Last week we questioned whether last Friday's market pullback, despite overall upbeat earnings reports, suggested that the risk appetite was losing steam, if for no other reason than that stock prices were already high and that the recovery picture was already priced in. This week's action seems to confirm our impression that at minimum the market needs some time to digest gains and/or get some news to raise expectations further. While we believe a pullback is due, markets have been very resilient, and so a period of range trading rather than strong pullback is quite possible as well if nothing comes along to move sentiment in either direction.
GOLD AND OIL – see Full Version for Details
A steady, rising trend channel calls up congestion at the end of a very prominent bull run.
This is the same general chart pattern that can be seen in the Dow Jones Industrial Average and (the inverse of) the US dollar. From this, it is clear that all three are responding to the same driver: sentiment. Should optimism give way, the lack of any yield income to offset the potential capital losses will likely mean a sharp correction from profit taking. At these levels, demand is largely speculative.Oil
We can see the hesitation to carry prices to new highs, with congestion below the recent high of $82 and the trend low $80. A break is inevitable; but direction is uncertain.
Supply demand fundamentals do not support current price levels. Clearly the true driver for price action is risk appetite and the pace of the US dollar. Should risk appetite falter, profit taking and a fundamental equilibrium set well below current price would act to accelerate crude’s plunge.
Ready to Rise on Tired Stock Market?
Outlook for US Dollar: Bullish/Neutral
- The Fed’s Fisher maintains the bank’s efforts to deflate any and all rate speculation
- Risk appetite continues to drive the USD
- Is there an extreme to the dollar’s steady tumble?
Now considered the ideal funding currency to the recuperating carry trade, the USD continues to move in the opposite direction of risk appetite, and is unlikely to shake that role and its downtrend until there is a fundamental reason to hold the currency, or to dump its chief crosses. While the downtrend to new lows with rising risk appetite continues, this week’s action in equities could signal the first stage of a reversal in yield appetite, recovery in the US dollar, and allow a positive surprise for the Q3 GDP to raise hopes for US recovery, an increase in US interest rates, and provide fundamental justification to hold the USD.
The Big USD Event – Advanced GDP
This Thursday the US reports Q3 GDP. If it can meet the projected 3.2% annualized pace of growth, which would be the best in 2 years, it might show the markets that it really is shaking the recession and boost hope for a solid recovery. Will the USD respond to results like a safe-haven currency or according to what the data says about the US economy? Also, much will depend on the breakdown of growth in the major sectors of the economy. See full version for more on this, the USD's long term prospects, T-bond auctions, earnings reports this week, and coming NFP data.
The EURUSD Continues to Defy Expectations for a Pullback, Awaits ECB Rate Forecasts
Outlook for Euro: Bearish on overextended rally
- Riding Risk Sentiment Higher
- Hits fresh annual highs on bullish Euro Zone economic data
- European Central Bank (ECB)on alert as key indicators continue to show recovery
- EUR, Dow stay above key levels
The Euro finally broke above the psychologically significant $1.50 mark for the first time in 14 months. Unlike previous weeks, however, the EUR held up against the safe-haven US Dollar despite a struggling S&P 500 and other key risk sentiment barometers. We have repeatedly said that the EURUSD needed support from risky assets to continue its impressive rallies. Yet the S&P 500 finished the week 0.75 percent lower and yet the Euro traded higher. Positive news helped a lot. The EUR is likely to continue to follow risk appetite as represented by global equities. See full version for details and events this week
Losing Ground on EUR, USD
Outlook for Japanese Yen: Bearish
- USDJPY rises as stocks fall now that USD is new safe haven king
- Is the dollar to remain the top funding currency?
- Key Events: Retail Trade m/m, Industrial Production m/m, Jobless rate, Housing Starts
The Japanese Yen fell against major forex counterparts for the third week in a row, slipping further on outperformance across key risky asset classes. Yet the 20-day correlation between the US Dollar/Japanese Yen pair and S&P 500 actually turned negative for only the second time in two years—emphasizing the dollar’s new role as premier safe haven and funding currency for carry trade.
We have repeated that financial market risk sentiment, as perhaps best represented by the S&P 500, would be the major determinant of USDJPY price action. With stocks moving down, and the USD as the new prime safe haven currency, the USDJPY should indeed rise.
Against other counterparts, the Yen’s continued losses are typical for the lower yielding currencies when risk sentiment is up.
Impressive performance and fresh highs across key barometers leaves markets at prime risk of pullback and likely yen rally against the higher yielders. However, until we see plausible signs of market turnaround, we have little reason to believe in a yen recovery.
BoE “Hawk Talk” Is Not Enough-GBP Jawbone Driven Rally Collapses Under the Weight Of Reality
Outlook for British Pound: Neutral
- GBP rallied on pure BoE spin, plunges when Q3 GDP shows “hawk talk” is just that
- Bank of England’s October meeting minutes signal neutral interest rate policy
- The UK economy unexpectedly contracted in Q3, dashing hopes for recovery
- GBPUSD rallied too far, too fast, on too little. What is the technical picture of this major pair?
When currencies (or any assets) are badly oversold, they can rally on the slightest good news because there are usually some nervous traders ready to take profits ahead of the growing herd. That’s the main explanation for the pound’s recent rally. All the BoE did was re-state the obvious, that one day, it too would raise interest rates. However, once confronted with actual facts to the contrary, the deception fails and the real trend resumes. In this case, the unpleasant reality was that UK GDP reeked and rate increases still lay in the distant future. We expect further retracement, especially if stocks continue to waver.
