Euro staged an impressively strong rebound last week and reversed recent fortune on a couple of factors. Firstly, bond auctions in Portugal was unexpectedly successfully which, at least temporarily, took bailout off the table. Secondly, ECB Trichet surprised the markets and struck a hawkish tone in the post meeting press conference which raised speculation of a rate hike in the latter half of 2011. Thirdly, there were speculations that EU will finally boost the bailout fund after the meeting in Brussels in the early part of this week.
EUR/USD had only a brief stay below 1.3 psychological and closed firmly at 1.3387 after a strong rebound. Rebound in EUR/CHF and EUR/GBP were also impressive. While it looks like Euro has established pivotal support in the first two weeks of the year, it has yet to take out some key near term resistance. Some more follow through buying in the common currency is still needed to confirm bottoming.
Portugal successfully sold maximum target of EUR 1.25b of 2014 and 2020 government bonds last week with bid-to-cover ratios at 2.6 and 3.2 respectively versus prior bid-to-cover ratios of 2.8 and 2.1. Average yield for 2014 bonds was at 5.396%, up from prior 4.015% while the average yield for the 2020 bonds was at 6.716%, slightly down from prior 6.806%. 80% of demand came from foreign investors. The sub-7% yield of the nine-year bond eased worry of an imminent bailout, even though analysts still believe that bailout is eventually inevitable. Spain also managed to sell maximum targeted EUR 3b of five-year bond today with strong demand. The bid-to-cover ratio was at 2.1, higher than 1.6 in previous auction. Yield jumped from prior 3.576% to 4.542% but was below prevailing level of around 4.6% in the secondary market.
ECB left benchmark interest rate at 1.00% as widely expected. Trichet noted the jump in inflation last month to 2.2%, which was the first time inflation has risen above ECB's target of 2%. Trichet noted evidence of short-term upward pressure on overall inflation, mainly owing to energy prices. Such developments will has not affected ECB's assessment that price developments will remain in line with price stability over the policy-relevant horizon. However, risk could move to the upside. Trichet's comment was taken as a mild warning to markets that ECB could indeed raise rates, even in uncertain times, if inflation outlook worsens.
EU finance ministers will be meeting on Monday and Tuesday in Brussels. There were increasing call for enlarging the bailout fund. The so called European Financial Stability Facility (EFSF), was created last week to cover weaker countries like Greece and Ireland. But the total EUR 750b of funds are generally seen as insufficient to bailout countries in the size of Spain and Portugal. Belgian Finance Minister Didier Reynders called to double the fund to EUR 1.5T again last week. European Commissioner Michel Barnier said that EU had a clear position to boost support mechanisms. French Finance Minister Christine Lagarde told reporters Friday that euro-zone members are considering expanding the EFSF. Though, there was still opposition from Germany, as Wolfgang Schaeuble called increasing the size of the pot was not realistic.
Dollar was mixed generally soft last week except versus Aussie. One development to note is that USD/JPY has been in range together with longer term treasury yields over the week. So far, 3.25% in 30 year yield looks like a strong support which could help USD/JPY defend 82.3 level. ed's Beige Book economic report offered little help to the greenback. All twelve districts reported improvement in economic activity in November to December period. Improvements in retail, non-financial service industries and manufacturing were generally widespread. Though, real estates remains weak in both commercial and residential markets. Plan for hiring were upbeat in most districts though.
Swiss franc was pressured last week after SNB Vice President Thomas Jordan said that appreciation in the franc were posing an extraordinary challenge to the economy. Jordan noted that volatility has strongly increased due to European debt woes and Switzerland has an enormous interest for Europe to solve its debt problems.
Another development to note last week was China unexpectedly raised bank reserve requirement again by 50bps in response to strong inflation reading of 5.1% yoy in November, highest in more than 2 years. This is the fourth time PBoC raised the so called reserve ratio in two months. Australian dollar, while still troubled by Queensland's flood, was knocked down on concern of slowing demand from its main trading partner. Canadian dollar also weakened as Crude oil failed to penetrate through recent high of 92.58 and retreated.
Based on recent price actions in the dollar index, we're favoring the case that firstly, rebound from 75.63 is not finished yet. Price actions from 81.44 are in form of a consolidation pattern with the sharp fall from 81.31 as the third leg. Deeper decline might be seen initially this week but strong support should be seen at 77.97 to contain downside and bring another rise. Nevertheless, decisive break of 77.97 will indicate that whole rebound from 75.63 has finished and will turn outlook bearish for extending the whole fall from 88.77.
The Week Ahead
The result of the EU finance ministers meeting on Monday and Tuesday will be a main focus of the week and that would be important to determine whether Euro could break through key near term resistance levels. In additional focus will also be on a number of growth and housing data from US as well as UK. BoC is widely expected to leave rates unchanged at 1.00% this week, but main attention will be on Wednesday's Monetary Policy Report on whether there will be adjustment on the outlook of inflation.
- Monday: UK rightmove house price; Japan household confidence
- Tuesday: UK nationwide consumer confidence; RICS house price balance, CPI; German ZEW; US empire state manufacturing, TIC capital flow, NAHB housing market index; BoC rate decision
- Wednesday: UK job report; US new residential construction; BoC monetary policy report; New Zealand CPI
- Thursday: German PPI; Swiss ZEW; Canada wholesale sales, leading indicator; US jobless claims, existing home sales, Philly Fed index, leading indicator; New Zealand retail sales
- Friday: Australia import price; Japan all industry index; German Ifo; UK retail sales; Canada retail sales
EUR/USD Weekly Outlook
EUR/USD's reversal from 1.2873 and strong rebound from there suggest that fall from 1.4281 is possibly finished at 1.2873 already. We'd favor another rise another as 4 hours 55 EMA (now at 1.3158) holds. Decisive break of 1.3469 resistance will confirm this case and target 1.4281. Also, note that the corrective structure of the fall, with 1.2643 support intact, will indicate that rebound from 1.1875 is possibly not over yet and another high above 1.4281 would likely be seen. On the downside, sustained trading below 4 hours 55 EMA will turn focus back to 1.2873 support instead.
In the bigger picture, main question remains on whether medium term correction from 1.6039 has finished with three waves down to 1.1875. Current development, the shallower than expected fall from 1.4281, suggests that could indeed be a correction to rebound from 1.1875 only. And with 1.2643 support intact, rise from 1.1875 would possibly be in progress. break of 1.3433 will target a test on 1.4281 resistance. On the downside, below 1.2873 will turn focus back to 1.2643 instead.
In the long term picture, considering the five wave impulsive structure of the long term up trend from 2000 low of 0.8223 to 2008 high of 1.6039, price actions from 1.6039 are viewed as a correction only. Hence, firstly, we'd expect strong support between 61.8% retracement of 0.8223 to 1.6039 at 1.1209 and 1.1639 to contain downside. Secondly, we'd expect another high above 1.6039 eventually, after correction from 1.6039 is confirmed to be finished.