Currency markets in hibernation

On Thursday, in quiet, uneventful trading, EUR/USD consolidated, following some steep losses on Wednesday.  The losses on Wednesday were principally due to overall dollar strength, inspired by higher US bond yields, rather than by underlying euro weakness. EUR/USD settled close to the recent lows (just above the 1.32 mark). The recent price action showed that in thin trading rather big market reaction occurred without much new information.  However, on Wednesday a long list of eco data on both sides of  the Atlantic was not able to move the pair away from previous close. The European PMI data were mixed with the manufacturing index coming out much stronger than expected at 56.8 (due to Germany), but the services
indicator was below consensus. EUR/USD gained a few ticks after the publication of the release, but only very temporary. In  the US, the claims, the Q3 current account and the housing data were also too close to expectations to push EUR/USD out of the intra-day 1.3210/1.3265 trading range. Traders were in a wait-and-see mode.

The uncertainty on the outcome of the EU summit this time was a good excuse to stay on the sidelines. We don’t make a big issue of it, but in a recent past, this kind of uncertainty most often tended to cause additional euro losses. However, this was not the case this time. At the 15.00 GMT, the ECB announced it decided to increase its capital by EUR 5.0B. In the current market environment, investors could have taken this as a euro negative (does the ECB expect capital/credit losses at some point). Once again,  there was no reaction in EUR/USD. It was only when the Philly Fed survey printed out stronger than expected that a move worth this name occurred. The pair dropped from 1.3240 to about 1.3180, testing first important ST support levels. However, as no follow through selling occurred, short covering kicked in, allowing EUR/USD to erases the losses and close at 1.3243, even slightly above Wednesday’s close at 1.3214.

The EU Heads of State and government leaders agreed to create a permanent financial safety net from 2013. They will insert two extra lines to the EU Treaty that apparently don’t need to be approved in referenda.  The member states of the euro area may erect a stability mechanism that is activated if it is indispensable to guarantee the stability of the euro area. The decision need to be taken by unanimity. Both the condition of “indispensable” and unanimity seemed to be inserted on demand of Germany that wants to avoid countries asking for help too fast and have a final say on every decision. So, in fact it is only a broad agreement and now the hard work of agreeing a detailed European Stability Mechanism will be started, even if the Finance Minister already painted the broad outline.

Markets were maybe expected some more  from the top, even  if that was probably not the most likely outcome. Euro group  chairman Juncker said the decision was taken not to enlarge or deepen the funding means of the EFSF (temporary crisis mechanism). However, the leaders said they were prepared to do whatever it takes to protect the euro. There was little immediate reaction on the EUR/USD.  In Asian
trading, the pair moved higher currently near the 1.33 level, but we think the move might be again more technical inspired than due to the outcome of the EU Summit. While we aren’t disappointed by the decision, which shows that Germany is still well on board. Indeed, they  effectively dropped the initial no bail-out
clause of the Maastricht Treaty, not a minor step for the country. However, the ever impatient markets might be  somewhat disappointed to  the absence of additional measures. We’ll see the reaction of London traders soon, but think that the downside remains protected and soon attention will focus on other matters.  Moody’s downgraded the Irish rating by 5 notches to Baa1 at the time of writing. We only expect some temporary negative euro reaction, mirroring what happened early when the Spanish rating was but on negative outlook. The rating action on Ireland shouldn’t come as a surprise.  

Today, the calendar of eco data is uneventful. The IFO business climate indicator is the exception to the rule. Recently, but since it is published after the PMI’s, the market moving potential of the IFO has diminished. The risks are for a stronger-thanexpected report. Markets will continue to  chew on the outcome of the EU Summit and eventual more comments of the leaders (see higher). Once the euro summit is digested, markets will probably shift to order-driven end of year trading with erratic price movements in thin market conditions.

Global context. Since early November,  EUR/USD is captured in a negative trend. The trade-weighted dollar reached a new correction low (75.63) after the November Fed decision to embark for QE-2. EUR/USD reached a top in the 1.4280 area. However, the negative impact of QE-2 on the US dollar faded soon while the tensions in peripheral Europe came again to the forefront. EUR/USD was ripe for a more pronounced correction. Contagion fears kept  the euro under pressure.

EUR/USD reached a correction low at 1.2969 two weeks ago. Since early December, the tensions on the European markets eased as ECB bond buying gave investors some comfort. This caused a temporary short-squeeze in EUR/USD too, but the move had no strong legs. The rebound ran into resistance in the 1.3440 area. Regarding the USD side of the story, the signals were mixed of late. Bernanke kept door open for more QE, while at the same time the budget agreement between the Obama administration and the Republicans was seen as supportive for US economic growth. Nevertheless, until Monday,  the US budget agreement and the subsequent rise in US bond yields were seen as USD supportive. The euro made a temporary comeback to the 1.3500 area early this week, but failed to recapture the uptrend line from the year lows (today in the 1.3500 area). In case, EUR/USD would regain this line in a sustained way, the short-term picture would improve, opening the way for a retest of the 1.3698 level (previous  range bottom)/1.3786 (22 Nov high) area. We hold on to the view that a break above this area is unlikely. It would probably imply a material deterioration in the global market appraisal of the US dollar.

