Sunrise Market Commentary

• US Treasuries sell off and curve flattens, as inflation concerns affect rate hike expectations
  Fed Bernanke downplayed the weakness in payrolls, but upped its concerns about inflation, making markets think that a rate hike might be decided sooner rather than later. This sudden change in Fed focus spook investors and cause quite some re-positioning, volatility and extreme price action.
• Gilts sharply lower on record high PPI data
  Yesterday trading was very volatile, as the Bund first surged higher, but finally closed the day at the contract lows. This indicates that sentiment on the European bond market is still bearish. In the UK, Gilts even underperformed the European bond market following the record high PPI data.
• FX : US dollar fights back
  A series of US policy makers including Treasury Secretary Paulson again indicated that a weak dollar is no longer seen in the advantage of the US. Together with the Fed stepping up its inflation rhetoric this helped the dollar to regain the postpayrolls losses.

The Sunrise Headlines

• US Equities end the session mixed as the impact of upped rate hike expectations are offset by lower oil prices and Friday's steep losses. Asian stocks drop, taking their cue from Wall Street.
• Oil climbs above USD 135/ barrel overnight, after a 3% drop on profit taking
• US Paulson doesn't rule our interventions in the currency market
• Chinese stocks tank, as Central bank tightens policy via higher reserve requirement.
• Fed's Bernanke ups its inflation concerns and downplays downside eco risks.
• Lehman raises 6B, as it reports a record 2.8 billion $ Q2 loss, putting more pressure on financials that were the worst performer.
• South Korean president warns for a resource crisis.
• Central Bank speakers and Bank of Canada's rate decision main highlights of the day.

Currencies: Dollar Fights Back

On Monday, it was again a hectic trading environment on almost all financial markets and also the currency markets didn't escape from this turmoil. At the start of trading in Europe, EUR/USD tested the 1.5820 resistance area. The pair briefly traded above this level, but a sustained break didn't occur and later in the session EUR/USD dropped two big figures. Interest rate differentials were part of the explanation. Trading on the bond markets on both sides of the Atlantic was hectic but short term US yields this time rose at breath-taking pace. Of course, the 'slower' rise in European yields yesterday needs to be put against the aggressive move at the end of last week. The dollar also received some support from fact that Lehman brothers managed to secure USD 6 bln of new capital to restore its balance sheet. Later in the session, a stronger than expected pending home sales release was another good excuse to reinforce the dollar rebound and EUR/USD after the figure dropped below the 1.57-barreir. However, the most important news came later in the session. US Treasury Secretary Paulson in an interview warned that currency interventions can never be excluded as a policy option, Fed's Geithner said the Fed is closely monitoring the value of the US dollar while Mr. Bernanke in a speech overnight stressed that the Fed would strongly resist an erosion of inflation expectations. So, while EUR/USD was testing upside resistance in the 1.5820/40 area yesterday morning, the pair already dropped below the 1.56 mark today. The message from the US central bankers and other policy makers is quite clear: Inflation is a policy priority and for the US this means that more dollar weakness is no longer welcome.

Today, the US the trade balance figures for the month of April will be published. The European data calendar is thin, but after last week's ECB warning on interest rates and the harsh inflation talk from the Fed over the last 24 hours, the speeches from some ECB members will be closely monitored.

Until last week's ECB press conference and US payrolls release, we thought that the topside in EUR/USD has grown better protected and last week's warning from Mr. Bernanke on the weak dollar in our view was an important factor to support this view. However, the combination of the ECB pre-announcing a July interest rate hike, a disappointing payrolls report and sharply higher oil prices were enough a reason for investors to turn again USD skeptical at the end of last week, while the euro at the same time enjoyed the prospect of additional interest rate support. Nevertheless, already at the end of last week we advocated that, at some point, rising interest rates in an environment of sharply slowing growth could turn out to be euro unfavorable. We don't call victory after yesterday's correction, but we are happy that after the ECB rate hike threat, this has not become a one-way euro upside market.

In a medium term perspective, we have a neutral bias on EUR/USD and assume the pair to stay in the 1.5285/1.6020 range as long as visibility on the economic picture in the US and Europe remains low. We started the week with a neutral bias for EUR/USD after the sharp swings at the end of last week. We hold on to that view. From a technical point of view, EUR/USD trading short term is confined to the barriers of the 1.5840/1.5285. A break sustained break outside these ranges is needed for a directional move in one way or anther. In the current volatile market conditions we don't want to front-run on such a break. However, the strong US message that a weaker dollar is no longer in the advantage of the US should give topside in EUR/USD pair decent protection. So, in a day-to-day approach we still slightly favour a sell-on-upticks approach as long as the pair stays below the recent highs in the 1.5840/1.5820 area.

EUR/USD: Dollar fights back with support from US policy makers

Support stands at 1.5559 (ST low), at 1.5533 (Reaction low hourly), at 1.5460 (reaction high hourly) and at 1.5366 (reaction low).

Resistance is seen at 1.5607/12 (STMA/MTMA), at 1.5665 (Break down hourly), 1.5763 (Break down hourly), at 1.5844 (Reaction high).

The pair is in neutral territory.

