Highlights

• Can EURUSD stay above 1.30?
• Global PMI’s to bring growth back in focus
• D-day for UK Chancellor Osborne
• RBA likely to resume monetary easing

EURUSD closed the weekly London session above 1.30 on Friday for the first time since mid-October. This is a very bullish development for this cross, however, the question to ask now is can the euro extend these gains into the end of the year?

To answer this we need to look at both the technical and fundamental factors impacting the single currency. From a technical perspective the bulls are still in control. EURUSD broke above the top of the daily Ichimoku cloud last week, which is the start of a technical uptrend, added to that it also broke above the base of the weekly cloud at 1.2840 early last week. This suggests that the longer term downtrend may be coming to an end. The market is still net short EUR according to the latest CFTC data. However, after reaching record levels, the number of short contracts has been cut dramatically since June 2012 – just before ECB President Draghi said that he would do everything possible within his mandate to protect the single currency.

So from a technical perspective there is room for further upside, and momentum indicators don’t suggest that the euro is currently overbought in the short term. However, there is a major resistance level coming up at 1.3175 that could thwart the bulls without a major shift in the fundamental picture.

The problem with a sustainable uptrend for the euro is that the fundamental picture is still dismal. On Friday unemployment data for the currency bloc was released that reached another record high of 11.7%. Next week sees the release of final November PMI surveys, which are expected to remain mired deep in recessionary territory. The OECD expects the Eurozone to remain in recession until early 2013, after that it expects the bloc to experience a milder contraction of 0.1% of GDP next year; however the risks are to the downside.

Sovereign concerns may also flare up again. Although Greece managed to get over the last hurdle to receiving more bailout cash when the German Parliament approved the release of funds at the end of last week and Spanish bond yields fell 35 basis points on the week, we think this may be a temporary respite. Greece’s debt burden remains unsustainable as long as EU officials refuse to accept haircuts on official holdings of Greek debt. Likewise, Spain may be fully funded for 2012, but it has a record amount of debt to issue for 2013, thus we could be close to a bottom in Spanish bond yields.

Whether or not Spain’s yields can fall back to the lows below 5% at the end of February may depend on the ECB. The Bank meets this Thursday and is expected to keep rates on hold and no further policy announcements are expected. Thus, in the absence of Spain making a formal request for aid, 2012 may end without the ECB’s bond-buying OMT programme being activated. We expect ECB President Draghi to say that the ECB stands ready to activate the OMT programme; however in a speech on Friday Draghi made very clear that the OMT won’t solve all of the currency bloc’s woes. He was very clear that it is up to governments’ to tighten budgets and forge a banking union. He urged politicians to leave behind the “fairy world” that allowed problems to grow, and get on with reform efforts.

Draghi does not mince his words, thus we expect similar comments during his press conference on Thursday. If the ECB does not enact anything new at this meeting, the last of 2012, then we may see sentiment towards the euro start to sell off at the tail end of next week. 1.2950 then 1.2830-80 – a cluster of daily smas – should act as good support in the short term.

Early next week, November manufacturing PMI’s are due out of the world’s key economies. China sees the release of its official manufacturing PMI on Saturday with the private sector reading (reported by HSBC) due on Monday. Monday will also see manufacturing PMI’s from major European economies including Germany, France, Italy, Switzerland, and the UK as well as the Eurozone reading. Lastly, the US is set to release the November ISM manufacturing report. These surveys from purchasing managers are significant leading economic indicators because they indicate the demand for supplies, rate of orders, inventories and hiring from large manufacturers which gives a sense of economic activity. Services PMI’s are also due out next week and are similar surveys of purchasing managers in the services sector. The indicators are a diffusion index and a reading above 50 indicates expansion, while one below signals contraction.

Of the major economies to release manufacturing PMI’s next week, only China and the US are expected to show above 50 prints which signal expansion. Regional Fed surveys of manufacturing activity for the month of November have been soft and suggest that the pace of expansion has slowed. Indeed, this was indicated in the Fed’s latest Beige Book report which noted that “manufacturing weakened, on balance”. As such, we may see a slight decline in the ISM manufacturing reading. On the other hand, China’s print is expected to show a pickup in the pace of expansion as the Chinese economy (the second largest in the world after the US) has begun to show signs that the economic slowdown may be nearing a bottom. Improvement in Chinese manufacturing is likely to be supportive of the overall risk environment and specifically the AUD if demand for Australia’s natural resources picks up. Therefore, the AUD is likely to be sensitive to any surprises in Chinese data. However, it is important not to overlook the impact of next week’s RBA meeting on the Aussie as well (see below).

