• Risk trades are better, but still not quite there yet
• BOJ may send the JPY weaker
• EUR and GBP enter correction phase
• US economy still trending higher
• Key data and events to watch next week
(N.B. Please note, daylight savings time will resume this weekend in North America. As a result, the difference between EDT and GMT will be four hours instead of five.)
Risk trades are better, but still not quite there yet
As we suggested last week, risk appetites improved a bit further this past week and most risky assets advanced, with the notable exception of precious metals and commodities. In FX, the clear standouts were the JPY crosses, like EUR/JPY, CAD/JPY and AUD/JPY, which all moved above recent highs. Solid data out of China and the US supported the notion that the global recovery is on track, though many doubts still remain. Indeed, the failure of metals and commodities to press higher suggests that the current risk rally may already be stalling before it has even gotten underway. We would have expected commodities to lead the way higher on better recovery prospects, but it would seem excessive long positioning is restraining the upside.
In fact, all that has happened is that many markets have simply moved up to recent range highs, e.g. S&P 500 at 1150. In the JPY-crosses, the two USD components (e.g. EUR/USD and USD/JPY) have moved to their recent highs, but so far have failed to break them. As a result we are still dealing with USD pairs trapped in relatively narrow ranges, with the possible exception of USD/CAD (though the move to new lows may be a transient effect of stronger than forecast Canadian jobs data). Last week we also raised the prospect that the JPY-crosses may return as the primary risk barometer and replace the USD as the risk beneficiary. Until we get a break of the USD ranges, however, we still don't see a resolution to that question, but it looks increasingly likely.
Stepping back from the fray, we remain cautiously optimistic that risk assets and JPY-crosses in particular may yet break higher. Increasing signs that the US labor market has turned the corner on job creation (to be seen in the March NFP report) is seeding a renewed round of optimism on the economic outlook. As well, stabilization in the Greek debt crisis suggests a EUR-negative may be receding for the moment. We favor re-buying JPY-crosses on any pullbacks of about 150/200 points from Friday's closing levels, and we are mindful of the potential for a short squeeze to develop, especially in EUR/USD and GBP/USD. Eurozone finance ministers are meeting on Monday and Tuesday next week, and the latest tactic seems to be talking up confidence in the EUR to avert a speculative assault on the common currency. Look for EUR supportive rhetoric from the ministers.
BOJ may send the JPY weaker
The Bank of Japan is meeting next week and will announce their policy decision on Wednesday afternoon in Tokyo. The growing expectation is that the BOJ will increase its liquidity provision to the banking sector, a move they first made back in December. Deflationary pressures persist and are growing, forcing the BOJ to step up efforts to prevent entrenched deflation, which undermines consumption and threatens the recovery. The Dec. 1 announcement of JPY 10 trillion in emergency credit to banks came just after USD/JPY had tested below 85, and in subsequent days USD/JPY traded up to nearly 91.00. While we don't expect that much of a reaction, we do think USD/JPY has the potential to break higher toward the 200-day mov. avg. at 91.82 and possibly the 92.50 area. USD/JPY is holding inside the daily Ichimoku cloud, and a close above the cloud top at 90.55 would likely signal more gains to come.
EUR and GBP enter correction phase
The EUR's break above the EUR/USD1.3735 resistance level reflects a turn in the sentiment with respect to the EUR. EMU officials most notably the ECB's Trichet and European Commission's Juncker have both thrown their weight behind Greece, suggesting that the government's austerity initiatives have been convincing. The near-term outlook for the EUR has thus become one of correction and consolidation with a move up towards the USD1.3850 now looking likely. Above that level could trigger a larger short squeeze toward the 1.4000 area, where we would be inclined to re-sell EUR/USD. Medium-term the road back to budgetary prudence is likely to be a tough one for many parts of the Eurozone suggesting the possibility of further volatility in EUR/USD. The forthcoming release of Eurozone CPI data is expected to show a softening in the core inflation rate will may highlight the potential for interest differentials to move in favour of the USD in the latter stages of this year.
Sterling has also been squeezed higher in a rush to cover short positions. The news, however, remains predominantly negative for the pound. Opinion polls continue to place a high probability on a hung parliament after the UK general election. This heightens the threat that no strong action to tackle the huge budget deficit will be taken. After a shockingly poor set of data for January, February public finances data are likely to again serve as a reminder of the scale of the issue facing the UK government. These data will be particularly important as they will be the last set ahead of the March 24 budget. UK labor data have the possibility to offer some respite to the economic outlook. However, with economic data likely to be increasingly overshadowed by politics in the coming weeks, sterling is likely to remain on the back foot.
