The greenback remains under pressure as the global risk rally continues. Concerns over the US fiscal deficit, the status of the US dollar as the primary global reserve currency, and near zero US interest rates all provide background noise to encourage USD selling, but the real source of USD weakness is the ongoing improvement in risk appetites globally. While we strongly believe that current risk asset market gains are overdone and ripe for a correction, solid indications of a pullback are tenuous at the moment. However, we would note that the ratio of the S&P 500 to its 200-day moving average is at historic extremes last seen in May of 1983, which was followed by a 2.5% decline in the following week. Gold prices surpassed the psychologically significant $1000/oz level and posted a weekly close above the recent highs at 1007/1008, but only just barely. After peaking just below $1025/oz (below the all-time high of 1032.70) prices retreated, forming a spinning top on the weekly candlestick. Spinning tops are a sign of indecision regarding the current advance and a potential early warning signal of a reversal. Interestingly, oil failed to surpass recent highs, despite USD weakness.
(This just in: as The Week Ahead was being finalized, at 4:45 PM EDT on Friday the IMF announced it had authorized the sale of 403 million metric tons of gold from its stockpile. The amount represents roughly $13 bio and about 12.5% of the total IMF gold holdings. The IMF indicated it would sell its gold in a phased manner, so as not to disrupt market prices. It also said it stood ready to sell directly to central banks, potentially keeping some of this supply out the market altogether. However, we would be surprised if this news did not negatively impact gold prices in the days/weeks ahead, especially if the $1000 level fails to hold. The IMF is clearly taking advantage of recent high prices to unload some of its gold, which is the pattern among central banks globally, and gold longs are apt to take note. Gold below $980/90 suggests the move up is done, and would leave behind a potential long-term double top at the $1025/35 area.)
On the USD itself, the USD index also posted a spinning top on the weekly candles. Against individual currencies, for the week the USD fell against the EUR and CHF, gained against GBP and JPY, and lost small ground against AUD, CAD and NZD, posting potential spinning tops in those pairs. In terms of leading indicators, USD gains against JPY and GBP may be a bright spot for the USD, as are relatively minimal losses against commodity currencies AUD, CAD and NZD. In terms of sentiment, USD bearishness is also universal and at extreme levels. CFTC COTR positioning data reflects that sentiment and last week's price action, with EUR longs at the highest level in more than a year, JPY longs being reduced, AUD longs largely unchanged, and a minor increase in NZD longs, and an increase in GBP shorts.
However, none of that matters as long as stocks and commodities continue to gain ground. While they do, the greenback is likely to stay under pressure overall. That noted, we will be watching closely for signs of a reversal in key risk markets. In terms of catalysts for a correction, improving data seems inclined to continue to support risk sentiment, so the risk would be for an unexpected disappointment to trigger a reversal. The most likely catalyst, in our view, is simply exhaustion followed by profit-taking. Such reversals are the hardest to gauge, coming as they do without any clear trigger. As such, we will be paying close attention to the primary trend lines guiding stocks, gold, EUR/USD, AUD/USD, NZD/USD higher and USD/CAD, USD/CHF and USD/JPY lower over the last two weeks. Monday's price action may set the tone for the week, simply because traders are likely to try to extend the current risk rally at the start of the week. But if further gains fail to be sustained, we think it may be the spark for the much awaited correction.
G20 meeting outlook for FX
According to late reports on Friday afternoon citing the usual 'sources', the role of the USD will not be a topic for discussion at the Pittsburgh G20. This could be a blessing for the USD, as any formal discussion over the dollar's reserve status would be taken as a major USD negative. However, sideline comments from participants over the buck's reserve function should be expected and may still dent the dollar. Also, USD bears may observe that the G20 is not inclined to issue a statement of support for the currently weak USD, and interpret that as a green light to keep selling it. The G20 is also reportedly not going to discuss interest rates. Most of the G20 agenda looks to be devoted to reining in financial sector compensation and orchestrating exit strategies from current stimulus efforts. Most likely, the G20 will pledge to continue stimulus efforts until a more solid recovery is assured, but that the punchbowl will eventually be taken away. The key will be if they provide any concrete timeframe for the end of the party. If they do and the market judges it to be too soon, risk appetites may experience a hangover. There will be additional pre-G20 briefings early next week, so pay close attention to news reports.
Fed meeting and Treasury auctions loom large for the buck
The FOMC is scheduled to release its interest rate decision and press conference on Wednesday at 1415ET/1815GMT. Consensus is unanimous that the Fed will leave rates unchanged at the current 0.00% to 0.25% range and thus the focus will once again be on the communiqué. In terms of the economy, the committee is likely to repeat its prior assessment that activity continues to level out. They are likely to give a nod to improving conditions in the financials space while acknowledging that household spending and employment remain weak. We also think they will not veer much from their inflation assessment. In other words, they will note the increase in energy prices and bottoming out in the annual rate of CPI but will remain optimistic that price pressures are muted at present.
