Stay focused on the big picture
The past few weeks have seen events unfold at a furious pace, making it sometimes difficult to keep up with developments, which is exacerbated by heightened market volatility. During such times, it’s important to stay focused on the big picture which we currently see as an on-going global recovery, which is generally positive for risk assets such as stocks and commodities. In precious metals and oil, we prefer to be buyers on dips. In particular, we would note impending UN-sanctioned military action against Libya, likely early next week or sooner, has the potential to see precious metals and oil prices spike higher. Libya’s Gaddafi is attempting to forestall attacks on his military infrastructure by proclaiming a cease-fire, but the western and Gulf regional nations appear intent on driving him from power, suggesting they will go ahead with strikes. Gaddafi’s response is unpredictable, but there is potential for him to lash out at regional Gulf nations, potentially threatening further oil supply disruptions. In gold prices, we would note a potential bull flag consolidation pattern, where a break above $1422/23/oz. could signal a fresh wave higher, possibly taking out the key $1440/50/oz. resistance zone and targeting higher to $1500 or more.
In FX, the key is the divergence between monetary policies of the major central banks, with the Fed maintaining extraordinary measures and most others generally removing accommodation, with the ECB in the lead at the moment. In this environment, the USD is likely to remain weak in our view, and we prefer to be sellers on bounces. There had been some speculation that events in Japan could cause the ECB to postpone its threatened April rate, but comments on Friday from Pres. Trichet suggest he is intent on pushing rates higher. EUR/USD appears set to challenge the Nov. highs around 1.4280 and ultimately appears destined for gains to the 1.4450/4500 area. Of course, there is always potential for global events to deteriorate in further unexpected ways, potentially triggering a wave of safe haven USD buying at some point, but we would look at that as an opportunity to re-sell the greenback. EUR/USD immediate upside potential remains while above 1.4000/50.
Concerted intervention in JPY is for real
The G7 stepped in to currency markets for the first time in over a decade on Friday, with the BOJ leading the wave of JPY selling, and sending USD/JPY higher to 82.00, before settling back just below 81.00. Importantly, we would note that other central banks bought their local currencies and sold JPY, amplifying the intervention’s impact to the JPY-crosses, like AUD/JPY and CAD/JPY. Though the amounts bought by other central banks were reportedly small, we think the G7 is serious in preventing the JPY from strengthening again and that follow-up rounds of intervention are virtually guaranteed. The MOF and BOJ appear intent on seeing the JPY weaken back to pre-earthquake levels around the 83.00 USD/JPY area. A price move above that level has the potential to spur algorithm-based trading systems to reverse from long to short-JPY positions, potentially triggering gains to the psychologically significant recent highs around 84.00/85.00 and higher. In the aftermath of the tragedy in Japan, we expect the JPY to weaken in the months ahead on economic fundamentals, as the Japanese economy struggles, the BOJ adopts additional easing measures, and government borrowing for reconstruction undermines faith in the currency. We think the 79.00/80.00 area will be defended from here out, and that dips in USD/JPY and other JPY-crosses represent buying opportunities.
Germany throws a spanner in Europe’s works
There is a chance that Germany could scupper a long-term solution to the sovereign debt crisis. The Lower House of the German parliament approved a motion last Thursday that will ensure that the German Parliament remains closely informed about the decisions made by the EU regarding a permanent solution to the sovereign debt crisis and the creation of a permanent crisis resolution mechanism (ESM), which is due to be in place by 2013.
This has added another layer of complexity to the creation of the ESM, which is crucial to ensure that markets remain confident that the EU authorities have the situation under control. Public opposition to Germany’s involvement in the bailouts of weaker Eurozone states has hardened the stance of some politicians in Berlin towards the ESM negotiations.
Events in Germany make the future effectiveness of the fund far from certain. We are worried that last weekend’s surprisingly advanced discussions might not reflect the end result of the upcoming summit later this week and the markets could be looking for too much from the EU authorities.
Germany’s Lower House ruled out the issuance of joint bonds by the Eurozone and crucially it also opposed the guaranteed debt purchase programme for bailed out nations in the primary debt markets. This was the key message that cheered the markets after last week’s EU summit. In our opinion this is a major step back on the road to finding a long-term solution to the debt crisis. Although it hasn’t been reflected in the FX markets, it has the potential to de-rail the euro’s progress further ahead. If the summit disappoints then we could see EURUSD return to the bottom of its recent range towards 1.3800. It would also weigh on peripheral bond yields and may cause 1, further discussions about a re-structuring of Greek and Irish debt. 2, sovereign debt downgrades from credit rating agencies for the weaker Eurozone states and 3, a bailout for Portugal.
