USD sputters, EUR recovers, but risk lags
This past week saw broad based USD weakness against all other major currencies as tensions over the eurozone debt crisis eased further and optimism returned that the global recovery would stay on track. The EUR was a prime beneficiary of the rebound in global sentiment (more below), but by the end of the week its progress looked to be stalling.
From a broader perspective, risky assets (stocks, commodities and JPY-crosses) failed to exhibit the same degree of optimism, suggesting risk aversion remains just beneath the surface. Indeed, gold surged to new all-time highs while US Treasuries rallied and yields remained around recent lows, suggesting safe haven refuges remain in demand. As well, stock markets broke to new highs for the current rebound but seemed unable to extend those gains in any significant fashion going into the end of the week.
From the technical side, the picture is a bit more mixed. Most risk assets have shown some constructive potential on the Ichimoku charts, with the S&P 500, many of the JPY-crosses, and most of the USD-pairs making bullish crossovers of the daily Tenkan and Kijun lines, suggesting more upside potential lies ahead. But they are all still below their daily Ichimoku clouds, which serve as critical resistance zones above. Daily momentum studies are all risk-bullish, but shorter-term studies (e.g. 4 hours) have been registering bearish divergences on the late-week price gains, highlighting the view the rebound may be stalling.
Perhaps it's just a case of World Cup lethargy restraining risk sentiment, but overall we remain extremely cautious on the prospects for the risk rebound to continue (see below) and we'll be alert to any signs of a reversal lower. In particular, we are focused on the key risk support levels of 1105/1110 level in the S&P 500, 1.2250 in EUR/USD, 0.8500 in AUD/USD, 1.0400 in USD/CAD (resistance), and 77.50 in AUD/JPY. While those supports hold, further corrective potential higher in risk assets remains and there the daily Ichimoku clouds are the focal points.
G8/G20 next week may reveal global rifts
Canada will play host to a meeting of the G8 early in the week in Huntsville, Ontario, followed by a meeting of the G20 at the end of the week in Toronto. Both meetings raise the prospect of revealing a split between US desires to maintain stimulus efforts until a recovery is more firmly entrenched and European efforts to impose austerity measures immediately. The Europeans, led by Germany and France, and also the UK, seem unlikely to be moved by the US entreaties, as they seek to demonstrate fiscal discipline in the wake of the European debt crisis. If a lack of cooperation appears between the main global economic powers at the summits, markets may begin to question the sustainability of economic cohesion going forward and an increase in risk aversion may be the result.
As well, next week will see the release of several key eurozone sentiment indicators, including the German IFO business climate index, GfK Consumer Confidence, and PMI's for manufacturing and service sectors. Should those gauges see a plunge similar to what the German and EC ZEW surveys saw this past week, the outlook for the EUR could switch sharply.
EUR: corrective rally more likely than broad based recovery
The EUR has performed well in recent sessions though it seems probable that this is a short-covering correction rather than a broad based rally. Comfort for the EUR has been provided by this week’s 10 and 30 yr Spanish bond auctions which provided decent bid/cover ratios of 1.89 and 2.45 respectively; though unsurprising borrowing costs did increase. As with this month’s 3 year auction the ability of Spain to raise funds on the open market can be seen as an endorsement of the recent policy commitments of the Spanish government, the ECB and the EU.
That said, Spain has a very long way to go before its returns to fiscal health and it could be a long and bumpy ride for investors. Over the past few days, the Spanish government has been making a concerted effort to nip in the bud market fears over the weight of private sector debt. The Bank of Spain committed itself to publishing the results of bank stress tests and also the Spanish savings banks denied the need for an emergency credit line. The publication of banks stress tests in Europe may help bring to end broad based suspicions between banks.
Although transparency is good for overall long term health of the market, it seems unlikely that all banks will be given a clean bill of health and this will test investor’s resolve in the provision of fresh capital. At the very least this could increase market volatility through the summer months, though risk aversion could be given a fresh boost if negative surprises are greater than feared.
UK budget; austerity on its way
The new UK coalition has made it very clear that the June 22 budget will be a painful one. The CBI has estimated that GBP 70 bln will have to be slashed or saved to return UK public finances to health in an effort which it estimates could shave 1.75% from growth by 2016. That said there have been glimmers of better news with respect to the state of UK public finances recently. The May borrowing requirement came in at GBP 16 bln compared with a median expectation of GBP 18 bln. Encouraging news within this release was the GBP 6.1 bln pick-up in tax receipts in the first 2 months of the fiscal year. Although this was almost entirely offset by the GBP 5.7 bln increase in expenditure, the figure nevertheless hints that upward trend in the borrowing requirement has been leveling off potentially in reflection of the decline in the number of unemployment claimants and to signs that overall demand is stabilizing.
This may mean that the axe to public spending could fall a little less heavily than feared going forward. That said, ongoing concerns that budget austerity will be a drag on growth threatens to weigh on the medium-term potential of cable. Sterling may perform better vs. the EUR on the assumption that the latter falls foul of another bout of risk aversion, though currently EUR/GBP is correcting higher. Resistance lies at the previous trend line support at 0.8410, this may provide GBP buying opportunities for a move lower potentially towards 0.8200.
Disclosure: No positions