcome of the test of 1.2930; should this bullish rally fail then another slump to the downside would focus on 24 Aug’s low 1.2588, and below there 1.2522 (13 Jul low), 1.2485 (lower edge of the 3-week downtrend) and then the 2 & 6 Jul lows of 1.2483.

GbpUsd After bouncing off fibonacci support and trendline support around 1.5325 on Tuesday, GBPUSD spent much of yesterday squeezing out weak shorts and hitting a peak of 1.5492. Rather than heralding the start of a new bull trend, this move does look like a mere corrective rally; as the bulls failed miserably to get anywhere close to challenging the prevailing 2 & 3 week downtrends and have now conceded to a dip below 1.5400. The pair looks to be pointing itself back lower, with first destination expected to be that 1.5325 support seen on Tuesday. Should the buying interest at 1.5325 have been exhausted by the last rebound, next weak support is expected at 1.5235, and then major support kicks in at 1.5115-25 (50% fibonacci level and 21 Jul lows). Those caught long and looking for an exit will likely step in back around 1.5430 (200-day moving average, yesterday’s highs 1.5492, and 1.5580 (23.6% fibonacci retracement of 1.4229 –1.6000 challenged on Monday).

UsdJpy No change to our analysis of USDJPY today; the uncomfortable whipsaws between 83.60 and 84.60 have continued, but net change since Tuesday has been minimal. We still expect a high chance of another visit to 83.60 (24 Aug low) as the week draws on and BoJ intervention remains absent, then a trip to the lower edge of the 6-week downtrend (currently 82.75). Really not many technical landmarks are highlighted below as this area has not been explored since 1995. Our short-medium term target (barring the possibility of physical BoJ intervention) is therefore the 79.75 –80.00 area where the pair bottomed out on that run 15 years ago. On the topside the key levels of note remain the upper edge of the 6-week downtrend (now 84.90), major resistance at 85.90 (where the bears thwarted a previous break of the 6-week downtrend) and 86.50 (5 Aug high).

UsdChf USDCHF continues to be dominated by its 4-week downtrend, and yesterday experienced a very ugly plunge to lows of 1.0065 (25 pips off our bearish flag target). Despite a sharp squeeze higher subsequently, bears should find encouragement in the fact that the stubborn resistance at 1.0185 has held firm, and the pair is now headed back towards the downside. Admittedly the triumphant march towards parity is not exactly rampaging onwards, and one consideration for the bears will be the hammer candlestick on the daily chart which may suggest a lack of impetus to go lower just yet. We still think that a return to parity is inevitable, and below there the key remaining supports 0.9960 (3 Dec 2009 low) and 0.9920 (26 Nov 2009 low). Expect rallies to be hindered by resistance through 1.0185 (overnight highs) and 1.0229 break-out area. Extended rallies likely to be blocked by 1.0550 (13 Aug high), 1.0640 (27 Jul high), and 1.0673 (200-day moving average).