- The USD rebounds, or was it the EUR finally stalling?

- So what has really changed? Lots and not so much

- Key data and events next week: FOMC, ISM & NFP

The USD rebounds, or was it the EUR finally stalling?

Many in the media and the market are pointing to the USD’s gains this week as a turnaround for the beleaguered greenback. But I think a better way to view this past week’s developments is in the context of sudden shifts in ECB rate expectations. Recall that over the last several weeks markets had been pricing out the prospect of anticipated ECB easing, both in light of repeated ECB warnings and resilient Eurozone data, which led to a steady rise in the EUR. Then, early this past week, some ECB officials went so far as to suggest that the ECB might even need to raise rates to fully combat inflation, and that led to a surge higher in EUR, which saw EUR/USD crest 1.6000 very briefly. I can almost imagine the phone line lighting up between the ECB in Frankfurt and the Banque De France (BdF) in Paris with an enraged Trichet calling Noyer to take back his comments that a rate hike might happen. The reaction was swift—Noyer the very same day held an interview with the WSJ in which he retracted his comments, saying they had been over-interpreted by the market. The very next day, ECB Pres. Trichet came out and unequivocally declared that the current ECB rate was sufficient to ensure price stability, pointedly noting that was ‘the view of the governing council.’

The market reaction over this period saw reluctant asset managers, many who had stepped to the sidelines after the repeated failure of EUR/USD to take out the 1.6000 level, react to the hawkish comments from Noyer and others on Tuesday , and pile into long EUR/USD positions as it broke above 1.5950, finally pushing it over the 1.6000 level. The rug was pulled out from under them after Noyer back-tracked and after a final try at 1.6000, EUR longs took it between the eyes on Thursday with a weaker German IFO corporate sentiment survey and Trichet’s steady rate comments. The great bailout from 1.6000 was on. The move lower was complemented by jawboning from EU finance chief Juncker and some ‘not as bad as expected’ data out of the US (weekly jobless claims and durable goods orders). Looked at from this perspective, the moves seem to make better sense. It also helps explain why the EUR (and CHF) has seen a significant adjustment lower against other key currencies (e.g. GBP and JPY), while the USD remains relatively range-bound against those same currencies.

So what has really changed? Lots and not so much.

• Cracks appear in the Eurozone’s economic façade—The April German IFO disappointment (business climate 102.4 vs. exp. 104.3 and prior 104.8) was preceded by an unexpected plunge in Belgian business confidence from +1.20 to minus -7.9, its lowest level since late 2005. Since when does anyone care about Belgian data? Belgium (and the Benelux in general) is heavily reliant on trade and the steep drop is seen as an indication that EUR strength had become unbearable and was undermining economic prospects. The German IFO decline reinforced that impression. Still, I would note that April Eurozone PMI’s offered more mixed readings and continue to point to slower, but ongoing growth (Eurozone April services PMI rose from 51.6 to 51.8; manufacturing PMI dipped from 52.0 to 50.8; April composite PMI rose from 51.8 to 51.9—readings above 50 indicate expansion.) So the case for a pronounced Eurozone downturn remains to be seen.

• EU officials appear more determined than thought to cap the strength of the Euro—Jean Claude Juncker, the head of the group of EU finance ministers, spoke out virtually in real-time on several occasions to object to EUR gains since the G7 met two weeks ago. ECB pres. Trichet similarly voiced strong concern that further EUR strength jeopardized the economic outlook. While the US still does not appear to be on board concerning market intervention, it appears increasingly likely that unilateral European intervention may yet come into play if EUR strength returns. The effect of this is to introduce two-way risk in the minds of speculators, creating a self-limiting dynamic, with 1.6000 now the clear line in the sand.

• US rate expectations have shifted to embrace either steady rates from here or one more ¼% cut to 2.00%, followed by a pause. Since last Friday, US rate expectations have seen US 2-year yields rise over 40 bps and 10-year yields gain nearly 20 bps. The fundamental outlook has not really changed and I still expect a deeper and more protracted US downturn. (That changes when the following stop/reverse: declining US home prices; rising energy (oil) prices; rising unemployment; tight consumer/corporate credit conditions.) As such, the Fed is likely to need to cut rates later at some stage, and the data will continue to drive that outlook. For the time being, however, interest rate differentials are set to cease being a USD negative, but remain far from becoming a positive.

