Did things just get better or worse?
Regular readers of TWA will know we have been cautioning since early June that risk markets (Stocks, commodities, JPY-crosses, CHF-crosses and commodity currencies) were ripe for a serious setback as incoming data consistently disappointed and optimistic outlooks needed to be tempered. We think the declines of the past two weeks constitute that pullback, though we were somewhat surprised by the speed and degree of some of the declines. At this point, we think markets have broadly adjusted to the more sluggish global recovery we had projected and we're cautiously optimistic that the worst of the downturn is behind us. We also think markets likely overshot to the downside this past week and we're leaning toward upside corrective potential in coming weeks. It's too soon to sound the all-clear, but a number of key developments have occurred that suggest to us that markets should stabilize at the minimum, and possibly rebound further.
The ECB, dragged kicking and screaming as the Eurozone institution of last resort, has been successful in stabilizing Spanish and Italian government debt markets, with 10-year yields for both back below 5%. The ECB will need to maintain its debt buying likely for months to come to ward off fresh speculation, but for now the contagion has been stopped. We think concerns over France are a red-herring and would note the credit rating affirmations and stable outlooks from the major ratings agencies as more important. The Fed has taken the unprecedented step of attaching a timeframe to near zero interest rates (until mid-2013) and this should remove any uncertainty that the Fed will act too soon. But it's also a reminder of the weakness of the US recovery and the overall state of the global economy. Along those lines, the Fed's action opens the way for other major central banks to step back from additional tightening, and we think the low interest rate environment will ultimately be more growth supportive. Additionally, central banks from the SNB to the BOE to the BOJ are considering additional easing measures to support the economy or weaken the currency in the case of Switzerland and Japan. We think the actions of major central banks are likely to calm markets further in coming weeks (they finally 'get it'), and investors are most likely to return to markets to take advantage of recent declines.
In line with our more optimistic interpretation of this past week we would shift our overall bias to buying risk assets on dips, rather than chasing what may prove to be only a short-term rebound. (See more in Intermarket Analysis below.) In particular, we would focus on buying dips in the CHF- and JPY-crosses, especially against the commodity currencies, like NZD/CHF . Commodity currencies (AUD, CAD and NZD) look to us to have further recovery potential higher against the USD, which should stay soft on the Fed's zero rate pledge, sluggish US growth, and a potential further rebound in risk appetite. We will be closely watching various risk cross pairs to see if they can rise above the daily Ichimoku Kijun lines, a major upside pivot after recent declines. Encouragingly for our 'risk on' view, NZD/CHF is finishing the week above its 0.6429 daily Kijun line.
JPY holds its ground as a safe haven but intervention risk remains high
The Japanese yen was the largest gainer against the greenback this week with an advance of over 2% against the buck while the remainder of the G10 currencies softened against the USD. In a week of tremendous uncertainty and volatility, the yen emerged as the only safe have to hold its ground. CHF corrected lower following increasing rhetoric from the SNB and rumors of a potential peg to the euro while gold declined amid increases in margin requirements. The Aug. 4 unilateral intervention which is estimated to be a record amount of nearly 4.5T yen has already seen USD/JPY pare gains to trade back near record lows. The previous single day record amount of intervention was the 2.12T yen sold on Sept. 15. The market reaction has not been proportional to the increasing scale of intervention. Thus, we would expect that the element of timing rather than size alone is likely to be of importance when the BOJ decides to be active in the FX markets again.
Japanese Finance Minister Noda was on the wires Friday noting that 'yen moves have been one sided' and he called on the G7 to take action in the coming weeks. Noda mentioned that he will keep watching the markets closely and that more time is needed to evaluate the intervention effect. Economic data of late has been disheartening with a downward revision to CPI that showed deflation in June of -0.2%. The government recalculated previous figures to change the base year for prices from 2005 to 2010. The country faces deflation and is already back in a recession with two consecutive quarters of negative GDP highlighting the fragile economy. The week ahead sees the preliminary 2Q GDP figures which are expected to show continued contraction with the market forecasting a print of -0.6% q/q from the previous -0.9%. Continued economic weakness may prompt the BOJ to take action as a strong yen will limit growth by restraining exports.
