- G-10 FX goes range-bound
- JPY-longs get squeezed out
- Bond insurersâ€™ credit ratings are the big near-term risk
- Key data and events for next week
USD strength that was evident late last week fizzled in the face of fresh signs of economic weakness and ongoing uncertainty over the near-term outlook. January advance retail sales printed better than market expectations, but after excluding gasoline and auto buying, they were flat, suggesting US consumers are indeed pulling back. Fed Chair Bernanke also kept the focus on the negative by citing the downside risks to the US growth outlook, while assuring legislators in testimony Thursday that the Fed would cut interest rates further if necessary. EUR weakness that was similarly apparent this time last week gave way to an unexpected improvement in ZEW surveys of Eurozone investor sentiment and jawboning from ECB Pres. Trichet. Trichet seemed intent on convincing market players that rate cuts are not on the table and that the ECB was still focused on restraining inflation. The net effect was for the USD and EUR to revert back to the middle of recent well-worn ranges.
Other key currencies experienced similar range-bound behavior. GBP weakness was largely reversed after the Bank of Englandâ€™s quarterly inflation report suggested the BOE would not cut rates as much or as quickly as had been expected. By the end of the week, however, GBP was on the way back down as expectations for slower growth and a housing downturn overwhelmed inflation concerns. Even AUD, which enjoys both high relative interest rates and strong growth, was unable to make much progress to the upside, failing on several attempts to break through 0.9100. (For AUD/USD, though, a series of rising lows and a flat top at 0.9100 do suggest a likely attempt to break out above 0.9100 in the near future.)
The net result of the last several weeks of trading boils down to a range-bound trading environment for most of the G-10 currencies and crosses. Given the ongoing uncertainties still facing markets and with no clear resolution on the outlook expected any time soon, Iâ€™m going with the expectation that range-trading conditions will persist for a while longer. Currency option interest now firmly brackets both sides of recent ranges and with option volatility heading lower, options traders will be looking to make up the mileage by increasing gamma trading, reinforcing recent ranges. Incoming data will be the key to short-term market movements. Until we see a clear break of recent ranges (roughly 1.43-1.50 in EUR/USD and 105-110 in USD/JPY), Iâ€™m looking for range conditions to persist.
JPY-longs get squeezed out
The other major trading themeâ€”high volatility/risk aversion leading to lower JPY-crossesâ€”fell victim to excessive market positioning and a drop in volatility. JPY-longs increased to their highest levels last week as traders positioned themselves for fresh volatility, creating large short-positions in the JPY-crosses, such as short EUR/JPY or GBP/JPY. Stock market rebounds early in the week led to a drop in volatility and a stabilization in risk aversion. With short-JPY cross positioning at high levels, the short squeeze was on. Fed Chairman Bernankeâ€™s downbeat outlook for the US economy nipped the stock market rebound in the bud and the JPY-cross recovery stalled. To be sure, uncertainties persist and market sentiment remains highly ambivalent.
Bond insurersâ€™ credit ratings are the big near-term risk
In terms of the major sources of risk in the near-term horizon, the most important is the uncertain fate of the credit ratings of the major bond insurers. Efforts to raise capital for these firms have been reasonably successfulâ€”they have been able to raise capital, but at extremely dear prices. The trouble is theyâ€™re aiming at a moving target: while theyâ€™re increasing capital, mounting mortgage delinquencies are depleting it almost as fast as itâ€™s secured. The key credit ratings agencies are set to decide (most likely by the end of the month) whether the bond insurers AAA ratings will be maintained. Efforts to split the bond insurers into two entities, one for municipal debt and the other for the securitized debt linked to sub-prime credit, will not eliminate the risks to the financial sector. If the bond insurersâ€™ ratings are cut, the securitized debt backed by them will also suffer ratings downgrades, forcing the banks and brokerages holding the debt to take additional multi-billion dollar write-downs and losses. If that happens, we will see yet another massive spike in volatility and a further deterioration in the near-term US outlook. Should the bond insurers rating be sustained, a collective sigh of relief will be felt by most all financial markets, leading to a further stabilization in riskier assets. It seems almost unthinkable that such a ratings downgrade could materialize, but a year ago bank losses of the magnitudes seen in recent months were also unthinkable.
Key data and events for next week
US data next week is going to focus mostly on inflation and the housing market. The impact of inflation readings are likely to be interpreted according to what they imply for the US growth outlook and further Fed easing. Benign inflation readings are likely to be viewed as not restraining further Fed easing and thus promoting better chances for a US reboundâ€”USD positive. Higher inflation readings are likely to be viewed as limiting the Fedâ€™s ability to ease in support of growthâ€”USD negative. Housing data have been heading down for so long now, the market seems ripe to try to call an early bottom on the first sign the bleeding has stopped. Should housing data come in better than expected, I look for a pretty strong USD-positive reaction. Weaker-than-consensus readings may be downplayed as old news and see only a limited USD-negative reaction, but if theyâ€™re substantially below forecasts, donâ€™t look for any bounce.
Monday is a bank and market holiday in the US and FX trading after the European close is likely to be relatively limited. US data starts on Tuesday afternoon with the Feb. NAHB Housing Market Index, followed by weekly ABC consumer confidence at the NY close. Wednesdayâ€™s focus will be on Jan CPI and Jan. housing starts and building permits in the morning, followed by the FOMC minutes from the Jan. 29-30 meeting in the afternoon. Thursday sees weekly jobless claims, the Feb. Philadelphia Fed Index and Jan. leading indicators. Fed speakers include Minneapolis Fed Pres. Stern on Tuesday; St. Louis Fed Pres. Poole on Wednesday and Dallas Fedâ€™s Fisher on Friday.
Eurozone data sees Dec construction output on Tuesday. Wednesday sees Jan. German producer prices. Thursday sees Jan. French CPI and the Dec. Eurozone current account. Friday sees Jan. French consumer spending and Feb. French business confidence, but the key will be advance Feb. Eurozone PMIâ€™s for services and manufacturing.
Japanese data begins on Monday morning Tokyo-time with the Dec. Tertiary Industry Index, followed by the final Leading Economic Index in the afternoon. Tuesday afternoon sees Jan. Nationwide/Tokyo Department Store Sales. Wednesday morning sees the release of the BOJ MPC minutes from January. Thursday morning sees the January merchandise trade balance and the Dec. All-Industry Activity Index. Friday has only the release of the Governmentâ€™s February monthly economic assessment.
UK data begins on Sunday/Monday at midnight GMT with the Feb. Rightmove House Price gauge. Wednesday morning sees the key release of the latest BOE MPC minutes, along with January money supply and the Feb. CBI Industrial Trends Survey. Thursday sees Jan. retail sales.
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