It takes a brave investor to bet
against further downside in GBP/G10 crosses following the brutal sell-off and
speedy decline through key technical levels over the last three trading
sessions. We remain medium-term USD bulls and GBP bears, but ask whether the
lurch lower in EUR/USD is overdone. The threat of a sharp rebound in the US unemployment rate above 10% in
February could result in the unwinding of post discount rate hike USD gains,
with the EUR separately standing to benefit from a flawless Greek 10y bond
auction and more concrete plans of EU debt guarantees. Overall, the failure of
major equity indices to challenge recent highs, stagnant commodity prices and
speculation of tighter monetary conditions in China still warrant a cautious approach
towards pro-risk strategies. With bearish seasonals lurking in March for the
JPY, we think the SEK is well positioned within the G10 to extend its stellar performance,
supported by hawkish central bank rhetoric and a relative sound fiscal position
vis-a-vis other G10 nations. Shrinking UK/G10 rate differentials and talk of a snap
UK general election should keep GBP on
the defensive, with the tempo of liquidation increasingly characterising fears
of a precipitous GBP rout.
â˘ In the G-10 space this week, the Japanese yen and Swedish krona
outperformed versus the US dollar. USD/JPY fell through 90 to end the week at
88.87, the lowest close since 15th Dec, benefiting from the reduced
appetite for risk. USD/SEK fell 1.57% as rate hike expectations were brought
forward following hawkish central bank minutes and strong Swedish retail sales
â˘ Sterling was the worst performer, going
through key technical levels versus the euro and the US dollar following dovish
comments from MPC members at the Treasury Select Committee hearing. Despite an
upward revision to Q4 GDP to 0.3%, GBP/USD hit a ninemonth low, briefly trading
below 1.52 while EUR/GBP rose 1.6% on the week to 0.8953.
â˘The euro recovered some poise despite starting off poorly as the
four largest banks in Greece were downgraded. Reports of another
austerity package and a 10yr bond issue next week in Greece helped EUR/USD to bounce as 1.35
failed to hold. EUR/USD closed up 0.38% at 1.3618. In emerging markets, the
Chilean peso outperformed, gaining 1.37% versus the US dollar while CNY 12m
non-deliverable forwards were largely unchanged at 6.64.
It takes a brave investor to bet
against further downside in GBP/G10 crosses following the brutal sell-off and speedy
decline through key technical levels over the last three trading sessions. We
remain medium-term USD bulls and GBP bears, but ask whether the lurch lower in
EUR/USD is overdone. The threat of a sharp rebound in the US unemployment rate above 10% in February
could result in the unwinding of post discount rate hike USD gains, with the
EUR separately standing to benefit from a flawless Greek 10y bond auction and more concrete plans of EU debt guarantees.
Overall, the failure of major equity indices to challenge recent highs,
stagnant commodity prices and speculation of tighter monetary conditions in China still warrant a cautious approach
towards pro-risk strategies. With bearish seasonals lurking in March for the
JPY, we think the SEK is well positioned within the G10 to extend its stellar
performance, supported by hawkish central bank rhetoric and a relative sound
fiscal position visa- vis other G10 nations. Shrinking UK/G10 rate
differentials and talk of a snap UK general election should keep GBP on
the defensive, with the tempo of liquidation increasingly characterising fears
of a precipitous GBP rout USD
â˘ A turn lower in US economic data for
January and resulting lack of conviction to push risk assets convincingly
higher have given the USD a lift in the G10 except vs the JPY. Though
technically the USD is looking increasingly overbought, negative news flow from
the G10, sovereign debt concerns and the Fed plan to withdraw liquidity are
supportive of additional USD gains as we head into March. Strong direct bidding
at Treasury auctions should alleviate some of the (debateable) concerns over
reduced direct Asian buying. Our medium-target is 83.20.