Key technical levels in USD/JPY include the all-time lows of around 76.25/30. A break below may see losses extend towards the psychological 75.00 figure. To the upside, the 21-day SMA comes in around 77.90/78.00 which also happens to be where the weekly Kijun line lies. A move above here may see towards the 80.00 figure which is where the base of the daily ichimoku cloud is seen in the middle to later part of the week ahead.
Extraordinary CHF strength calls for extraordinary SNB measures
The SNB has undertaken a number of measures to curb record shattering CHF appreciation over the past two weeks. A number of officials ramped up rhetoric with Governor Hildebrand stating 'the franc represented a danger to the economy'. Not only did the central bank talk the talk, but they walked the walk - measures taken so far include two increases to Swiss banks' sight deposits of +CHF50B on August 3rd followed up with another +CHF40B on August 10th totaling CHF90B, narrowing the 3-m Libor target range to 0-0.25%, and conducting foreign exchange swap transactions to accelerate CHF base money supply. The SNB's intentions have materialized into results as CHF has lost about 7 big figures against the buck to 0.7700 and EUR/CHF reversed from a near test of parity to current levels around the 1.1000 figure. However, some of the sharp CHF declines are attributable to elevated speculation of a potential franc-euro peg and a 1% tax on CHF deposits. Further fueling CHF weakness was the relief rally in risk which extended from Thursday into the weekly close.
Reports on Thursday noted SNB Vice Chairman Jordan indicating that the central bank 'could take any temporary measures to influence the exchange rate'. This is in direct contrast to Hildebrand's comments on August 5th that 'a fixed CHF-EUR exchange rate would be incompatible with the SNB's job'. We tend to agree with the Governor's comments and think a franc-euro currency peg would only be considered upon exhaustion of alternative measures mainly due to the multitude of political/implementation risks involved in its undertaking.
However, we do think the SNB will likely counteract future CHF appreciation through further liquidity measures - driving rates lower in efforts to push market participants away from CHF paper & assets. Therefore, we believe a 1% tax on CHF deposits which essentially sends rates negative may be the most probable and effective policy tool to be implemented when and if needed. This may also be combined with unilateral or possibly even coordinated intervention dependent on the pace of CHF appreciation upon necessary policy reactions.
Near term CHF downside may continue as the SNB's dedication to combatting excessive domestic currency appreciation has clearly been communicated and markets appear to have heard the message. Further boosts to SNB induced CHF weakness may stem from a continuation of the current risk rally which has lifted US stocks higher by more than +5% on average and 10yr yields on Spanish and Italian government debt back below the 5% level. In fact, it seems the most effective measure to counteracting CHF strength would be further abatement of EZ sovereign debt concerns.
The technical picture provides some evidence that upside in risk assets may extend a bit further. A number of bullish weekly hammer formations are evident across a myriad of securities - the S&P 500 and AUD/USD to name a few. EUR/CHF and USD/CHF have also completed their own respective hammer formations suggesting continued CHF weakness in the week ahead. Potential topside targets in EUR/CHF may be seen into the daily Tenkan line around 1.1200 ahead of the psychologically and technically significant 1.1500 figure. In USD/CHF, further Swissy weakness may see the pair extend gains towards the daily Kijun line around the 0.7800 figure ahead of more meaningful resistance into the key 0.8000 figure.
Taking a look at intermarket analysis
With markets being as volatile as they've been over the last two weeks, intermarket analysis has never been more important. For those of you unaware of what we're referring to, intermarket analysis is the study of several markets at once such as stocks, bonds, commodities and currencies rather than each one in isolation. Thus, it may help trader's pinpoint market reversals or confirm the trend earlier based upon their respective price movements. With that said, below we have highlighted a few of these markets to keep an eye on in the current trading environment. Should the technical levels in the noted markets below get breached (higher or lower), then be on alert for a similar type movement in many of the high beta currencies - AUD, NZD, CAD as well as the perceived safe havens - CHF, JPY and even the USD.