USD/JPY

On Monday, the same drivers that supported the dollar overall (cfr EUR/USD part) were also at work in USD/JPY. US policy makers giving priority on inflation, sharply higher US interest rates and official warnings on the weakness of the US dollar were enough a reason for USD/JPY to move higher again, reversing the (rather limited) losses after Friday's US payrolls report. This morning's warning from Mr. Bernanke even pulled the trigger for this pair to set new short-term highs. In this respect it is clear that overall dollar strength is currently more important than growing risk aversion (as mirrored on the stock markets).

After a rebound from mid March to early May, USD/JPY settled in a narrow 102.55/105.87 trading range throughout the month of May. The topside of this range was tested several times. However, no sustained break succeeded and last Friday the poor US payrolls blocked again the topside in this pair. Nevertheless, the losses in USD/JPY were rather moderate given the market context (sharp equity losses, negative US data, record oil prices).

Recently we advocated that the downside in this pair was still rather well protected. We hold on to that view. Also the technical picture in this pair improves as the break above the previous range top (105.75 area) now looks more or less confirmed. The 14 may high at 108.68 now becomes the next target on the upside in this pair. A drop below the MTMA (105.04 today) would suggest that the uptrend is losing momentum.

USD/JPY: uptrend confirmed?

Support stands at 106.43 (Previous reaction high), at 105.83/70 (STMA/Previous reaction high), at 105.03 (MTMA), at 104.43 (ST low), at 103.87 (Reaction low).

Resistance comes in at 106.83 (ST High), at 107.17 (Break down Febr.) and at 108.68 (Previous reaction high).

The pair is in overbought conditions.

EUR/GBP

Yesterday, there were also some very wild swings in sterling trading in general and in EUR/GBP trading in particular. Global euro strength made EUR/GBP testing the 0.8050 resistance area (21 May high). However, as was the case for EUR/USD, the technical break didn't succeed. On top of that, the UK PPI data came out terrible high and caused a very sharp rise in sterling interest rates, especially at the short end of the curve as markets are now forced to believe that also the Bank of England will have no other option but raising rates in the near future. As is the case for the single currency, we consider this kind of interest rate support as very ambiguous. However, at least short term this relative interest rate support gives the sterling some downside protection and also the sharp correction in EUR/USD filtered through in EURMGBP trading. Overnight the RICS house prices came out very weak, but this was not really a surprise. Today the Industrial production data are on the agenda. Also these data are expected to confirm the almost stand-still in this part of the economy but recently the sterling was often more sensible to global market factors rather than to domestic data. In the current environment, the speech of BOE's King will get all market attention.

Since mid April, EUR/GBP develops a consolidation pattern after the steep sterling losses of the previous months. We turned neutral on EUR/GBP recently as a new attempt to move higher ran into resistance, mostly due to a loss of momentum in the euro overall. However, also this euro correction was blocked after the hawkish ECB press conference last week. We were sterling negative longer term and hold on to that view. Short-term, the pair trades again in the middle of the 0.7766/0.8098 consolidation range. We still think that the room for a sustained comeback of the sterling is limited. The 0.7833 reaction low is the first hurdle on the downside in this pair.

EUR/GBP: Test upside rejected?

Support comes in at 0.7891 (ST low), at 0.7845/31 (Boll bottom/Reaction low) and at 0.7766/46 (Reaction lows).

Resistance stands at 0.7942 (STMA), 0.7954 (Break-down) at 0.8017 (Boll top), at 0.8033/34 (ST high/21 May high), 0.8051 (MT reaction high) and at 0.8098 (All-time high).

The pair is in neutral territory.

News

US: Pending Home Sales far outreach expectationsUS April

Pending Home Sales rose 6.3% M/M (but still down 13.1% Y/Y) versus the 1.0% M/M drop in March, beating the expectations for a 0.4% M/M decline. It was the highest level since October 2007 and a positive sign for the existing home sales later this month, for which the Pending Home sales are a leading indicator. However, we should keep in mind that the Pending Home Sales is a very volatile indicator and therefore while encouraging, it isn't enough of evidence to conclude that the housing market is bottoming. .

Other: Escalating inflationary pressures puts Bank of England in a corner

In the UK, the PPI showed a dramatic rise in inflationary pressures, as May Output PPI rose 1.6% M/M and 8.9% Y/Y, the highest gain since 1982. Input PPI increased 3.8% M/M and 27.9% Y/Y, also representing record highs. These are first of all caused by severe jumps in petroleum products, but it is all the more worrying that also core PPI accelerated sharply. This increases fears that inflation expectations are becoming unanchored and may force the Bank of England to raise rates, despite a severe slowing of the economy.

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Disclaimer: This non-exhaustive information is based on short-term forecasts for expected developments on the financial markets. KBC Bank cannot guarantee that these forecasts will materialize and cannot be held liable in any way for direct or consequential loss arising from any use of this document or its content. The document is not intended as personalized investment advice and does not constitute a recommendation to buy, sell or hold investments described herein. Although information has been obtained from and is based upon sources KBC believes to be reliable, KBC does not guarantee the accuracy of this information, which may be incomplete or condensed. All opinions and estimates constitute a KBC judgment as of the data of the report and are subject to change without notice.