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Markets to Spend Remainder of Day Digesting Monetary Policy Event Risk

Markets to Spend Remainder of Day Digesting Monetary Policy Event Risk

2011-09-08 11:33:00
Joel Kruger, Technical Strategist
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  • Sentiment rally in recent sessions at risk of faltering
  • Commodity bloc and emerging markets exposed to weakness ahead
  • Bank of England leaves policy unchanged as expected
  • Australian employment report comes out much weaker than expected
  • Fitch warns of potential downgrades to Japan and China
  • Morgan Stanley calls for coordinated central bank intervention this weekend
  • ECB event risk on tap into North American open

While risk correlated assets have on the whole responded quite favorably to the increased prospects for QE3 and the latest German court ruling, which ensures the continuation of the Eurozone bailout, we continue to warn of the dangerous irony in these moves. Markets have stubbornly chosen to focus more on government actions to step in and artificially support the global economy, and less on the fact that the reason they are doing so is because the situation is so very dire. Indeed, we recognize the need for official action in order to prevent a global financial markets collapse, but at the same time, we do not feel that rallies in risk correlated assets are justified.

Relative Performance Versus the USD on Thursday (as of 11:25GMT)

  1. NZD +0.50%
  2. GBP +0.25%
  3. JPY +0.01%
  4. CAD -0.05%
  5. AUD -0.22%
  6. EUR -0.33%
  7. CHF -0.82%

We also do not support the twisted and backwards view that some of the higher yielding commodity currencies and emerging market FX should be used as attractive safe-haven alternatives in an environment where most of the risk is believed to be solely in Europe and the United States. It is true that the United States has been hit hard by the global recession, and quite clearly, the Eurozone is also showing the effects of this meltdown. But in our opinion, it therefore stands to reason that the fallout from this major crisis could very well start to extend into the commodity bloc and emerging market economies. Our strategy is to continue to look to play into safe haven markets, and with the Franc and Yen becoming much less attractive safe-haven options on the currency front, we see the US Dollar as the primary beneficiary across the board going forward.

The Bank of England has come out and as expected left policy and the asset purchase target as is at 0.50% and 200B respectively. The initial reaction to the decision was slightly GBP positive after some had been anticipating a potential move to expand asset purchases in light of the latest deterioration within the local and broader economy. However, any rallies following the rate decision are expected to be met with very solid resistance as the overall outlook for the currency remains suspect. Market participants will now look ahead to the BOE Minutes due out on September 21st for more color and insight into the Bank of England’s thought process.

Moving on, most of the major currencies are back under pressure against the buck on the day with the Swiss Franc and Australian Dollar standing out amongst the weakest. The relative underperformance in the Franc comes from European session talk that the SNB was in the market checking rates. Meanwhile, with yesterday’s better than expected but backward looking and stale Aussie GDP report far behind us, today’s much softer than expected employment data has reminded investors of just how much the Australian economy is regressing. The RBA has shifted to a less restrictive stance in recent months in reaction to a cooling in both the global and local economy, but we contend that the Aussie central bank is still far too restrictive and needs to be moving towards more accommodation at a faster rate. Perhaps this latest bout of data will get the ball rolling.

Elsewhere, Fitch has been out dampening sentiment after talking of good chances for a downgrade to Japan’s rating, and the possibility down the road for a China downgrade. This news along with the weaker than expected Aussie data mentioned above, some more bad data out of Japan, and comments from the Governor of the Bank of Korea of raised downside risks to growth, could all continue to weigh on the markets into the European open.

Morgan Stanley is getting some attention on Thursday after the investment house came out aggressively calling for a coordinated G7 intervention as early as this weekend where the Fed, ECB, BOJ and BOE all jointly participate in a mix of rate cuts and quantitative easing. Still, we see these calls as somewhat ambitious to say the least, especially when monetary policy is already so very accommodative and the risks of additional accommodative measures are quite threatening to the longer-term global economic recovery (too much accommodation carries with it major inflationary consequences). Fed Chair Bernanke and President Obama will be speaking later today and it will be interesting as always to see what they have to say (well at least one of them and I’m not talking about the President).

Looking ahead, the key event risk for the day comes in the form of the European Central Bank rate decision due out into the North American open. While no change is expected to policy, it will be interesting to see what Mr. Trichet has to say about the latest tension in the Eurozone, particularly with regard to the bailout and the European banking sector.

ECONOMIC CALENDAR

Markets_to_Spend_Remainder_of_Day_Digesting_Monetary_Policy_Event_Risk_body_Picture_5.png, Markets to Spend Remainder of Day Digesting Monetary Policy Event Risk

TECHNICAL OUTLOOK

Markets_to_Spend_Remainder_of_Day_Digesting_Monetary_Policy_Event_Risk_body_eur.png, Markets to Spend Remainder of Day Digesting Monetary Policy Event Risk

EUR/USD: The market still remains confined to a broader consolidation since April, with rallies well capped above 1.4500 and pullbacks finding decent support below 1.4000. However, the contraction in volatility over the past several months warns of a near-term breakout and given the more bearish structure on the monthly chart which suggests the formation of a longer-term lower top by 1.5000, we project the breakout to be to the downside. In the interim, look for setbacks to establish below 1.4000 over the coming sessions, with any intraday rallies expected to be well capped ahead of 1.4200. Tuesday’s bearish close below the 200-Day SMA is significant as the market has not been able to achieve this feat since early 2011.

Markets_to_Spend_Remainder_of_Day_Digesting_Monetary_Policy_Event_Risk_body_jpy2.png, Markets to Spend Remainder of Day Digesting Monetary Policy Event Risk

USD/JPY:Although the market recently broke to fresh record lows below 76.00, failure to establish any downside momentum on the break suggests that the market could be looking to establish a more meaningful base. The latest daily close back above 77.30 encourages recovery outlook and we look for additional upside over the coming sessions back towards critical short-term resistance by 80.25. Back above 77.75 should confirm and accelerate while ultimately, only a daily close below 76.50 delays constructive outlook.

Markets_to_Spend_Remainder_of_Day_Digesting_Monetary_Policy_Event_Risk_body_gbp2.png, Markets to Spend Remainder of Day Digesting Monetary Policy Event Risk

GBP/USD: The market remains locked in a broader consolidation off of the April highs, and a fresh top is now sought out by 1.6600 in favor of the next downside extension back towards the recent range lows at 1.5780. Ultimately, only a daily close above 1.6550 would delay outlook and give reason for pause, while the latest daily close back under the 200-Day SMA should accelerate declines. In the interim, look for any intraday rallies to be well capped below 1.6200 on a daily close basis.

Markets_to_Spend_Remainder_of_Day_Digesting_Monetary_Policy_Event_Risk_body_swiss1.png, Markets to Spend Remainder of Day Digesting Monetary Policy Event Risk

USD/CHF: The latest sharp reversal off of record lows just shy of 0.7000 is encouraging and could finally be starting to signal the formation for a major base. Weekly studies and monthly studies are also confirming with the formation of a very bullish bottom close. The latest acceleration of gains beyond critical resistance and a previous lower top at 0.8550 further confirms bullish bias and from here, we see room for fresh upside towards the 0.9000-0.9500 area over the coming days. Look for any setbacks to now be well supported above 0.8000 on a daily close basis.

Written by Joel Kruger, Technical Currency Strategist

If you wish to receive Joel’s reports in a more timely fashion, email jskruger@dailyfx.com and you will be added to the distribution list.

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