View: Persist with selling EUR/USD rallies, current move looks stretched, timing the risk
We’ve seen a solid bounce in EUR/USD after a brief penetration of the 1.3000 level this morning, maintaining immediate bullish momentum. While there are doubts surrounding the execution of the ECB’s OMT plan as Spain looks to avoid a formal bailout and the oversight that would accompany this, which is a prerequisite for any central bank support, the onset of QE3 followed by BoJ easing has refocused attention on the influence of central banks on currencies. This is naturally bad for the dollar with the Fed clearly having the most robust/effective track record for keeping the Greenback weak in contrast to Europe where a strong currency is still seen as a sign of confidence in the project rather than a helpful adjustment mechanism. The less said about the Bank of Japan’s ability to guide the JPY weaker the better.
Full report below…
View: Near-term equity upside doesn’t change longer-term bear picture
The returns from the summer’s front running exercise have been very healthy across many equity markets but now central banks have actually delivered, directly in the case of the BoE, the Fed and as of this morning the BoJ and via promised intervention by the rather more standoffish ECB, the question comes back to whether this move is actually sustainable. As ever there is the sales pitch that valuations are compelling which appears particularly relevant for the beleaguered Eurozone periphery and the more dubious view that higher equity markets themselves are a precursor to better economic times. Of course the central bull driver really is positive expectations as to how this further quantitative easing will impact asset prices, reflecting on the lift risk assets saw following QE1 and more relevantly QE2.
Full report below…
View: View any further UST curve steepening opportunistically, like flatteners vs. 5yr
Resurgent equity markets continue to take centre stage with a raft of analysts’ papers regurgitating the likely benefits of more quantitative easing, cobbling this move together with evidence of economic green shoots (which higher equity markets supposedly tell us are there). That other favourite topic, what all this means for bond yields, is also back in the spotlight, centring on the fact that this uptrend in stocks will invariably trigger rotation out of safe haven bond markets into riskier assets, as evident during both previous instances of QE. But with the Fed committed to holding rates low until mid-2015 at the earliest now, with an additional bias for directing policy to flatten the curve via the twist, it’s difficult to see this juncture as a significant inflection point for core yields. Indeed, higher yields are one thing that would kill a recovery in a still debt heavy economy where dynamics are still ultimately deflationary. Rather it should exert shorter-term corrective pressures within the broader trading range, particularly at the longer-end of the curve, before yields edge lower once again.
Full report below…
View: Still prefer Gold over balance of commodity complex, specifically Oil
Markets have been gearing up all summer for another dose of stimulus from the Federal Reserve and increasingly, the prospect of hard action from the ECB to prop up peripheral debtors, which although sterilised would still fit under the umbrella of looser monetary policy. Equities went early and have been range trading near the highs for the year as they await these decisions but other doors have opened with Gold breaking out of its long held trading range on August 21st to take run back towards the $1,700 level and commodities more generally have continued to edge higher, evident in the rise in the CRB and GSCI indices. Of course not all of this appreciation has been driven by expectations of more central bank printing; soft commodities have pushed up on US drought conditions specifically and oil prices continue to draw a bid from fears over Israel’s willingness to strike Iran’s nuclear programme not to mention the Syria situation which by itself is irrelevant for oil but nonetheless reminds on how divided the Middle East is (Syria in many ways now looks like a Saudi/Iran proxy war).
Full report below…
View: Fed expectations buoy stocks, better risk reward looks to be Gold
Reading through the Fed minutes is the boring part of those Wednesday evenings, far more entertaining is just how the market interprets what is often just subtle tweaks in the committee’s rhetoric, the August minutes being an excellent example of this. Headlines would lead us to believe that there has been a substantial shift in tone, inferring that the Fed has now primed the market for QE3 in September, snatching the comment that the Fed “will provide additional accommodation”. However, this overlooks the balance of the sentence which read “as needed to promote a stronger economic recovery and sustained improvement in labour market conditions in a context of price stability.” Together this is far from a definitive statement even if it sounds a little more accommodating than the minutes from the June meeting which itself is unsurprising given the data flow which completed the picture for (the softer) Q2.
Full report below…
View: BoE demand to keep back of the curve steep, close 30yr-10yr flattener
It wasn’t a great surprise to see the BoE dust of its tool bag this morning, delivering a further £50bn increase in its asset purchase programme while leaving base rates on hold at 0.50%, as we and pretty much the rest of the market expected. There had been some calls for more (£75bn), as a signal of intent really, but the bank doesn’t look particularly constricted by delivering ‘just’ another fifty which will be deployed over the next four months, bringing the printing cycle back into line with the quarterly inflation reports. We were disappointed as to how this cash will be disbursed, evenly across the existing maturity buckets when we’d been hoping for some additional duration. It will be interesting to see how this impacts liquidity, currently the BoE won’t buy bonds once its holdings hit 70% of outstanding stock, the GBP375bn QE programme in comparison is equivalent to around 37.5% of UK debt stock.