We don’t exclude such a scenario further out in 2011. However, with uncertainty on the euro still high and US eco data improving; this is not our favorite scenario short-term. We hold to the working hypothesis that the topside in EUR/USD is well protected and continue to put the risk for a retracement lower in the 1.3500/1.2969 trading range. However, such a move should be more the result of dollar strength, rather than underlying euro weakness.

On Thursday, USD/JPY joined the lackluster trading pattern seen in most other major cross rates. There was a small technical correction on Wednesday evening’s rebound late in Asia/early in European dealings. The pair filled bids in the 84.00 area.

However, there was no impetus to push the pair in any clear direction. So, USD/JPY kept a sideways trading pattern in the in the low 84.00 area and this pattern was extended during the early US trading hours. The pair gains a few ticks on the better than expected Philly Fed survey and went for  a retest of the recent highs in the
84.40/50 area. However, similar to what happened in EUR/USD, the test failed and disappointed short term players threw in  the towel, closing some dollar long positions. The pair eased into the close that occurred at 83.91, which compares to 84.24 on Wednesday evening.

This morning, trading developed directionless in a still narrower band between 83.79 and 84.08. Traders lacked new economic info, while equities trade as lackluster as currencies. So, many traders simply stayed sidelined.  After the Mid-September interventions, USD/JPY trading for some time became a tactical game between the BOJ and the market. Investors felt comfortable with yen long positions (USD/JPY shorts) as Japan was considered to have little room of maneuver to execute a strategy of aggressive interventions to stop the rise of the yen.

Indeed, the debate in the G20 was about excess countries taking steps to artificially lower the value of their currency. However, finally the global  decline of the dollar slowed and USD/JPY developed a  bottoming out process.  The rise in US bond yields was an important driver behind this move. This improved the ST technical picture in the pair. We didn’t/don’t expect a major U-turn in the USD/JPY cross rate. Nevertheless, there was room for repositioning in a unidirectional positioned USD short/yen long market. Two weeks ago, the 84.40 area was tested several times but no break occurred. From there, we reinstalled a cautious sell-on-upticks strategy for return action to the 80 area. Early this week, it looked that the attack on the 84.40/50 area was finally rejected. However, it was obviously too early to cry victory. Yesterday, the pair even set a minor new high at 84.50. A break beyond this level would open the way for a rest of the post-intervention high at 85.95 area. US bond yields remain the key driver in this cross rate. We keep tight stop-loss protection in the 84.50 area to shield USD/JPY short positions against the potential fall-out of such a further rise in US bond yields.

On Thursday, the EUR/GBP cross rate ceded some minor ground that however in no way changed the picture. The move might also be considered as a ‘correction’ on the EUR/GBP rebound over the previous days. The UK retails sales for November were perfectly in line with expectations (M/M), but an upward revision of previous months lifted the Y/Y figures. EUR/GBP lost a few ticks after the release. During the US trading hours, the pair initially settled in narrow rang at around 0.8480. Later on, it ceded some ground in step with EUR/USD after the publication of the Philly Fed. However, contrary to EUR/USD, the cross sidn’t  rebound, leaving the cross at 0.8472 in the close, compared to 0.8500 on Wednesday evening.  In Asian trading,  the pair climbed again higher and seemed on its way to retest the key resistance area at 0.8548/98. The pair touched 0.8529 when Moody’s announced it cut the rating of Ireland by 5 notches to Baa1. It pushes the pair slightly lower, but just as earlier this week in the case of the rating action versus Spain (on negative outlook), we expect only a temporary negative euro reaction. We think such action is largely discounted.

Today, eco calendar in the UK is empty. So, EUR/GBP trading should be driven by global factors, particular the market reaction to the EU summits, and/or technical considerations. Global context:  from late August till end October, EUR/GBP rebounded from the 0.8200 area to reach a recovery high of 0.8942 on October 25. Investors discounted higher chances that the BoE would join  the Fed and enlarge its program of asset
purchases. The harsh UK budgetary measures were seen as a potential drag on UK growth and this could be a good reason for the BoE to maintain an accommodative approach. This kept sterling under pressure. However, stronger eco data (especially strong Q3 GDP) torpedoed the hopes for additional BoE policy accommodation short-term and helped sterling to regain ground. Rising tensions in the euro zone were also a good excuse to scale back EUR/GBP exposure. The pair dropped below the key 0.8532 support area and reached a correction low in the 0.8335 area two weeks. From there, the pair joined the broader rebound of the euro.

Longer-term, we don’t expect a major comeback of sterling. The debate on more QE is delayed, but probably not closed. The impact of  the budgetary measures on growth has still to materialize and we assume that the BoE will lag the ECB on the way to policy normalization. Two week’s ago, the pair showed some tentative signs of bottoming. So,  we installed a cautious buy-on-dips approach. Last week, global sentiment on the single currency remained fragile. In addition, the UK currency didn’t trade that bad either. So, the day-to-day momentum didn’t go our way.

Nevertheless, we maintained our tactics. We don’t cry victory, but the price action over the previous days gave us some breathing space. The pair regaining the 85.27/98 area (recent highs) would further  improve the short-term picture for this cross rate. On the downside the 0.8335 level (Dec 01 correction low) remains
the line in the sand.
Full report: Currency markets in hibernation