It’s been a fairly quiet start to the week as the US is out on a public holiday and the G20 ended up being fairly uneventful. The communique said nothing remotely controversial – Japan was not mentioned by name and although the most powerful nations in the world spent a lot of time talking about currencies, they didn’t say anything that is likely to dramatically alter the FX landscape. However, don’t be fooled, there is a lot going on this week so watch out.
Private pressure from G20 rather than public humiliation
Back to the G20 and lack of fingers pointed on Japan. That was perceived as a green light to sell the yen once more and USDJPY duly jumped 200 pips to 94.00. However, there are still many hurdles to 95.00 and beyond, and for now 94.20 is acting a short term resistance. Firstly, although there may not have been public pressure on Japan there could well have been private pressure from the G20 to stop talking down the yen. Added to that, a lot of easing is already priced into the yen, which could limit further downside in the Japanese currency. The key focus in Japan is now on the next BOJ governor, who could be announced as early as this week. The current governor Shirakawa is leaving in 3 weeks, so there isn’t much time to prep the market. The front-runner is Toshiro Muto, who although is considered dovish, he is probably the least dovish of all the candidates the market has speculated on. Thus, if Muto is announced as the next governor we could see a short term rally in the yen, knocking USDJPY back towards 92.80, an important short term support level.
Tomorrow’s BOJ minutes will also be important to gauge what sort of time frame the BOJ will employ to meet the 2% inflation target. If the minutes suggest that the 2% rate is a long-term goal that requires incremental policy changes rather than a mad rush by the bank to weaken the yen and push up inflation then we could see the pace of the yen’s decline start to slow. Thus, although the G20 passed by without diplomatic incident, its effect could be more covert in the medium term.
Draghi to determine next move in EURUSD
In the absence of much economic data this morning and with volumes thinned because the US is out, the market will likely focus on ECB President Draghi’s speech in Brussels during the quarterly hearing on the ECB. This takes place at 1430 GMT, and Draghi is expected to start speaking at 1445 GMT in English. There are a few things to watch out for:
• Will Draghi hint at a potential to cut rates to try and boost inflation?
• What will he say about the dreadful Q4 growth figures?
• Will the G20 limit what he can say about the euro?
We tend to think the most likely outcome from today’s speech is:
• Draghi doesn’t state that the level of the euro is problematic, but instead focuses on the threat to inflation.
• He may say that the risks to growth are still to the downside, but that some signs of stabilisation are continuing.
• He may mention that the monetary policy transmition mechanism is still blocked, and credit to struggling peripheral businesses is not getting through. This is a way to suggest that further monetary policy could be targeted.
Going forward though, Drgahi and co at the ECB need to be careful about activating something like the OMT to stabilise the peripheral bond market, without putting extra upward pressure on the euro, which weighs on the growth outlook. Due to this, a rate cut could be more effective than bond purchases, from a currency perspective, at this time. We will also look out for a subtle shift in rhetoric from Draghi from focusing on the OMT to hinting at the possibility of using more conventional monetary policy tools like interest rates and deposit rates in future, although we are aware that the powerful German Bundesbank would likely be opposed to this.
The euro has not fully recovered from Draghi’s press conference earlier this month. If he extends the debate about potential future policy moves then we could see further weakness in the euro and a potential decline through 1.3295 – the 50-day sma –a key support zone. We still tend to think that the upside in EURUSD is capped around 1.3500 – the 10-year average.
Political risk back in focus
Other crosses are also vulnerable, including EURGBP. This cross has recovered back towards 0.8650 – although 0.8720 is a tough resistance level. Monetary policy risk will be compounded with political risk later today as the last week of election campaigning in Italy kicks in. Berlusconi and Bersani (the two front runners) are both holding rallies today. Any sign that 1, Berlusconi’s share of the vote is increasing or 2, the prospect of a Bersani/ Monti coalition (the most market friendly outcome) is under threat could also cause waves in EURUSD and upward pressure on Italy’s bond yields. This is bad news for EURJPY, as it has a fairly tight inverse correlation with German- Italian bond spread. Support levels to watch in EURJPY include 124.95 then 124.25, in the short term. It is also worth pointing out that EUR long positions fell sharply last week, according to CFTC data. The market is still net long EUR, but the Draghi comments at the last ECB meeting led to a reduction in bullishness, further highlighting that 1.3720 could be a medium-term top in the single currency.
Ahead today, Mexican GDP is the data highlight. The market expects Q4 annualised growth to remain steady at 3.3% (according to Bloomberg), although the risks could be to the downside after the dreadful US GDP for the last three months of 2012.
One to Watch: Gold
Precious metals still look weak in our view and the medium-term risks are to the downside. Gold briefly dipped below $1,600 at the end of last week, as rising Treasury yields, falling risk aversion and no signs of inflation pressure, and erased demand for gold. The drop to $1,600 was too much too soon, and there was an inverted hammer candle pattern on Friday’s chart, suggesting that $1,600 is a temporary bottom. With Fed minutes due this week expected to show that there is no end in sight to QE3, the gold price recovery may continue. However, we tend to think that any recovery will be short-lived and we could see selling pressure around the $1,645-50 mark.
