Week of April 17, 2011
USD consolidates, while metals shine
The US dollar managed to hold its ground against most other major currencies, and it still remains vulnerable, essentially consolidating near recent lows. Incoming US data over the past week suggest the US recovery is continuing, with strength in manufacturing as the lead driver. Renewed concerns over debt restructuring in the Eurozone re-surfaced, adding pressure to the EUR against most other currencies, and preventing a break above the key 1.4500/30 resistance in EUR/USD (see below). The exception for USD stability was against the JPY, where it gave back some recent gains and posted a bearish engulfing line for the week, suggesting further downside potential ahead. Moreover, weakness in USD/JPY also hints at increasing risk aversion as seen in lower JPY-crosses, higher US Treasury prices and potential stalls in major stock indexes below highs for the year. The return of Eurozone debt fears has the potential to reignite overall market uncertainty, as a restructuring or default would lead to major losses in the Eurozone financial sector, where the banks are major holders of peripheral Eurozone government debt. While we don’t anticipate an announcement of a debt restructuring in coming weeks, we will be alert to markets pricing-in such a scenario. We would also note that it’s the week before Easter, when many investors take holiday, typically reducing liquidity and raising the potential for heightened volatility.
With the USD weak and the EUR being put back under the microscope, precious metals have surged higher as so-called currency alternatives. If there is a risk sell-off, especially if focused on EUR, the metals may find even greater demand in the weeks ahead. But if any risk retreat turns particularly ugly, metals may also end up being dumped, as speculative longs may be forced to exit positions to preserve margin for other trades. Gold prices appear on track to test the $1500/oz psychological/round number resistance level, but we would expect some profit-taking around that price and we’ll be on alert for any subsequent failure or rejection. We think XAU/USD has additional upside potential while above the $1445/50 area. Silver prices are also soaring, but face resistance at $43.05/10 (123.6% of primary wave higher), then 45.05 (138.2% of primary wave higher). XAG/USD has upside potential while above 40.90/41.00, in our view.
Could peripheral concerns disrupt the ECB?
Portugal’s bailout was expected to draw a line under the peripheral debt crisis as Spain was believed to be out of the woods. But last week the start of what could be the sovereign debt crisis v. 2.0 came to the fore.
The second phase of the crisis is likely to concentrate on the prospect of restructuring and haircuts on sovereign bonds. Greece, which has the worst debt position of all the peripheral nations and has the highest risk premium attached to its government debt, could impose haircuts of between 50 and 70 per cent, according to analysis from a major ratings agency.
This caused credit markets to shudder. Added to this, at the end of last week Moody’s credit rating agency downgraded Ireland yet again and Dublin is now clinging on to its investment grade credit status. Moody’s cited a deteriorating growth outlook made worse by the ECB rate hikes that could further depress consumer demand.
While we continue to believe that the ECB will embark on more rate hikes due to inflation pressures, there are currently three further hikes priced in to the European rates curve between now and the end of the year. If the pace of tightening accelerates, then we could easily see further ratings downgrades to Portugal, Ireland and even to Spain.
Protecting Spain from financial turmoil is pivotal for European asset markets and to keep the single currency supported. Over 80 per cent of homeowners in Spain have variable rate mortgages, so they get hit quickly from rising interest rates. Credit ratings agencies will be watching closely to see if this hurts growth going forward. If there are signs that the Iberian nation’s economy is faltering under the weight of increased mortgage payments, then Spain is at risk of a downgrade.
While ECB speakers have sounded increasingly hawkish in recent weeks, the ECB will be wary of Spain’s plight and further rate hikes beyond the three already priced in by the markets may not materialise. This could keep EURUSD trading in a range. 1.4530 is a key resistance level; if we get a convincing break above here then we may see 1.4600 first towards 1.4800.
The Bank of England to keep cool on rates over the summer
We have been non-consensus on the outlook for UK interest rates for a while and don’t think the Bank of England will hike until the fourth quarter of this year. This is due to three factors. The first is that growth signals, although volatile, have tended to point to another disappointing quarter for the UK economy. Although we don’t expect growth to be negative like it was in Q4 2010, a rate of about 0.5 per cent in Q1 is all we think the UK economy can muster at the present time.
Retail sales are weak, the manufacturing sector looks like it is coming off the boil, the housing market is under pressure and public sector spending cuts are only just starting to bite with any real force. Although the March PMI services sector survey surprised on the upside and reached its highest level in nearly a year, we think this was just an anomaly.
Likewise, the improvement in the unemployment rate to 7.8 per cent last month from 8 per cent February is unlikely to be the start of a trend as growth remains lacklustre and state jobs get cut later this year.
Although headline inflation moderated in March to a 4 per cent annual growth rate from 4.4 per cent in February, inflation remains elevated and continues to eat into households’ disposable income. Crucially, headline inflation pressures are not feeding into wage growth, and average weekly earnings in February actually fell to a 2 per cent annualised growth rate. Until we see the economy start to boost wages we think the Bank will be cautious about raising rates too soon.
One caveat is the Q1 2011 GDP report released on 27 April, which may be the game changer. If growth was strong in the first three months of the year then the Bank may choose to hike in May. We think this is unlikely.
Although in the long-term reduced support from yields should weigh on the pound, in the short-term the UK currency is benefiting from a weak dollar. We expect GBPUSD to remain well supported above 1.6000. We prefer a long position in EURGBP, which should benefit from the diverging interest rate stances of the ECB and the BOE. If we can break above this 0.8900 resistance level, then we may see back towards 0.9050 first and then 0.9350 next.