The key in the statement will be the musings with regards to the Fed debt purchase programs. The bank has purchased 95% of the proposed Treasury purchases and is about 2/3 of the way through in their Agency and Agency MBS purchases. The Fed is expected to let the Treasury program expire in October but the MBS purchases, which have helped keep the mortgage and housing market from imploding, remain an open question. In the prior press release the committee said that they will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. If they leave that line in and say no more about the matter, we expect this to be a non-event. However, if they allude to expanding the MBS program or cutting it short (on the back of an improving economy) we could see some sharp volatility in rates. Expanding the program would see rates trade lower and put pressure on the yen crosses - which have been exceptionally correlated with US yields. Deciding to cut it short would have the opposite impact.
Speaking of Treasuries, the US is poised to auction $112 billion in notes next week. This includes $29 billion 7-year, $40 billion 5-year and $43 billion 2-year notes. The auctions of late have been robust across the curve - with even the long bond (30-year) seeing impressive demand. More positive results should give the dollar bears some pause. As always, the bid/cover (the ratio of bids relative to the auction size) and the indirect bidder's share (proxy for foreign central banks) will be key. For reference, the average bid/cover over the past three auctions are 2.73 for the 7-year, 2.34 for the 5-year and 2.87 for the 2-year note. Over that same time frame, the average indirect take of the auctions have been 64% for the 7-year, 52% for the 5-year and 50% for the 2-year. We will use these averages as benchmarks in order to gauge the health of each auction. The risk is that we see bid/cover ratios and indirect participation well below current trends, in which case the US dollar would come under intense pressure.
Cable gets hammered on bank woes and BOE reflections
The past week brought severe losses for the pound. Both the technical and fundamental outlooks have taken a turn for the worse in recent sessions suggesting there is scope for even further losses. Concerns about the outlook for monetary policy combined with more bad news from the banking sector have weighed on the pound. Sterling is likely to be particularly vulnerable in the run up to the October MPC meeting given the possibility of further easing from the BoE is still on the table. That said, with the market short of the pound, there is the possibility of corrective pullbacks on better economic data or on any positive surprises from the minutes of the September MPC meeting.
The Sep 15 comments from BoE Governor King that the MPC will reflect on lowering deposit rates for commercial banks' reserves held at the BoE reinforced the threat of further policy action. Ahead of this the market was becoming used to the view that potential for action on rates may be drying up and that further assessment of QE would be delayed until November given the coincident publication of the Quarterly Inflation Report. King's assessment of the economic outlook remains very cautious and he sees inflationary potential weighed down by spare capacity; this view underpinning the risk for more policy action. Of particular interest in the week ahead will be whether the minutes of the September MPC reveal if the steady policy announcement this month was a close call. In Aug, the MPC surprised the market by voting in favor of a large GBP50 bln addition to QE. Even more surprising was that the minutes of the Aug MPC revealed that three members of the MPC, including the Governor, had voted for a larger GBP 75 bln increase. Sterling may thus garner some solace if there were no dissenting voices this month. Sterling may also find support if the upcoming slew of housing market data bring further evidence of stability in the sector. However, we would be buyers of EUR/GBP on dips in the run up to the Oct MPC.
The EUR's recent strength is a function of improved risk aversion. Contributing to this was the ability of both France and Germany to grow (by +0.3% y/y) in the second quarter. The upcoming releases of Eurozone PMI data and the German IFO are expected to further the picture of economic recovery.
Key data and events to watch next week
In the US, the calendar in the week ahead is on the relatively light side. The index of leading economic indicators kicks off the action on Monday. The highlight is Wednesday with the FOMC rate decision and statement (more on this above) and we also get the usual oil inventory data that day. Initial jobless claims and existing home sales are up on Thursday while Friday rounds out the week with the all-important durable goods report, University of Michigan confidence and new home sales.
The eurozone is not exceptionally busy either but has top tier data on deck nonetheless. Eurozone PMI services/manufacturing, eurozone industrial new orders, French consumer spending and French business confidence all get the ball rolling on Wednesday. The German IFO business surveys are up Thursday while Friday closes things out with French consumer confidence and French GDP.
It is very light in the UK. Home prices get it started on Sunday while the Bank of England meeting minutes are due on Wednesday. Business investment rounds things out on Friday.
Japan sees a holiday-shortened week. International trade is on tap for Wednesday while the all industry activity index and the BoJ meeting minutes are up Thursday.
Canada is even less busy. Monday kicks off with international security transactions while Tuesday has the key retail sales report - that's it.
There are some important reports lined up down under. NZ performance of services is scheduled for Sunday while NZ credit card spending is up on Monday. The highlight is NZ GDP on tap for Tuesday. Australia sees new home sales while NZ has consumer confidence on Wednesday. Thursday closes out the week with NZ trade.