• Commodity correlations have broken down in the short run—but it remains unclear if this will persist. Gold has broken down significantly, in line with a stronger USD and weaker Euro, but oil has diverged and actually made new all-time highs adjusting for the change in contract dates. For today at least, the weak USD/strong oil relationship has not functioned, but it seems unlikely it is dead just yet. Traders need to keep one eye on oil and the other on the USD.

• Technically speaking, damage has been done to the EUR/USD uptrend, but it’s not dead yet. 1.5550 is critical trendline-support that effectively contained the EUR/USD plunge this week and weakness below that level is likely to trigger further downside potential. Also, intermediate trendlines were broken and they now offer viable selling points at 1.5710/20, followed by the 21-day moving average at 1.5780. Ichimoku charts saw EUR/USD plunge through the Tenkan line at 1.5787 and the Kijun line at 1.5680, and both offer resistance now. The cloud top is the next source of support at 1.5425 ahead of the overall range low at 1.5330/40. Also of note, the USD index tested higher into its Ichimoku cloud on Friday, but has not been able to close above the cloud base at 72.84.

• What to conclude from this?—There have been a lot of short-term shifts in expectations, and this has unfolded against a deteriorating economic backdrop, especially in the US, amid markets lacking in conviction. Data will remain an important short-term driver and while I reckon with renewed USD weakness based on expected incoming weak data, I can’t rule out that we are experiencing a larger shift in trend. More often than not, major price breaks precede concrete fundamental evidence suggesting trend conditions have changed, so I will be watching the following price points very closely. The USD (via the USD index) is on the cusp of breaking higher if it can close above 72.84 on a daily basis. Such a close would suggest significant upside potential for the greenback on the order of 1.5-2.0% to the top of the cloud initially. Similarly, EUR/USD has tested critical trendline support at 1.5550, which may provoke a bounce. If that level fails and EUR/USD drops through the top of its cloud at 1.5425, it argues for sharper weakness to the cloud bottom at 1.5135. I remain a USD-bear at heart, but I am prepared to flip if USD resistance breaks (EUR/USD support at 1.5550 breaks) as the follow-through could be substantial. USD/JPY above 105.00 is another signal that the USD may break higher.

Key data and events next week: FOMC, ISM & NFP

Given the highly uncertain outlook, I would continue to anticipate heightened volatility in short-term trading conditions. Beginning May 1 and 2, Golden Week holidays in Japan and Labor Day holidays in China will tend to see reduced liquidity during Asian market hours, potentially leading to even higher volatility.

US data next week is heavy with important data, not the least of which is the FOMC rate announcement on Wednesday afternoon. Starting on Tuesday morning, we’ll see the Feb. S&P/CaseShiller home price index and the Conference Board’s consumer confidence reading for April. Wednesday starts with the ADP national employment report, advance 1Q GDP, and the April Chicago PMI, followed by the FOMC rate decision in the afternoon. Thursday sees March personal income & spending, March PCE core inflation readings, weekly jobless claims, April ISM manufacturing, and March construction spending. Friday finishes up with the April unemployment report and March factory orders.

Eurozone data sees May German GfK consumer confidence to start with on Monday. Tuesday sees April French consumer confidence and French business survey of overall demand. Wednesday sees March German unemployment reports and April Eurozone CPI estimates, along with a series of European Commission surveys of business and consumer confidence for April. Thursday has no European data of note. Friday sees March German retail sales, March French producer prices, and final-April manufacturing PMI’s for the Eurozone.

UK data is mercifully light. Sometime between Monday and Wednesday, the Nationwide Building Society will release its house price index for April. Tuesday morning sees March consumer credit and mortgage lending data, along with the April CBI distributive trades report, a privately calculated survey of retail sales. At midnight local UK time on Tuesday night, the April GfK consumer confidence index will be released. Thursday morning sees April manufacturing PMI, followed on Friday by the April construction PMI.

Japanese data begins on Monday morning with March retail trade. Wednesday morning sees the Nomura/JMMA manufacturing PMI for April, March unemployment report, March household spending and preliminary March industrial production, followed in the afternoon by the BOJ rate decision and March housing starts and construction orders. Thursday afternoon sees March labor cash earnings. Friday sees no data of note.

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