â˘ Arctic January weather is wreaking
havoc on US data releases and has resulted in the âsurprise indexâ turning
lower in February (see chart). The question for next week is whether this also
applies to the February employment report. The possibility of a return to
sharper falls in non-farm employment and a good reception of the Greek 10y
auction could stall the USD index in its tracks below 81.0, with profit taking
and EUR relief buying knocking the index back through trendline support at
80.382. Support below runs at 80.0, followed by 79.55.
â˘ We took nothing away from Fed
chairman Bernankeâs testimony last week that we didnât know in terms of exit or
Fed funds, with the premise still holding that interest rates will stay low for
an âextended periodâ. The debate over the timing and sequencing of asset MBS
sales and a higher FF rate remains highly uncertain. In the context of the
upcoming non-farm payrolls data , US/G10 rate differentials are likely to
dictate major fx flows.
â˘ As a proxy of risk aversion, the
steep drop in EUR/JPY to 119.66 overshadows the relative resilience in EUR/USD
around the 1.36 area. As we state above, we are tempted by the upside potential
in EUR crosses over the week ahead, particularly against the USD conditional on
a tightening in 10y Greece/bund spread towards/below 300bp and a rise in the US jobless rate from 9.7%. EUR/USD
1-month risk reversals have also held up above -1.76, the February 8 low,
signalling that bearish momentum is stretched. A test of 1.3688 resistance (21d
MA) would attract short covering and pave the way for a move up to 1.3750, with
more ambitious targets situated at 1.3850-1.39.
â˘ EUR/USD outperformance vs GBP/USD,
month-end flows and gilt dividend redemptions pushed EUR/GBP though 0.8822
(200d MA) and 0.8928 (100d MA) last week, leaving the cross to trade above 0.89
for the first time since mid-January. A compression in the UK/EU 2yr spread to zero
supports the bullish set-up, though technicals are looking increasingly overbought
(upper Bollinger band). Fears of a hung parliament (Conservativesâ lead over
Labour cut to 5pts according to latest Ipsos poll) suggest the cross is well
placed to extend up to 0.90, with a good Greek 10y auction and tighter
sovereign spreads adding upside potential.
â˘ Euro zone data over the week ahead
features the final readings of the manufacturing and services PMIs for
February, revised Q4-09 GDP (f/cast unrevised at +0.1% q/q). We expect the ECB
to leave the key refi rate on hold at 1%. The Bank is also likely to extend
unlimited funds at fixed rates into Q3, though disagreement may emerge over
whether to cover only the main weekly liquidity operations or longer-term
â˘ We donât have high hopes for a
relief bounce in the major GBP pairs following the brutal sell-off last week.
The collapse through key technical levels leaves no alternative but to remain
wary of further selling pressure, especially vs the JPY considering the
precarious pro-risk context. Selling rallies is the favoured tactic into
Thursdayâs BoE MPC meeting.
â˘ The market is torn between on the
one hand, scepticism over political courage to cut the public deficit, and on
the other hand, the fear of a double dip recession in Q1. Sterlingâs apathy to
the upward revised Q4 GDP (+0.3% q/q vs +0.1%) and high correlation with
negative data surprises makes us wonder will turn around negative sentiment.
â˘ The rapid descent below 1.55 and
1.5357 does not bode well for the near term and supports our call for a decline
to 1.50. The fact that IMM short GBP contracts are some way off the October
2009 low (56,000 vs 65,300) suggests that from a pure speculative standpoint,
further downside in GBP/USD cannot be ruled out. Key support runs at 1.5069,
the 61.8% Fibo retracement.
â˘ For next week, we expect the BoE to
stand pat on Bank rate (0.50%) and the QE target (ÂŁ200bn). The February
manufacturing and services PMIs will be crucial in shaping confidence about
Q1-10 GDP and will impact expectations about a resumption of gilt purchases by
the BoE in Q2. The DMO will auction ÂŁ2bn of 4.25%, 2039 gilts on Tuesday (last
b/c 1.74) and ÂŁ4bn of 2.75%, 2015 paper on Wednesday (last b/c 2.68).
â˘ An impressive rally boosted JPY/G10
last week, clocking up gains of 3.5%- 4% against the high yielders on
flight-to-quality and lower oil and gold prices. Strong weekly inflows into JPY
securities, the highest for nearly 3 months, supported JPY demand, with
overseas investors piling in to JGBs and money market securities.
