What to look for in the week ahead The Week Ahead updated June 4, 2010 • Risk faltering again on EUR woes, weak US NFP • EUR breaks lower, looking for 1.1800/50 soon • New Japanese PM may see JPY weaken • Central bank meetings next week

Risk faltering again on EUR woes, weak US NFP Risk trades had been faring reasonably well for most of the last two weeks, as seen in solid gains in JPY-crosses, in line with our view that risk sentiment was due for a rebound. All that came to an abrupt end around the middle of the global trading day this past Thursday as concerns surfaced over the state of Hungary's commitment to cut its deficit. Those concerns exploded onto the scene again on Friday, as the PM's spokesman indicated that the economy was in 'very grave situation' and even raised the specter of a default. Then came the extremely disappointing US May employment report, which sent risk trades into a tailspin to finish out the week. What had looked like stabilization in risk sentiment potentially turning into a rebound has seen a distinct relapse. Markets look set to embark on a new phase of 'risk off' and this should see the USD, CHF and JPY outperform, while commodities and commodity currencies (AUD, NZD especially, but CAD too) are likely to suffer. The EUR remains utterly friendless and barring intervention seems to have no place to go but down (more below).

Before we get too depressed, let's look at the two main catalysts for the reversal in risk this past week: Hungary and the US jobs data. On Hungary, much of it appears to be a badly communicated political message hitting a market with raw nerves. The Fidesz party of PM Viktor Orban swept into office taking two thirds of parliamentary seats on promises to end fiscal austerity measures, engage fiscal stimulus and cut taxes. But Hungary has been on EU/IMF credit support since it was bailed out in Oct. 2008 at the height of the financial crisis, and the EU essentially nixed the new government's request to allow it to run a higher budget deficit to reinvigorate the economy. PM Orban then is being forced to renege on campaign promises and has resorted to the time-honored traditions of blaming the prior government, accusing them of falsifying government accounts similar to what happened last Nov. in Greece. Needless to say, markets did not respond well to a message mostly intended for domestic political consumption. Hungary will continue to receive IMF support and is unlikely to default in the near future, so we think the actual risks from Hungary are relatively small, but that doesn't mean it won't depress sentiment in the meantime.

On the US May employment report, it's next to impossible to find a silver lining in any of the data. The trickle of private sector jobs added (+41K) suggests serious doubts will grow over the strength of the US recovery, which will in turn cast doubt on the global rebound. Looking a little deeper there's even more reason to be depressed: the Household Survey saw an actual decline of -35K jobs; the average duration of unemployment rose to a new high of 34.4 weeks; the share of unemployed out of work for more than six months also hit a new high at 46%; and the unemployment rate would have moved back above 10.0% had 300K-plus people not dropped out of the labor force. While it's only one month of data, and subject to revision, it certainly casts doubt on the view that US labor markets are on the mend in any palpable way. The weak May labor report will, of course, reverberate around to restrain consumer/corporate sentiment, spending, hiring and so on. In short, the May NFP disappointment is likely to be a much more significant and lasting negative for risk sentiment in the weeks ahead than any new credit issues emanating from Europe.

Looking ahead to next week, we would point out that the main risk events are likely to be the EU fin. Min. meeting on Monday/Tuesday, Fed Chairman Bernanke's congressional testimony on Wednesday, and Chinese trade/CPI/retail sales/industrial production data on Thursday and Friday.

EUR breaks lower, looking for 1.1800/50 soon If it weren't for bad news, the Euro would have no news. Not only did it fail to make any significant rebound after posting a double bottom at 1.2130/50 area, it has since broken below and dropped to new lows against most major currencies. The immediate downside in EUR/USD is in play while below 1.2075/80 and a daily close back above 1.2150 would be needed to signal any recovery. On the downside, we target 1.1820/30 March 2006 lows, followed by 1.1630/40 Nov. 2005 lows. The drop below 1.2130/40 broke the 50% retracement of EUR/USD's lifetime range, suggesting potential to see the 61.8% at around 1.1210/20. On the brighter side, possibly, Eurozone finance ministers are gathering in Luxembourg for their regular monthly meeting and we may get some verbal support for the sinking currency. But barring outright intervention, any rebounds are likely on short-covering and would offer selling opportunities. The head of the EU finance group, Jean Claude Juncker, gave the lie to European efforts to support the EUR, when he declared this past week he was not concerned about the level of the EUR, only its rapid decline.

New Japanese PM may see JPY weaken Naoto Kan was chosen as the successor to former PM Hatoyama, who lasted just nine months in office and resigned due to a failed promise to move a US military base and shake up government bureaucracies more swiftly. PM Kan is known to prefer a weaker JPY to support Japanese exports. He has also indicated that his government does not wish to add further to public debt, effectively ruling out additional fiscal stimulus. That leaves the BOJ and another round of quantitative easing (QE) as the most likely avenue of economic support, and we think Kan will press for just that. More QE is another likely JPY negative. However, the off-setting tendency is for risk aversion to see the JPY strengthen against other currencies, including the USD. USD/JPY has tested up into the daily Ichimoku cloud and is in danger of failing and closing the week below the cloud bottom at 91.45/50. If so, a larger move down may be in store and a daily close below the 91.08 Tenkan line would serve as confirmation and suggest potential to recent 89.00 and 88.00 lows. If markets regain risk composure, we would then prefer to be buyers of USD/JPY down there.

Central bank meetings next week Next week will see rate decisions from the ECB, Bank of England, and the RBNZ. Only the RBNZ is expected to make any changes, with a 25 bp rate hike from 2.50% to 2.75% on Thursday morning Wellington/Wednesday evening NY time. The RBNZ decision is by no means clear cut, and current market turmoil may force a delay in the expected start of the tightening cycle, which would hurt NZD in the immediate aftermath. On Thursday, the BOE will hold rates steady at 0.50% and is not expected to make any additions to its asset purchase target of GBP 200 bio. The ECB will also hold its benchmark rate steady at 1.00%, but we anticipate a lively Q&A session at the press conference, given EUR weakness, Hungary issues, and the outlook for European banks.