European, Chinese PMIs Provide Minimal Impact in Light Market Conditions
- Monday holiday trade expected to be very thin
- Yen crosses under pressure with Eur/Jpy below 100.00
- European, Chinese manufacturing PMIs come in better than expected
- Germany’s Merkel warns of tough year but expresses some optimism
Happy New year to all! Markets have been moving a bit in the lightened holiday trade and the most interesting price action has come from the Yen, with the currency rallying to result in some multi-year lows below critical psychological barriers at 100.00 in EUR/JPY. The Yen has found some renewed bids on the broader risk off sentiment flows and this has helped to accelerate its gains against most of the major currencies including the US Dollar. However, with the exception of the Yen, we enter the 2012 year with the buck fairly well bid and looking poised for some across the board outperformance over the coming months.
For today, most markets remain closed and the economic calendar is very light. The key release on the day has come from China, with the country producing an above 50 and better than expected manufacturing PMI result. This could help to inspire some risk correlated bids, although we would again advise waiting for things to pick up a bit before considering fresh positions. European PMIs from Germany, Italy, and France were all slightly better than expected.
Elsewhere, Germany’s Merkel has been on the wires warning of a challenging year ahead after saying that 2012 “will no doubt be more difficult than 2011.” Merkel does reassure that she will do everything to strengthen the region and that Europe will eventually emerge stronger than it was before.
Relative performance versus the USD on Monday (as of 10:00GMT)
Looking Ahead to 2012 - Foreign Investment in US Equities
While on the surface, the recommendation appears to be non-currency specific, we view this as an extremely attractive opportunity for a portfolio hedge in 2012 and potential arbitrage strategy. Currencies have been broadly outperforming against the US Dollar in recent years and it finally appears as though this trend could be on the verge of some form of a reversal back in favor of the buck. However, long USD positions have also been quite risky and exposure to the Greenback might bring with it some unwelcome stress. As such, our recommendation is foreign investment in US equities. What does this mean?
Here is how we see this playing out. Should current correlations stand, if US equities are to head higher, then the investor will benefit from the US equity return, but at the same time, likely have his/her investment offset by the sell-off in the US Dollar and appreciation in his/her local currency on the resurgence in risk appetite and outflow from the safe-haven US Dollar. If on the other hand US equities head lower, then the risk off market environment will allow the investor to offset his/her loss in US stocks through the appreciation in the US Dollar on its safe-haven flows (remember – the investor in invested in US equities and thereby has USD exposure).
So if this is the case, then where is the benefit in this trade, and why even do it? Well, what if we see a break down in familiar correlations where the US equity market rallies and the US Dollar also rallies at the same time? What if we see a situation where US equities and the US Dollar become positively correlated? In this scenario, the investor stands to benefit a great deal and will not only make money from his investment in US equities, but will also enhance his/her returns on the appreciation in the US Dollar.
The global recession appears to be moving in phases, and with the markets now dealing with phase two of the crisis in Europe, we can start to anticipate the transition to phase three, where we believe that China, the commodity bloc economies and emerging markets will all be exposed. At the same time, we see a first in and first out type of situation, with the US economy the first to emerge from the global recession which should translate into a more upbeat outlook on low valuation US equities and the US Dollar as well, on a narrowing of yield differentials back in favor of the Greenback as the Fed begins to signal a reversal of ultra accommodative monetary policy.
EUR/USD: After finally taking out the 2011 lows from January by 1.2870, the market seems poised for the next major downside extension. Overall, we retain a strong bearish outlook for this market and look for setbacks to extend towards the 1.2000 handle over the coming months. While we would not rule out the potential for corrective rallies, any rallies should be very well capped above 1.3500.
USD/JPY:Despite the latest pullbacks, we continue to hold onto our constructive outlook while the market holds above 76.55 on a daily close basis. We believe that any setbacks from here should be limited in favor of a fresh upside extension back towards 79.55 over the coming weeks. Look for a break above 78.30 to confirm and accelerate, while only a daily close below 76.55 negates and gives reason for pause.
GBP/USD: Rallies have been very well capped ahead of 1.5800 and it looks as though a lower top has now been carved out by 1.5780 ahead of the next major downside extension back towards the October lows at 1.5270. Key support comes in by 1.360 and a daily close below this level will be required to confirm bias and accelerate declines. Ultimately, only back above 1.5780 would negate bearish outlook and give reason for pause.
USD/CHF: The recent break above the critical October highs at 0.9315 is significant and now opens the door for the next major upside extension over the coming weeks back towards parity. A confirmed higher low is now in place by 0.9065 following the recent break over 0.9330, and next key resistance comes in by 0.9785. Ultimately, only back under 0.9065 would delay constructive outlook.
--- Written by Joel Kruger, Technical Currency Strategist
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