SEK firms as Riksbank tightening expected to continue
On Wednesday April 20, the Riksbank meets to decide on its key interest rate, the repo rate. We agree with the market consensus that the bank will increase rates by 25 bps to 1.75%. The bank’s monetary policy objective is to “maintain price stability” which the bank has interpreted to mean a low, stable rate of inflation of around 2% per year based on the CPI. Headline inflation accelerated to 2.9% in March up from 2.5% in February, exceeding the central bank’s 2% target for the fourth consecutive month. In response to the elevated inflation levels and tremendous growth, the bank has hiked rates 5 times since July. The first of the 6 yearly rate meetings occurred on February 15 and resulted in a 25 bps rate hike to 1.5%. The bank is expected to continue its tightening cycle and Riksbank Governor Stefan Ingves has said he can’t rule out raising rates at all five remaining policy meetings this year. First deputy governor Svante Oeberg went further saying, “it is quite possible that it will need to be raised by more than 0.25% at one or more meetings and that it will need to be increased to 4% already next year”. This suggests that the risks of a surprise from the Riksbank are that they hike more aggressively (50 bps), which the market has not factored in, potentially leading to outsized gains for the SEK.
The Swedish economy is Europe’s fastest recovering economy, which grew 5.5% in 2010 and is expected to expand at a pace of 4.6% this year according to a report released on Wednesday by the Swedish government. Not surprisingly the Swedish Krona has been the strongest performer of the G10 currencies against the US dollar year-to-date. USD/SEK is trading at lows that have not been seen since August 2008 as interest rate divergences widen. A break below the April lows of about 6.1800 is likely to see losses accelerate towards the 6.1200 pivot (mid-2008 resistance) initially ahead of the key psychological 6.0000 level. To the upside, the pair sees the 21-day SMA just under 6.3000 and the Kijun line above that at around 6.3500. In EUR/SEK, the 100-day SMA comes in around the 8.9300 level and a break below here may see towards the top of the daily ichimoku cloud which comes in around the 8.8600 area. The key level to the upside is the Tenkan line which comes in at about 9.0280.
The Aussie should continue to defy gravity
Last week Australia’s unemployment rate fell below 5%, to 4.9%, as the March employment figures surprised to the upside and climbed by 37.8K. Additionally, Westpac consumer confidence in April rose by 1.2% from -2.3% the month earlier and NAB March business conditions rose to 9 from -2 MoM. Bear in mind, Australia’s reconstruction efforts from the severe cyclone and floods are set to pick up in the second half of 2011 – consequently a rebound in growth should be expected.
Overall, stronger employment figures, rising consumer confidence, better business conditions and rebuilding efforts suggests future income growth is justifiable. Furthermore, as commodity prices continue to rise and exports to China remain robust, taken altogether this should stimulate the need for the RBA to react sooner rather than later. Presently the market implied expectations sees the RBA cash rate at 4.875% by the end of the year, from 4.75% currently. While a stronger AUD has reduced immediate inflationary fears, we believe the market has underpriced its severity and expect the RBA to hike rates at least twice before the end of the year. Watch the RBA minutes on Monday for any shift in current thinking.
The primary factor limiting the Aussie’s upside at the moment is positioning, as the IMM report earlier in the week showed the AUD is at record longs, and looks a little overextended. However, while the Fed continues to remain dovish and states that rising commodity prices are ‘transitory’, traders will continue to remain long commodities and thus commodity currencies. Moreover, the risk of further G7 intervention in the JPY should prevent a substantial sell-off in assets, which means a ‘buy on dips’ strategy should be the preferred plan going forward. Therefore, we would look to be a buyer of AUD/JPY on a dip towards 85.00/50 and for those seeking a relative commodity currency play – buying AUD/NZD on a dip towards 1.3125/75 could be a good idea in the week ahead.
Key data and events to watch in the week ahead
United States: Monday - APR NAHB Housing Market Index, Fed's Fisher, Lockhart to Discuss Globalization in Atlanta, Fed's Bullard to Speak on Banking Rules in Kentucky, Fed's Fisher to Speak on U.S. Economic Outlook in Atlanta Tuesday – MAR Building Permits, FEB Housing Starts, Wednesday - MBA Mortgage Applications (APR 15), MAR Existing Home Sales, DOE U.S. Crude Oil Inventories Thursday – Weekly Jobless Claims, FEB House Price Index, MAR Leading Indicators, APR Philadelphia Fed. Friday – U.S. equities closed in observance of Easter
Eurozone: Monday - APR EZ Consumer Confidence Tuesday - EZ APR PMI Manufacturing & Services, German APR PMI Manufacturing & Services Wednesday – MAR German Producer Prices, EU's Juncker Speaks on Euro Economic Governance in Brussels Thursday -APR German IFO Business Climate, Current Assessment, & Expectations
United Kingdom: Sunday – APR Rightmove House Prices Wednesday - Bank of England Minutes Thursday – MAR Public Finances (PSNCR), MAR Retail Sales
Japan: Tuesday – FEB Tertiary Industry Index (MoM), FEB Adjusted Merchandise Trade Bal., MAR Supermarket Sales Wednesday - BOJ Deputy Governor Nishimura to Speak in Yokohama City Thursday – FEB Coincident Index CI
Canada: Monday – FEB Int'l Securities Transactions Tuesday – MAR Consumer Price Index, MAR Bank Canada CPI Core, MAR Leading Indicators, FEB Wholesale Sales Thursday – FEB Retail Sales
Australia & New Zealand: Sunday – NZ 1Q Consumer Prices Monday – RBA’s Board April Minutes Tuesday – AU FEB Westpac Leading Index, 1Q Import and Export Price Index Wednesday – AU 1Q Producer Price Index, NZ MAR Credit Card Spending
China: Sunday – MAR Property Prices APR17/22 – MAR Actual FDI Monday – HSBC Flash China Manufacturing Tuesday – Conference Board Leading Economic Index
G20, IMF: Meetings start on Friday through the weekend
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