California Governor Issues Fiscal State of Emergency

January 22 2011 by Spencer McKay in Forex Release |No Comments

The declaration by California’s new Governor that the budget deficit had hit crisis level seems to have been shrugged off by FX markets so far. The Governor’s attempt to force lawmakers to address the nearly $25.6bn short fall by issuing a fiscal state of emergency highlights to us the impending risk and potential shift in focus of the sovereign credit story in the USA. Yields dropped and the spread between US and German bonds has now widened to a level more indicative of the EURUSD above 1.40. So while we are not seeing widespread USD selling, there are definitely cracks developing in the currency facade. Part of the problem is the encouraging US data which printed yesterday. Initial jobless claims fell more than estimates to 404k which implies the weaker trend in Q4 has been sustained. US Existing home sales astonishingly jumped 12.3% in Dec to a 5.28 million, the highest monthly print since mid 2010, and the Phil Fed. Manufacturing survey slipped down to a still robust 19.3 in Jan. Short term pundits expressed optimism around the US data and revived the concept that the USD should be considered a growth currency. We suspect this analysis is correct for short term macro traders, but over the long term it is unlikely to hold and in turn the USD rally will be brief. Once again, artificial stimulus in the form of QE2, and the fiscal side of the equation in the form of extending Bush era tax cuts, will not provide sustainable growth activity. Therefore without some level of US austerity or sustainable growth the US is a ticking financial bomb. Back in Europe, markets have yet to get the much anticipated agreement on the EFSF from European officials, and in fact have received just more divergent comments. The overriding sentiment is that eventually a deal will get done. Undoubtedly there will be bumps such as concerns over Irish elections mid-March and the European Council President Van Rompuy stating there was little chance of a separate meeting on the EFSF during the larger EU leader’s summit on February 4. This will provide ample opportunity for EUR skeptics to panic, but we see these dips as opportunities to build long EUR positions. And on a final note, the SNB’s Hildebrand and Danthine have both sounded concerned recently about the effect of current CHF strength on Swiss growth. However, Hildebrand reiterated that the justification was based on fears of deflation and these risks have most evaporated. We continue to expect that the SNB will stand on the sidelines, merely praying that risk in the EU dissipates and capital flows reverse, as FX intervention is clearly not an option.

08:00 CHF SNB Publishes Monthly Statistical Bulletin
08:00 CHF Money Supply M3 (Dec)
09:00 EUR German IFO – Business Climate (Jan) index
09:00 EUR German IFO – Current Assessment (Jan) index
09:00 EUR German IFO – Expectations (Jan) index
09:30 GBP Retail Sales, % m/m (y/y)Dec 0.0 (1.4) exp
09:30 GBP Retail Sales ex auto fuel , % m/m (y/y)Dec -0.3 (1.8) exp
13:30 CAD Retail Sales (Nov) m-o-m 0.4 exp , 0.8 prior
13:30 CAD Retail Sales Less Autos (Nov) 0.4 exp , 0.9 prior

The Risk Today: EurUsd The bullish cup and handle strategy we are engaged in at the moment is still working out nicely, with the pair now extending above 1.3550 –over 200 pips in the money. Readers may recall that yesterday we drew a very short-term uptrend on the last week’s price action (connecting the 14 Jan high with yesterday’s peak), to help us set a trailing stop on our position –the lower edge of this channel being the guide for our stop (currently 1.3340, effectively making this a zero risk trade). However, considering how far away that is, we can also suggest an alternative trend channel off the 11, 12 & 20 Jan lows, which now comes in at 1.3450. Clearly the benefit of using this alternative uptrend as a trailing stop is that getting stopped out would still result in over 100 pips of total profit; but the cost would be the possibility of getting stopped out prematurely and missing a subsequent move to the 1.4035 target. There is still quite a way to go until that ambitious target however, so there’s obviously plenty of levels noted on the topside before us; yesterday’s high 1.3539 is the first, followed by 1.3635 (23 Nov high), 1.3785 (22 Nov high), 1.3825 (10-11 Nov highs), and 1.3975 (9 Nov high). Supports are noted at 1.3400 (yesterday’s low), 1.3245 (Monday’s low) and 1.3145 (12 Jan high former resistance).Below there we have a large gap before major support at 1.3085 (the 29 Dec pivot and 13 Jan low).

GbpUsd The bearish omens for GBPUSD we noted in yesterday morning’s report (the downside breach of the 2-week uptrend channel and the shooting star candlestick on the daily chart) proved to be correct, as we witnessed an ugly slump mid-afternoon to lows of 1.5838. Nevertheless, as we also discussed, we do still like the prospects for GBPUSD to trade higher over the medium term, so welcome pullbacks in GPBUSD as an opportunity to buy the dip. We managed to buy some towards the 1.5835 near-term support at 1.5835 (as it represented the 17 Jan low), but we would not be alarmed to see a deeper correction to 1.5810 (14 Jan low) or 1.5785 (former resistance now turned support) –indeed we’d probably see the latter as a good level to add some more. Our bullish bias might start to wane if we saw a serious challenge threaten the 1.5718 support (13 Jan low). Until that point the topside levels of note are yesterday’s high 1.6010, then 1.6060 (18 Jan high) and 1.6095 (19 Nov high). After that is a long gap until 1.6185 (9, 10 & 12 Nov triple-high).

UsdJpy The sharp burst of USD buying yesterday managed to yank USDJPY straight up through the top of its 2-week downtrend channel, hitting a high of 83.12 –and furthermore ensuring a bullish engulfing candlestick was printed on the daily chart. In spite of these bullish cues however, the price action this morning has lacked upside momentum and the pair has now edge back within the downtrend. Should another bullish leg higher occur today, first resistance is yesterday’s high 83.12, followed by 83.50 (11 Jan high), 83.70 (7 Jan high), and the formidable old range ceiling from early December at 84.40. This latter level managed to contain numerous rallies back on 29 Nov, 1 Dec, 2 Dec, 8 Dec, 13 Dec and 16 Dec –so it’s likely to be a stubborn barrier should we manage to get back up there. If yesterday’s rally turns out to be just a flash in the pan, expect another return to 81.70 (4 Jan European/US session low) with the possibility of an extended move to 80.95 (31 Dec low), 80.24 (31 Oct low), and the all-time low from 1995 at 79.75.

UsdChf The short squeeze in USDCHF yesterday was extremely uncomfortable for us bears, but we have managed to cling on by the narrowest of margins to our two short positions. The peak of the squeeze hit 0.9687 –identical to the 14 Jan high (and second shoulder of our current head and shoulders pattern), and since then we have pared back towards 0.9605. That 0.9685 level will hold the key to our success, and it MUST hold for our two bearish scenarios to succeed. Should the bullish momentum return to ruin our party, resistance levels above only come in at 0.9784 (11 Jan high), 0.9850 (12-13 Dec highs) and 1.0065 (1 Dec high). As a reminder of our 2 current short strategies; the first is a bearish flag pattern with a target around 0.9480, and the second is a head and shoulders pattern which has a neckline around 0.9605 and a target at 0.9425. Only support noted on the horizon is 0.9530 (former resistance now turned support) as beyond there we have nothing until the all-time lows of 0.9301 seen on 31 Dec.

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