â˘ Speculative IMM long JPY positions
are well below historical norms (10,200) contracts) and indicate that JPY/G10
shorts may still have the upper hand. US non-farm payrolls and momentum in
equities will set the tone next week. A step-up in risk aversion is necessary
to break 88.56 support in USD/JPY, the February 4 low, and 119.66 in EUR/JPY.
Downside momentum in EUR/JPY is covered by the slump in the 2y bund/JGB spread
to 78bp. The cycle low rests at 76bp. GBP/JPY broke through 135.77 support,
putting 130.0 on our radar.
â˘ We remain wary of JPY bearish
seasonal trends which tend to develop and favour of short JPY positioning in
late February/March. Unless risk appetite returns, optimism for a rally back up
to the January highs around 94.0 could swiftly peter out, adding momentum for a
break below 88.50 in USD/JPY. Key support for the S&P 500 runs at vs 1,096,
the 100d MA.
â˘ Japanese macro data is fairly low
key next week and includes unemployment (f/cast unchanged at 5.1% in January)
and Q4 capital spending (f/cast 18.4% drop). The Nikkei-225 rests on key
trendline support at 10,061. A narrowing trading range for the Nikkei with
trendline resistance situated at 10,330 and support at 10,061 suggests a
breakout is imminent.
â˘ Though the CAD remains stuck in a
4-month trading range, signals emerged this week that the currency is
potentially starting to buckle under pressure from safe-haven outflows. We are
monitoring trends closely, and would be worried for USD/CAD if it edges closer
to 1.0730 with Nymex crude close to $80. Key support rests at 1.04. US/CAN 2y
rate differentials are locked in a 44-52bp range, offering no clear sense of
â˘ We expect the Bank of Canada to keep
its key interest rate on hold at 0.25% next week, and reiterate its verbal
intervention against CAD strength. Canadian employment stats for February are
due on Friday may underline the resilience of the labour market vs the US (January: +43k vs 20k, see chart).
This could tempt CAD bulls to push for as move back to/below 1.05.
â˘ The RBA meeting and accompanying
statement on Wednesday () are key for near-term direction. With
a 25bp rate hike to 4.0% priced in, a dovish statement and hint of a second
pause could undermine the relative resilience of the AUD vs the USD and
diminish the currencyâs carry potential compared to the NOK, SEK and CAD.
â˘ Long AUD IMM positions have settled
down in late February at less than half the January peak (34,000 vs 83,000,
hinting at waning conviction among AUD bulls. Key levels to look out for in
AUD/USD are 0.8974, and trendline resistance at 0.9024. Profit talking on the
RBA would trigger a move to 0.8625 support, the 200d MA. For EUR/AUD, a
widening in AUD longs vs EUR shorts has so far not been translated into
additional gains below 1.5043. Upside risk for a rally back up to 1.55 is
partly associated with the unfolding of the Greek 10y auction. Beyond the
short-term, we favour selling EUR/AUD rallies based on rate differentials, and
a 300bp AU/EU central bank spread.
â˘ Ahead of the RBA rate decision,
governor Stevens may lift a tip from the Bankâs strategy and the latest views on
the economy and rates in a speech late on Sunday in Melbourne. The correlation of AUD/USD with gold
has continued to lose momentum into late February (0.64 vs 0.95 high in December).
A break of gold above $1,127 resistance may negate a more dovish RBA influence
and help AUD the re-establish a more bullish footing.
â˘ The impressive pullback in NOK/SEK
below 1.2171 support testifies to growing bearish momentum, with selling into
the 1.2050 area clearing the way for a move below 1.20 if 1.2007 trendline
support is removed.
â˘ Hawkish Riksbank rhetoric was backed
up by strong Swedish retail sales data last week (+1.7% m/m in January), and
keeps expectations alive for a rate hike as soon as April. Swedish Q4 GDP data
is due next week. A positive outcome, forecast +0.3% q/q, would fuel talk of a
first Riksbank tightening since September 2008. Disappointing GDP stats would trigger
a bounce back over 1.2150. The NO/SWE 2y spread narrowed this week to 45bp, the
low end of the range.