Full report below…
View: Sell AUD/USD, looking for pair to reconnect with bearish commodity prices
Sluggish growth is becoming an increasingly global phenomenon; contagion from the Eurozone crisis takes the largest chunk of the blame though efforts to cool Chinese overheating are also playing a part, particularly on the commodity side slowing demand growth across the complex. We identified both Copper and the AUD as potential ways to pay the Chinese slowdown risk specifically back at the end of March (http://bit.ly/LDya3l), both ideas have proved their worth although the recent bounce in AUD has erased a good chunk of gains that short positions recommended back then had enjoyed.
Full report below…
View: Sometimes the market is right; EUR/USD has plenty of downside
As per our European update from earlier in the week, which merely brought up to date our long-term bearish view of the single currency, the technical picture for the euro is as equally troubling. The market has been in a downtrend since October’s blip – built around expectations that a breakthrough at the month’s Eurozone summit would actually be a watershed moment for the debt crisis – and while positioning (based on the CTFC non-commercials) is currently very short it still looks like price levels are lagging. Indeed, spot is still 9 big figures above the 1.1875 lows EUR/USD traded after the Greek problem first reared its head back in the spring of 2010.
There are a number of theories as to why the Euro held up so well despite relentless bad news since the Greece requested aid, the first being that the major alternatives were not too great either (the least bad currency view) and the smaller alternatives were at stretched levels, AUD probably being the most notable example, or protected – which sums up the Asia situation and latterly the CHF. Mistakes also played a role, by this we mean the ECB’s tightening cycle that ran until July last year which contrasted so markedly with the Fed’s ultra-accommodative stance which culminated in its pledge to hold rates until mid-2013 and the ‘twist’ launched in September. There is a good correlation between EUR/USD and 2-year swap spreads which reflect this dynamic and have supported the decline. More recently the very factors that should actually be euro negative have created a bid for the currency with cash starved bank’s from the region selling overseas assets to repatriate cash, needs that are clear to see looking at the demand for the various ECB borrowing facilities such as the €489bn lent in the first offering of 3-year loans before Christmas. Such flows, which we’ll likely see more of (bank solvency issues won’t go away), are a good opportunity to sell of course.
Many of the fundamental influences have been weakening, aiding the current leg lower. ECB President Draghi’s reversal of Trichet’s mistakes was the starting point to this with further rate cuts likely over Q1 and perhaps beyond as the central bank tries to steady the blocks stumbling economy (highlighted by contracting PMI’s). More importantly the US economy looks to have found a firmer footing which should continue to pare expectations of QE3 there – in contrast to the ECB’s actions which look like QE in all but name. In fact, it seems likely that Fed tone will turn more neutral in Q1 thanks to improved growth and possibly begin to exhibit a more hawkish lilt as the year progresses, all while the ECB digs. This is where our ideas on a cyclical dollar upswing find traction. The US will hardly boom, but on a relative basis the differences should look rather pronounced, and with rate differentials between the euro and dollar turning positive the path of least resistance too will shift.
Volatility is likely to remain elevated however as European leaders continue efforts to resolve the crisis. It is of course possible that they might come up with a credible plan before things really fall apart. Elections in France this year mean Sarkozy will be desperate to get things sorted out and Merkel with Federal elections next autumn (2013) will also want to rid herself of this headache.
This is where the charts should prove enlightening, as they proved in Q4, offering insight into timing and confidence to run with the trend. As can be seen on the chart below the long-term movement is clearly downward for EUR/USD but ranges can be wide as seen during October’s squeeze. The current band probably tops out at the 50% Fib line at 1.3407, an area which has proven to be something of a pivot area too, 1.3770 at a stretch. Those that remember our Nov 9th note (http://bit.ly/zJCxxy) recommending short Euro have more breathing space than more recent entrants of course but while the market remains under this area EUR/USD should be traded from a short base, using rallies back to 1.3045 and 1.3200/30 in the first instance while leaning on the 50% fib line.
Looking at things shorter-term momentum still favours downside with the immediate draw being the 1.2570/1.2600 area where we might see accounts begin to cover some shorts, especially if news flow turns more neutral which it has shown a tendency to do for (short) periods. There are some signs of divergence on the daily technical indicators too, RSI for example, although not yet confirmed by price action. We also like the MACD but it isn’t offering a clear signal here which might also warrant more immediate caution too. Spec accounts will be looking at the 1.2930’s in the first instance for stops but for those with deeper pockets it’s a close above 1.3080 that should be watched. If the market can stretch back through here it would be a signal the immediate bearish bias has shifted and we’d begin to think we might get a chance to sell into those higher resistance levels.
This is the preferred strategy longer-term (3-months plus), working a book built around a core short, using volatility and periods of calm to cover shorts and sell out again at richer levels. Ultimately we’re still of the view that this is the early stages of a pronounced euro decline and with the US looking fundamentally stronger (in relative terms) the best way to play euro stresses should be via this cross. Ultimately the chart suggests a run towards the low 1.17’s is the objective, a sustained flip through here would open even lower targets sub 1.000.
Spot Ref: EUR/USD 1.2783
- Dollar vs. euro: Battle of currency chumps (money.cnn.com)
- Euro architect: ECB knew of tensions (cnn.com)
- ECB QE through the back door Euro 489 billion Sell Euro (greatlakesforex.wordpress.com)
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