EUR/CHF has probed the downside, pushing below the 1.4600 level unhindered by SNB intervention. The fact that it took the CHF almost a whole day after the SNB's policy meeting to rally is indicative of the market's fear of the SNB. The SNB clearly warned that it will act decisively to prevent an excessive appreciation of the CHF. However, it also acknowledged that the economic recovery is becoming more tangible and that monetary policy cannot be maintained throughout its entire forecast period without compromising medium and long-term price stability. In essence the SNB's view on FX is largely unchanged: The SNB is likely willing to accept a stronger CHF vs. the EUR, but is likely to step in to control the pace of any further appreciation. Bounces on EUR/CHF may provide good CHF buying opportunities.
US economy still trending higher
The data in the US was on the light side this week, but continued to provide evidence of an economy clearly on the mend. Initial jobless claims have resumed their downward path, retail sales were booming, and even the University of Michigan report suggested that consumer confidence is perhaps not as bad as previously indicated.
The weather of late has wreaked havoc on the economic data and the US jobless claims numbers are a testament to this, peaking just below 500K in the middle of last month. That said if we make an educated guess about the weather impact, the trend in February claims has actually fallen to about 460K from 470K the prior month. To be fair, we need a number below 450K in order to be consistent with NFP job growth. However, the census hiring (which is expected to peak out at 1.2 million) should skew the payroll headlines significantly to the upside over the next three months. Over this time, we expect the jobless claims numbers to trend significantly lower and then perhaps pop once the census project is complete. One of the more recent sharp recessions (the early 1980s) provides some guidance on the potential path for claims. Running a simple model using the claims trend exhibited back then suggests we should be back below 400K for good by 4Q 2010. So while the medium-term will be choppy, the secular trend remains for slower job losses. The vast improvement in employment should help support retail spending on the follow.
Speaking of the retail space, headline sales for February printed a better than anticipated 0.3% MoM gain (consensus looking for -0.2%) while ex autos increased 0.8% (market had 0.1% penned in). More importantly, however, the number that feeds directly into the personal consumption component of GDP (retail sales ex auto dealers, gasoline and building materials) popped 0.9%, on the heels of a smart 0.6% gain the prior month. The better core number has seen economists ratchet up their expectations for personal spending and 1Q GDP and we are now hearing forecasts as high as 4.0% annual growth for the quarter. Given that much of the hard data have been negatively impacted by February weather, it is possible that this number would have looked even stronger. This suggests some pent-up demand for the month of March and the potential for another constructive number, capping a robust quarter for personal consumption. The recent pattern in the confidence numbers is a welcome sign for this space.
The University of Michigan consumer sentiment number gave risk appetite some pause as the headline came in weaker than expected, falling to 72.5 in the March preliminary read from 73.6 the prior month. The guts of the report confirmed the modest dip in the headline as both the current and expectation components slipped about one point. That said this number should be viewed in terms of how the broad consumer confidence picture has shaped up recently. If we look at the monthly changes in various metrics of late, the Conference Board dropped -16.4%, IBD/TIPP sank -4.4% while Michigan fell -1.5%. The theme here is that the more current the release, the less bad the monthly change has been (due to varying survey periods). This uptrend should remain firmly in place as more of the March data start to trickle in. Furthermore, the improvement in retail sales data and the recent confirmation that the unemployment rate is firmly below 10%, should give confidence a further boost. The cycle of higher confidence = better retail sales = improved employment picture should continue to feed on itself and make for a few rosy months ahead.
Key data and events to watch next week
The US data calendar heats up next week. NY Empire manufacturing, international capital flows, industrial production and the NAHB (homebuilder) confidence index are all out of the gate on Monday. Housing starts/permits and the FOMC rate decision (no change in rates or material shift in the statement expected) make for an important Tuesday while producer prices are on deck Wednesday. Jobless claims, consumer prices, the Philly Fed manufacturing index, and the index of leading economic indicators round out the week on Thursday.
It is also quite busy in the Eurozone. The employment report for 4Q kick off the action on Monday and Greece is also expected to submit their debt reduction progress report that day. Consumer prices and multiple ZEW surveys are on tap Tuesday while Wednesday has construction output lined up. The trade balance is due on Thursday and Friday closes things out with German producer prices. Keep in mind there is also a Eurozone Finance Ministers meeting on Monday and Tuesday as well - be on the lookout for more talk about sovereign debt risks.
The agenda in the UK is not very busy. Home prices are due on Monday while Wednesday brings the employment report and the latest Bank of England meeting minutes. Mortgage approvals and the CBI industrial trends report are up on Thursday.
Japan is characteristically light. Consumer confidence kicks off the week on Monday while Tuesday has machine tool orders and the tertiary industry index on tap. The Bank of Japan rate decision is the highlight for Wednesday. We will see the leading index on Thursday while the all industry activity index closes things out on Friday.
Canada has top tier data scheduled, as usual. Labor productivity is up on Tuesday while international security transactions are lined up Thursday. The week ends with the all-important consumer prices and retail sales reports.
It is super-light down under. Australia has the RBA meeting minutes and leading index on Tuesday. Meanwhile, New Zealand sees consumer confidence on Thursday and credit card spending on Friday.