Looking ahead to the next week, UK data shouldn’t have too much of an impact on rate expectations, but there is always the lingering risk that BOE MPC members will make comments that could impact trade. Thursday is really the only day with scheduled indicators on hand. The GBPUSD’s direction in the coming week will likely have more to do with US dollar trends than UK fundamental forces, but a break below the 50 SMA at 1.6265 opens the door to much steeper declines.
Will SNB Intervene or Let the CHF Hit Parity with the USD? Depends on Risk Appetite, and the SNB
Outlook for Swiss Franc: Bearish/Neutral
- Rising with risk appetite, likely to fall with it if stocks continue down
- Swiss exports fell 2.3% in September following a 2.0% rise the month prior
- Technical outlook calls for potential USD/CHF reversal
The Swiss Franc trended higher against the dollar over the past week as risk sentiment continued to drive price direction. The U.S. GDP report will cross the wires next week and a similar result could lead to support for the pair. Although Swiss fundamentals have little sway over Franc direction, the 2.3% drop in exports and 3.1% gain in imports during September could be influential if they lead to more SNB intervention.
Moving with Oil, then Risk Appetite, But May Feel Pressure from BoC Decision
Outlook for Canadian Dollar: Bearish
- How far can the USDCAD rally?
- The Bank of Canada warns interest rates will held “until the end of the second quarter of 2010,” but its Monetary Policy Report raises its exchange outlook, warns of intervention
What has been the fundamental basis for the Canadian dollar’s strength over the past weeks and months? Most analysts will say:
• Rising energy prices
• Much stronger underlying economy than most
• USD weakness prompting US capital to head north
However, the comprehensive assessment from the central bank indicates that growth seems to be at the heart of the matter.
This Friday, Canada will report its GDP report for the month of August. A modest 0.1 percent increase is projected for the August reading; but there were hurdles to overcome over this period.
• The US ‘Cash-for-Clunkers’ program expired during this month and the impact on Canadian manufacturing will be significant
• the economy ran a record trade deficit
• the unemployment rate hit an 11 year high
Scanning the rest of the Canadian economic calendar, there are no other major market moving economic indicators to be concerned with; but that doesn’t mean fundamental activity will start and end with the Friday release. It is important to recall two more highlights from this past week’s policy announcements, interest rate plans and SNB intervention. See full version for details.
RBA Hawk Talk Fuels Expectations for Coming Rate Increases, Keep AUD Rising
- Events could keep AUDUSD confined to narrow range
- RBA Minutes Spark Speculation For Further Rate Hikes
- Keep watch on the S&P, the pair continues to follow it regardless of other news events
The Australian dollar rose to a fresh yearly high of 0.9326 against the USD and, barring any major stock pullback the Aussie may continue to appreciate going into the following month as investors speculate the Reserve Bank of Australia to tighten policy throughout the second-half of the year
The Reserve Bank of Australia Minutes has provided plenty of hawkish talk to please Aussie bulls. See full version for details.
Note that if news this week shows low inflation, that may reduce already high hopes for impending rate increases and keep the AUD in a trading range.
Rally Vulnerable to Pullback in Stocks, or Rate Disappointment
Outlook for New Zealand Dollar: Neutral/Bullish
- Weekly Technical Outlook: New Zealand Dollar Top May Be Ahead – Depends on Global Stocks
- Sentiment Outlook Undecided as Speculators Vacillate
Analysis & Events
The interest rate announcement tops the news calendar. As is so often the case, the market moving news or surprises will be in the accompanying policy statement, which may provide hints about future rate hikes. Few believe a rate hike is coming, with a Credit Suisse index of priced-in expectations showing traders see no chance of a hike this time around.
Specifically, traders will be looking to gauge whether the timetable for the withdrawal of monetary stimulus has been accelerated from the previously given “latter part of 2010” estimate after consumer prices unexpectedly surged in the third quarter.
See full version for details
Looking beyond the economic calendar, the outlook for risk sentiment is likely to remain a key catalyst for price action. Indeed, a trade weighted average of the New Zealand Dollar’s value remains over 95% correlated with the MSCI World Stock Index as traders’ appetite for returns boosts stocks, commodities and high-yielding currencies alike. Thus traders should keep an eye on a handful of high profile third-quarter earnings reports including those from consumer goods giant Procter & Gamble, big oil names including Exxon Mobil and Chevron, and US Steel.
Barring major news surprises, expect risk assets and currencies to follow market response to the big name earnings announcements detailed above. If stocks can beat estimates AND grow top line revenues, risk appetite could continue to rule the day. Anything less makes the long extended rally in stocks, commodities, and higher yielding and commodity currencies very vulnerable to short squeeze driven pullbacks. The signs of waning risk appetite have already been showing for the past week, as earnings beat estimates but revenues and valuations remain a concern for stocks and other risk assets.
With US GDP this coming Friday, and Non Farms Payroll the next, earnings news has another few days to hold center stage before regular news events once again hold sway over global markets.
For now, stay with the rising trends, but be ready to take profits and / or take short positions on most risk assets and get long on the safe haven currencies.
Disclosure and Disclaimer: The opinions expressed herein are not necessarily those of AVA FX. The author holds positions in the above mentioned instruments.