Key Technical Levels to Watch in the Week Ahead
USD/JPY: A wild ride in FX-land this week saw a number of significant technical levels completely obliterated. The main focus has been on USD/JPY and other yen crosses as the crisis in Japan has led to a surge in volatility. USD/JPY made record lows around 76.45/50 on fears of deteriorating nuclear reactor conditions and technically driven price action. However, yen strength reversed on Friday to trade back above the 80.00 figure as coordinated central bank intervention absorbed repatriation flows. However, gains in USD/JPY stalled into triangle consolidation support (now resistance) around the 81.50/75 zone which looks to be a key resistance moving forward. Above the 82.00 figure sees additional resistance from the daily Ichimoku cloud base (82.40) suggesting the ride higher on the back of direct intervention may not be a smooth one.
USD INDEX: The USD Index looks set to post a weekly close below primary trendline support extended from the March ’08 70.69 lows suggesting further USD weakness may be in store. Daily Ichimoku clouds signaled a downside technical bias when the Tenkan line crossed the Kijun line from above to below after falling below the cloud base in late February. The breakdown level around 76.25 may now serve as key resistance and 75.60/65 (11/4/2010 lows) looks to be immediate support ahead of the psychologically and technically significant 75.00 pivot.
EUR/USD: The bearish technical picture in the USD Index is most ominous for the greenback against the euro which also breached a key technical resistance level this week. EUR/USD broke above the 1.4050 prior highs today - also trendline resistance from the Dec. ’09 1.5140/45 highs - which may serve as near term support on EUR weakness. The next meaningful resistance is likely to be found into the long term trendline from the record 1.6035/40 highs around the 1.4275/00 zone. The trendline also converges with the 1.4280/85 Nov. ’10 highs - a weekly close above may signal a potential upside breakout from the ‘08 primary downtrend.
GBP/USD: The sterling has managed to mount a decent recovery against the buck after falling back from the 1.6340 level in the beginning of March. Moving forward, 1.6340 is likely to remain a key technical level considering upside stalled into it on multiple occasions since March 1st. Adding to its technical significance is the possible convergence of trendline resistance extended from the 2.1160/65 record highs. Whether these technical resistance levels converge or not will depend on the rate of upside acceleration in GBP/USD – a choppy move higher would see the levels converge while a steeper ascent may see the trendline come in closer to the 1.6400 figure. Near term support may be found into the converging 55, 100, and 200-hr smas around 1.6100, also the midpoint of the broken s/t rectangle consolidation pattern seen on hourly charts. However, the pair’s ascent above rectangle tops suggests a measured move objective of 200 pips towards the 1.6400 figure and a potential attempt to break above its ’08 primary downtrend.
Key data and events to watch next week
United States:
Monday – Feb. Chicago Fed National Activity Index, Feb. Existing Home Sales
Tuesday – Jan. House Price Index, Mar. Richmond Fed Manufacturing Index
Wednesday – Feb. New Home Sales, Fed Chairman Ben Bernanke speaks
Thursday – Feb. Durable Goods Orders, Weekly Initial Jobless Claims and Continuing Claims, Fed’s Duke speaks
Friday – 4Q final GDP, Personal Consumption, Core PCE, Mar. final U. of Michigan Confidence, Fed’s Plosser, Fisher and Lockhart speak
Eurozone:
Monday – Euro-Area Finance Ministers to Hold Special Meeting
Wednesday – Jan. EZ Industrial New Orders, Mar. EZ Consumer Confidence
Thursday – Mar. advance German Manufacturing and Services PMI, Mar. advance EZ Manufacturing and Services PMI
Friday – Apr. German GfK Consumer Confidence Survey, Feb Import Price Index, Mar. IFO Survey, EZ Feb. M3
United Kingdom:
Monday – Mar. Rightmove House Prices
Tuesday – Feb. CPI, RPI, Public Sector Net Borrowing
Wednesday – BoE releases MPC Minutes, Chancellor Osborne announces budget
Thursday – Feb. Retail Sales
Japan:
Tuesday – Jan. All Industry Activity Index
Wednesday – Feb. Trade Balance
Thursday – Mar. Tokyo CPI, Feb. National CPI, Feb. CSPI
Canada:
Tuesday – Feb. Leading Indicators, Jan. Retail Sales, Finance Minister Flaherty presents 2011 Budget
Australia & New Zealand:
Monday – Feb. NZ Credit Card Spending
Wednesday – 4Q NZ Current Account, GDP, Jan. AU Conference Board Leading Index
Thursday – RBNZ Governor Bollard speaks
China:
Thursday – HSBC Flash Manufacturing PMI
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