â˘ For EUR/SEK, a lot depends on what
happens with respect to Greece next week and a relief bounce in
EUR/USD. One of the worst performing crosses last month following the plunge
from 10.11 to 9.70, the stakes could be raised for SEK bulls regardless of
whether Swedish GDP tops consensus forecast. Key resistance levels are situated
at 10.29 (100d MA), followed by 10.36 (the 50d MA).
â˘ For USD/NOK, a rally running out
steam in the 5.98 area hints at a fading of bullish momentum, with risk of a reversal
towards to 5.82 and 5.74 support. Repeated failure to challenge the 6.04 high
points to rangebound trading conditions near-term. Wait and see what US non-farm payrolls bring on Friday. Norwayâs central bank is expected to leave
the key deposit rate on hold next Wednesday at 1.75% but reiterate that rates
may still have to rise to 2.25%, the upper end of the forecast range. Norges
has also indicated it plans to make no
currency purchases in March for the Government Pension Fund.
Quantitative Market Analysis
Altaz Dagha, Strategist
â˘ Interest rate
spreads to be key driver of FX next week
â˘ Technicals and
trend indicators suggest further downside to sterling
â˘ Euro short
positioning not as overcrowded as the market thinks
Risk Reversal Skews (based on options
prices, see page 7) and IMM data (highlighting speculative positioning, see
page 6) are used to analyse foreign exchange to understand how stretched
currencies may have become.
The last set of IMM data (up until
16th Feb) showed the market has added further to its short EUR and
GBP positions. Both GBP/USD and
EUR/USD positioning currently lie close to, or at the zero percentile bound.
Although there is talk now that the marketâs short euro position may be
overcrowded, it is worth bearing in mind that in May 2007, net long contracts
for EUR/USD were twice the amount that are currently net short. This suggests
there is still some way lower to go before a major short squeeze higher.
GBP/USD positioning shows similar characteristics and as such, we remain
comfortable with our strategy of selling into any EUR/USD and GBP/USD strength.
Risk reversal skews (I analyse them by
ranking the data over a rolling year) remain stretched in favour of USD calls
although there has been some pull back in USD/JPY, reflecting the recent
appreciation of the Japanese yen as a result of a more risk averse tone in financial
As risk reversals continue to trend in
favour of the US dollar and on a 12-month comparison are close to, or
at, highs/lows over the year, this flags
the risk of a reversal. As mentioned above, however, we think IMM positioning
is not overcrowded as yet and the fundamental backdrop supports this view. As
such, while we remain wary of a correction in the US dollar, we expect the
theme of broad dollar strength to continue over the coming months.
Market correlations are shown on pages
10-12. 1- month rolling correlations are plotted for G-10 FX against interest
rate spreads, S&P500 and commodities (represented through the CRB index). Interest
rate spreads have continued to edge in a dollar positive direction although
correlations between rate spreads and G-10 FX have come down a touch over the
week. EUR/USD, however, remains well correlated with the 1-month correlation at
0.84. Interest rates, however, were clearly the main drivers this week with the
relationship between risk assets (equities and commodities) and spot rates
We expect interest rate spreads to be
more influential over the next week or so, especially with the all important US employment report next Friday. A
positive print combined with the ongoing uncertainty around peripheral eurozone
could see a further dollar rally. Much will depend on the Greece 10yr government bond issuance and new
austerity package - both expected next week. A successful auction and credible
fiscal measure could see some respite for the euro, backing up the near-term
bullish price action witnessed over the past couple of sessions.
GBP/USD has seen a break of key
technical levels also this week, falling through the 50% fibonacci retracement
level. Trend indicators also suggest further downside with the 10 and 55 day
moving averages having now crossed below the 200 day moving average. Our original
target of 1.50 is close. We envisage a move down to 1.4750 if 1.50 fails to
0207 158 1750
0207 158 1747
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