Economic activity in the Eurozone remains weak. Although no further deterioration in the November PMI readings (both manufacturing and services) are expected, figures should remain below the 50 threshold which indicates contraction. This past week, the OECD release economic projections which forecast Eurozone GDP to shrink by -1.3% in Q4. EUR/USD has been flirting with the top of its daily ichimoku cloud over the past several sessions and we expect the pair to continue to trade within the cloud. As expectations are for Euro area economic activity to remain weak, the risk is to the upside. A positive surprise in PMI figures could see the EUR/USD break the top of the cloud, however we would wait for a convincing break above the 1.30 level to signal a possible move back towards recent highs ahead of the 1.32 figure. Our long term outlook remains for the euro to decline as policy risk remains high and economic weakness is likely to persist.

It’s been a fairly quiet run-up to the autumn Budget Statement in the UK, which the Chancellor George Osborne will deliver at 1230GMT/ 0730 ET on Wednesday 5th December. The Chancellor won praise for his choice of Mark Carney to take the helm of the Bank of England when Mervyn King retires, which has consumed media attention in recent days. However, this week could be harder for the Chancellor to win praise.

The Budget statement is unlikely to announce too many big ticket changes to tax and spending plans for the rest of the fiscal year. January’s scheduled rise in fuel duty is likely to be postponed indefinitely and there may be new measures to tax high net worth individuals and close tax loopholes. However, the focus is likely to shift to whether the Chancellor will meet his own fiscal targets.

Expectations are rising that the Chancellor will be forced to extend the target for reaching a cyclical budget surplus and a decline in the UK’s debt-to-GDP ratio by a year to 2016/17 from 2015/16 after some dismal fiscal data in recent months. The fiscal data has been deteriorating after some good news earlier in the year. Revisions to government borrowing in the first five months of the year saw a reduction of GBP7 billion in the budget deficit. Added to that the Treasury’s decision to transfer cash from the Bank of England’s QE programme to the government coffers could also boost the fiscal data, however the problem lies with tax receipts. In October (the last public finance data available before Wednesday’s statement) the budget deficit was GBP8.9 billion, up from GBP5.9 billion last year. This suggests that full year borrowing for 2012/13 could be GBP 10 billion more than the current target of GBP 120 billion, if this trend continues. Since the economy is not expected to pick up until late 2013 (according to the latest OECD estimate) then there is a high probability that tax receipts won’t recover in time to save the Chancellor’s fiscal targets.

But what does a GBP10 billion increase in the borrowing forecast really mean for the market? Osborne and Prime Minister Cameron have staked their reputations on bringing the public finances back on a more stable footing, thus admitting defeat mid-way through their term in office is unlikely to win them any political points and could damage their credibility. However, increasing the targets may not be all bad news. The OECD released its latest growth forecasts for the next two years last week. Although the think-tank agreed the need to bring public finances back under control, it also urged caution to adjust targets in the event of weaker than expected growth. If the government does not adjust its borrowing target for this year that means more austerity that may weaken the growth outlook even more.

The UK has retained its triple A credit rating and the rating agencies have said this is down to the UK’s fiscal consolidation plan. However, if the Chancellor sticks to his fiscal targets religiously and the economy is plunged into another recession then we may lose our top rating anyway.

Thus, the autumn statement may not be as “negative” for UK risk assets and sterling as it first seems, but we would expect a lot of volatility in sterling crosses on Wednesday lunchtime.

The pound has been moving on the back of overall risk appetite in recent weeks and in the long-term we expect this to continue. On a broad basis the pound was flat last week after deteriorating against the euro and gaining versus the yen. GBPUSD was fairly flat after breaking through the key 1.5970 resistance zone – the base of the daily Ichimoku cloud. Any slackening of the fiscal targets may see a knee jerk reaction lower in GBPUSD, but we expect 1.5950 to attract buyers as long as the external risk environment remains stable. The long –term trend is still higher after GBPUSD broke above the top of the weekly cloud at 1.5925, which is the start of a long-term technical uptrend in this cross.

The Reserve Bank of Australia (RBA) will meet on Tuesday and announce interest rates. We agree with the market consensus that the Bank will deliver a 25bps reduction in the policy rate to 3.00%. The Bank has been in an easing cycle over the past year and last cut rates on October 2 from 3.50% to the current rate of 3.25%. With external uncertainties remaining elevated and key commodity prices significantly lower there is scope for the Bank to continue to ease. Indeed, minutes from the November 6 meeting show that officials said that “further easing may be appropriate”.

Inflation has picked up but risks falling again as the exchange rate remains highs and the industrial sector declines. Furthermore, inflation remains at the very bottom end of the RBA’s target range after increasing by more than expected. Recent figures on capital expenditure contained a downward revision to the outlook for the mining sector which has been a concern of the RBA.

AUD/USD has declined over the past few sessions and a move by the RBA to lower interest rates may increase pressure on the currency. Rising trendline support which dates back to the June lows is currently coming in below the 1.04 figure. This is also where the 100-day simple moving average (SMA) resides and is likely to be a key pivot. A break of the 1.0360 level is likely to see the 200-day SMA around 1.0300 next and below that may see the downside accelerate. To the upside, the 1.05 figure is a significant resistance level and a break above here would negate our bearish bias.

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