Quick update on the Euro

This morning, EZ August flash inflation came in at 0.3% YoY and confirmed falling trend (from 0.4% in July). The ECB meets next week (September 4) and the market is pricing some action: talks of corridor rates cut, updates on the ABS program…

Our advice is ‘stay short EURUSD’ for those who got in already, or wait for a bounce back above the 1.3200 level for entering a short position. Large offers are seen at 1.3200 – 1.3250 (combined with huge expiries, 4bn Euros of vanilla option according to Reuters). Though the first support stands at 1.3100 where we might see a pause, our MT target remains at 1.3000. After German retail sales printed much lower than expected at -1.4% MoM in July (vs. 0.1% consensus), Italian quarterly unemployment rate rose to 12.6% in July (vs 12.3% expected) and preliminary inflation (EU Norm) entered into a negative territory, printing at -0.2% YoY and joining Greece, Spain and Portugal in recording annual consumer-price declines.

Peripheral yields picked up a bit, with the 10-year Italian and Spanish yields trading at 2.44% and 2.24% respectively, up from Wednesday’s low of 2.36% and 2.09%.

Our view goes for a corridor rate cut in order to optimize the T-LTROs (first starting on Sept 18). ABS purchases sound a bit premature…

EURUSD-29-Aug(1)

(Source: Reuters)

Another way to play the Euro at the moment would be against GBP as we believe the market has overreacted to the some data disappointments and a slightly dovish QIR (Quarterly Inflation Report) back on August 13th. Good resistance level is at 0.7960/5, therefore going short EURGBP at around that level with a first target at 0.7880 (stop loss above 0.8020) could be a good strategy. Bank of England is also meeting next week but we expect it to be a non-event.

Recovery mode after market turbulence

Markets have been pretty shy this week, with equities recovering after two weeks of ‘correction’.
The S&P500 found support slightly above the 1,900 level on Friday after a 4.35% decline since July 24 high of 1,991.39. Market sentiment worsened as Obama launched another Iraq Assault, with traders potentially willing to put on some bearish positions; however it seems to me that markets don’t seem to be able to handle increasing risk well. AUDJPY eased 150 pips to find support at 94.40, which means that we reached our target of 94.60 based on our previous trade recommendation (see here).

AUDSP(2)

(Source: Reuters)

Another sharp move was in the German market with the benchmark DAX index (blue line) off more than 11% between July 2 high (10,032.28) and last Friday’s low of 8,903.49. If you add the French and UK benchmark indexes (FTSE100 in red and CAC40 in orange), you can see that they had approximately the same path (see graph below), both down 4.3% and 7.5% respectively.

Equities(1)

(Source: Reuters)

The single currency remains under pressure after last week equities sell-off and disappointing fundamentals. EURUSD is trading at a 9-month low, slightly below the 1.3350 level, after German ZEW survey came in well below expectations yesterday as geopolitical tensions and the sluggish recovery weigh on the European’s largest economy. Russia is one of Germany’s main trading partners, therefore there are signs that the German economy will grow at a lower rate than expected in 2014. As a reminder, final Q1 GDP came in at 0.8%; growth is expected to be flat on Q2 according to analysts’ first estimates.

Traders will watch EZ Q2 GDP first estimate and the final July CPI tomorrow, which are expected to come in at 0.1% QoQ and 0.4% YoY respectively. We are still bearish on EURJPY (entered at 137.20 with a MT target at 134.10), mainly based on a Euro weakness (ECB easing in addition to poor fundamentals).

Yen: The BoJ two-day meeting didn’t change any forecast on USDJPY, and the pair is still stuck within its 101-103 range for the past four months (couple of exceptions). Equities sell-off (Nikkei index down 1,000 pts between July 31 and Aug 8) combined with low US yields (10-year bottomed at 2.35% on Friday and is now trading slightly above the 2.40% level) played in favour of the JPY. USDJPY was sold to 101.50 on Friday and is now trading in the middle of its 200-range. Last night, we saw that Japan Q2 GDP collapsed by 6.8% according to Japan’s Cabinet Office (slightly less than the 7.1% expected), its worst contraction since 2011. While inventories additions added 1.0% growth, consumer spending fell 5.2% QoQ after the nation increased its sales tax from 5 to 8 percent on April 1st. We will get back to Japan this week with an article focused on its economic outlook and what are BoJ policymakers’ options.

What could wake up the Dollar (from its coma)?

The coming week will be quite busy in terms of events and economic reports, with the FOMC meeting and the Euro area flash CPI reading on Wednesday, the NFP report on Friday and some Q1 GDP first estimates (UK on Tuesday, Spain and US on Wednesday).