S&P500: After testing the key psychological level and 38.2% retracement at 1100 earlier in the week, equities have since recovered and look poised to test the daily Tenkan line around 1194. Furthermore, the S&P has formed a weekly hammer pattern which signifies a potential reversal may be in order. Currently, it is faced with immediate resistance between 1195 and 1215 (38.2% retracement of the 1347-1101 decline and August 5th high), with significant resistance at 1250/60 (March & June 2011 lows and 61.8% retracement). Meanwhile, downside momentum could pick up upon a break back below 1170/60. Ultimately, should 1100 give way there's very little in the way of technical support until the June 2010 at 1010 which is just ahead of the key 1000 level.
10-year yield: Earlier this week it tested the All-time low around 2.03% and has since stabilized around 2.25%. While the All-time low holds we see immediate resistance between 2.40/50% with significant resistance near 2.80/90% (critical support level in June & July and 50-day sma convergence). Meanwhile, should we see a break below 2% it would likely lead to massive risk aversion flows and strong demand for bonds. Under such a scenario we would envision a test of the 1.70/60% area initially.
Gold: After breaking above the prior high around $1683 on Sunday night the yellow metal began to soar and came within a whisker of $1815 (new All-time high). However, in response to this massive appreciation, the CME responded by raising margin requirements 22% mid-week and has since backed off rather dramatically (was down by nearly $90 from the high at one point today). At this juncture we believe a slow drift lower towards $1680/90 (38.2% retracement of the move higher in July & August and last weeks' high) sounds reasonable before fresh longs decide to jump back on board. Conversely, if it just bottomed around $1725/20 we would wait until a break back above $1770/75 for confirmation before seeking a re-test of the $1815 highs.
Oil (WTI): Appears to be faltering into $88 which sees the daily Kijun line and 50% retracement of the move lower since July 26th. Additionally, it is currently trading within a short-term rising wedge and hourly RSI has already broken below its corresponding support. Thus, we may see renewed selling pressure early next week back towards the $76 low. Should this not be the case, oil sees initial resistance around $90 (June lows) with staunch resistance above near $94/95 - Where the 50 & 200-day sma's converge and daily Ichimoku cloud base resides.
Key data and events to watch next week
United States: Monday - Aug. Empire Manufacturing, Jun. Net TIC Flows, Aug NAHB Housing Market Index, Fed's Lockhart Speaks Tuesday - Jul. Import Price Index, Housing Starts, Building Permits, Industrial Production, Capacity Utilization Wednesday - Jul. PPI Thursday - Jul. CPI, Weekly Jobless Claims, Jul. Leading Indicators, Existing Home Sales, Aug. Philadelphia Fed, Fed's Dudley Speaks Friday - Fed's Dudley and Pianalto Speak
Euro-zone: Tuesday - German 2Q Prelim GDP, EZ 2Q Advance GDP, Jun. EZ Trade Balance Wednesday - Jun. EZ Current Account, Jul. EZ CPI, Merkel to Discuss Debt Crisis with Sarkozy Thursday - Jun. EZ Construction Output Friday - Jul. German PPI
United Kingdom: Monday - Aug. Rightmove House Prices Tuesday - July CPI, RPI Wednesday - Bank of England Minutes, July Jobless Claims Change, Claimant Count Rate, Jun. Avg Weekly Earnings, Jun. ILO Unemployment Rate Thursday - Jul. Retail Sales Friday - Jul. Public Sector Net Borrowing
Japan: Monday - 2Q Prelim GDP Figures Tuesday - Jul. Tokyo Condo Sales Wednesday - Jul. Trade Balance Thursday - Jun. Coincident & Leading Index, Jul. Tokyo & Nationwide Dept. Store Sales Friday - Jun. All Industry Activity Index
Canada: Tuesday - Jun. Manufacturing Sales Wednesday - Jun. Int'l Securities Transactions Thursday - Jul. Leading Indicators, Jun Wholesale Sales Friday - Jul. CPI
Australia & New Zealand: Monday - NZ July Performance Services Index Tuesday - RBA's Board August Minutes Wednesday - AU Jun. Westpac Leading Index, AU Jul. 2Q Wage Cost Index, NZ 2Q PPI Thursday - AU May Avg Weekly Wages Friday - NZ July Credit Card Spending, NZ July Net Migration
China: Tuesday - Conference Board China June Leading Economic Index Friday - MNI Aug. Flash Business Sentiment Survey
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