As we work through the first full trading session of this week we see a strong move towards risk aversion, especially evident in Japanese yen pairs. Therefore, we want to ask the question what is driving current sentiment as well as what to look out for that may further expand or reverse the risk off start to this week's trading.
1. G20 Tells Europe to Step Up - Dents Risk Sentiment
The idea is for the European nations to unveil the €500 billion European Stability Mechanism and there has been discussion of adding the remaining €250 billion left over in the European Financial Stability Facility, which would put the total bailout lending capacity at €750 billion.
European leaders, had hoped that by making this commitment that the G-20 and the IMF would have moved to increase the remaining lending resources in the IMF, but G-20 countries were not willing to move on a simultaneous path with Europe.
Instead pressure was put on Germany to marshal through more commitments to the bailout facilities from European entities, after which time G-20 nations would make their contribution.
From Bloomberg: The decision by G-20 officials to rebuff European calls for assistance in their crisis-fighting effort pending an increase in its own financial backstop puts the onus on Germany, already the biggest national contributor to bailouts, to overcome its resistance to doing more.
With a parliamentary vote on a second Greek aid package looming in Berlin today, Chancellor Angela Merkel's government must now decide whether to back plans at a March 1-2 European Union summit to combine rescue funds and produce a potential firewall of 750 billion euros ($1 trillion).
This development likely takes away the chance of an announcement of an increase of the permanent bailout funds in the EU su ratifying approving of their Greek bailout package and the Greek debt restructuring.
Germany may be unwilling to move on its own, without reassurance from the IMF. With the prospect of a immediate increase to the ESM lending facility fading, the euro gave up its heady gains from Friday's trading session against the dollar and then.
2. Fear of Higher Oil/Gasoline Prices Weighs on Global Economy - Investors Retrace Friday's Yen Losses
The theme of oil prices causing hitting new highs, slowing the momentum of the global economy is gathering steam. Expectations of weaker growth, due to an oil shock, weighs on equities and companies as it likely means weaker profits. Even commodities have fallen back on account of the concern that oil prices can continue to head higher. So far, the signs point to oil prices higher sustaining.
From Financial Times: In a week when oil prices jumped to more than $125 a barrel, their highest since last year's civil war in Libya, the attention of investors has shifted palpably: from the crisis in Greece to the threat from crude. If it continues to rise - and the world's biggest independent energy trader Vitol has warned a rise to $150 is possible - then any immediate prospects for recovery in Europe, especially, are likely to recede.
The sharp gain in oil is due to a combination of supply disruptions as well as fears about the impact on Iranian exports from US and European sanctions. In Asia, and particularly Japan, robust demand for crude has contributed to market tightness.
Colin Fenton, head of commodities research at JPMorgan in New York, says that the rally in prices is economically driven and physically rooted. The risk premium due to Iran, he says, accounts for just a few dollars per barrel.
The change in risk sentiment is pretty evident in the below look at the EUR/JPY.
From a spot of risk appetite and heightened expectations for the global economy and a push higher in the pair, we have now retraced close to 200 pips, finding ourselves cutting about 50% of last week's gains from the pair.
In the EUR/JPY we had a strong pullback from the pairs recent strength. Since breaking out of a sideways congestion pattern, the EUR/JPY saw an almost uninterrupted rally of 600 pips. With risk aversion being the theme to start the week, we see a swift, but logical pullback to the 21-ema in the 4-hour timeframe.
That means that the pace of the rally, which was heading at an unsustainable level has cooled. As long as the 21-ema holds, it would also mean a bullish bias. If the 21-ema breaks the 55-ema would be the next target. This set-up is replicated in many of the other JPY crosses in the 4-hour timeframe.
How risk sentiment shapes up this week will be determined by the reaction to the LTRO 2 announcement as well as key manufacturing data from around the globe.
3. Global Manufacturing Data - Key Gauge for Sentiment and Risk
This week features manufacturing data from the US, China, UK, Euro-zone, Switzerland, Australia, and others.
It brings us an opportunity to gauge how well global manufacturing held up with some sense of calm returning to European sovereign bond markets.
Key this week will be how the US manufacturing sector is doing. The expectation is that the US manufacturing expanded at a faster rate in February than in January with the consensus forecast at 54.6 from January's 54.1.
China's government version of the manufacturing PMI is forecast to show a reading of 50.9, improvement on the 50.5 seen in January. This should be a positive for sentiment.
China's HSBC Manufacturing PMI came in at 49.7 reading in the preliminary version - the 4th straight month of contraction. .
In the UK, the manufacturing PMI is expected to continue expanding at a modest pace - with forecast of a 51.9 reading. However, this is a bit slower than January's 52.1. Still, not a bad reading for the UK economy which has seen growth uneven of late.
Switzerland SVME Manufacturing PMI is expected to be in contractionary territory at 48.6.
US durable goods, released on Tuesday, will also act as a leading indicator for US manufacturing, though its expected to show a flat reading for core durable goods orders, and a drop of 0.8% in the headline rate.
Can This Week's Manufacturing Data Act as A Catalyst for JPY Pairs?
Risk sentiment therefore will depend greatly on the picture that economists and traders gleam from the latest manufacturing reports. If data continues to show major economies like the US, UK, Germany, and China expanding, that can help justifty higher oil prices, and as a counterweight to risk aversion that we have seen to begin this week's trading.
The US economy will be the linchpin here. If US economic data continues to show momentum, then the risk rally can extend its momentum. But, if concerns grow that the global economy could be set back by an oil shock, then investors will begin to remove risk off the table and look towards safety in the USD and JPY. If global manufacturing data under-performs in February, that sets up for some disappointment for equities, which are testing 4-year highs.
Nick Nasad is a macro economist, currency market analyst, and educator; and one of the main contributors to FXTimes - provider of Forex News, Analysis, Education, Videos, Charts, and other trading resources.
Information and opinions contained in this report are for educational purposes only and do not constitute an investment advice. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness. FXTimes will not accept liability for any loss of profit or damage which may arise directly, indirectly or consequently from use of or reliance on the trading set-ups or any accompanying chart analysis.