As we said in our previous research (see below, at the end of the article), the 80 level has acted like a resistance for the past few weeks and the US Dollar index is now trading at 79.70 (it recovered a bit from its overnight losses after it fell down to 79.55 during the Asian session). We believe that the market is now waiting for some ‘action’ after all these policymakers’ talks; the next move should come from BoJ and/or ECB officials within the next couple of months according to economists, where both of the central banks target to increase the money supply by applying some unconventional monetary policies.

Technicals on USD index: If we have a quick look at the chart below, we can see that the upper and lower bands (Green lines) of the Bollinger Bands Indicator (20 days, 2-sigma) have acted like dynamic resistance and support for the past couple of weeks. The USD index has been trading below its 20-daily SMA (red line) since the beginning of the month (April 8th) and seems on its way to re-test its strong support area at 79.25-79.30 (which is considered as a good buying opportunity). The resistance zone on the topside stands at 80.45 – 80.60.

USDindex-28-avr

(Source: Reuters)

The question we are asking myself at the moment is: Will the $10bn cut in the QE program in addition of a strong NFP report be enough to rebuild confidence in the US Dollar this week?

Firstly, economic data in the US have showed some improvements (retail sales, ISM Mfg PMI, U. of Michigan confidence and Pending Home sales all came in higher than expected this month); therefore we think that the market has already priced in a $10bn cut from the Fed officials and this meeting could be a non-event. The Fed’s balance sheet will continue to expand for the five coming months at least and the Fed Funds rate will remain at a historical low for another year, pushing preferences for the British pound and the single currency at the moment.

However, a strong NFP report on Friday (expected to come in a 210K) could potentially push the US yields back to levels we saw in March and bring traders’ interest to the US Dollar. The 10-year US yield has been oscillating mainly between 2.60% and 2.80% since the beginning of February and is currently trading at 2.6750%. We think that a print above 200K (helped with a low EZ inflation on Wednesday) could bring the US Dollar index above the 80.00 level. The unemployment on its side is expected to edge down by 0.1% to 6.6% and approach its ‘once-to-be’ forward guidance threshold, but won’t have an important impact as Fed’s officials have switched to a qualitative guidance and will take into account a wider range of economic variables according to Yellen’s first monetary policy speech at the Economic Club of New York.

Article wrote on April 16, 2014 (see graph):

The Ukrainian crisis in addition to the on-going Chinese economic slowdown episode haven’t trigged risk-off sentiment yet. The US Dollar strengthened against the Dollar-bloc currencies (see our last article What’s next for the Dollar-Bloc currencies) and the yen, but remains weak against the Euro and the British pound. We saw that fundamentals in the US continued to expand this week, with industrial production and retail sales both coming in better-than-expected. The only disappointment was the housing starts and Permits data that grew 946K and 990K in March (vs 973K and 1,008K expected).

This evening, new Fed chair Janet Yellen emphasized the importance of the ‘qualitative guidance’ during her first monetary policy speech at the Economic Club of New York, a new guidance that ‘relies on wide range of information’. She sounded quite confident on the outlook of the US economy; however, she mentioned that ‘the goal has not been achieved at this point’. In our opinion, she eased early rate hike speculation, and the 2-year US yield is now trading at 37.5bps, 10 bps lower compare to last week’s high.

Hence, we are trying to figure out if tomorrow’s initial claims report is going to be an non-event based on what we have read and heard from US policymakers, or could a good print boost the value of the US Dollar? Last week, according to the Labour Department, the number of Americans filing new applications for unemployment benefits fell to a 7-year low of 300K (seasonally adjusted, smashing expectations of 320K), signalling a strengthening economy after the ‘weather episode’. However, it didn’t have a major impact on the financial markets and on the US Dollar. Therefore, with tomorrow’s claims expected to edge up by 15K to 315K, we don’t see any significant move from the greenback coming from that macroeconomic indicator.

Quick review on the US Dollar index: As you can see in on the chart below, the US Dollar index eventually found support slightly above 79.30 last Thursday, but it seems that the 79.85 – 79.90 is causing a problem. Low volatility combined with preferences for the Euro and the Sterling have enabled the US Dollar index to reach the psychological 80.00 level. We still remain bullish on the US Dollar in the medium (against most of the currencies), but we think some updates on BoJ stimulus combined with more ECB jawboning remarks on the Euro strength will help the US Dollar to climb above 80.00.

USDindex

(Source: Reuters)