Markets Focused on Widening EU Yield Spreads

November 9 2010 by Spencer McKay in Forex Release |No Comments

The market clearly needs a story and the mounting worries over debt problems in Europe seem to fill the gap. While we are seeing significant widening of yield spreads (Irish vs. German 10y spread climbed to 547bps) we are not seeing much follow through in money markets. This is an important fact since prior to the financial crisis and during Lehman collapse USD liquidly was a major problem and stress in MM was a key barometer of the growing risk. It still seems that the dark clouds on the EU horizon are distant, and forecasting what might be the trigger event has become tricky. The Greek “referendum” election on Sunday went off without a hitch, while the Irish government’s concession on pension reforms (to bring the opposition back to the budget discussions) all highlight the uncertainly in trying to predict these events. That said, there has been erosion in the post-QE2 optimism which has pushed Asia regional indexes lower.

EURUSD dropped swiftly through 1.3900 support at the Asian open as a rumor circulated that China’s FX regulators would publish rules to curb speculative capital inflows and 50bp of RRR hikes. However, given the risk “on” rally which sent US stock markets up nearly 3% in the last week and Gold above $1,400/oz, a slight pullback would be natural. Given the belief that issues in Europe don’t have the force to spiral into something worse such as a default and the suspicious lack of follow through in other risk correlated markets, we suspect that fading the news and buying EURUSD on dips might be a decent strategy.

Yesterday’s German data was slightly positive as exports grew by 3.0% vs. 1.5% exp; illustrating that the fundamentals in Europe’s economic engine remain robust. However the slight dip in industrial production to -0.8% m/m vs. 0.4% m/m exp (7.9% y/y vs. 9.5% y/y exp) tempered optimism.

Interestingly, within the Fed the debate over QE rages on. St. Louis Fed President Bullard stated that the benefits of further quantitative easing should be felt in 6 months. In contrast, Fed Governor Warsh spoke and stated that asset purchases might not benefit the economy at all and the expansion of the Fed balance sheet was “not a free option”. This discussion is important because the $600bn is an “intended” figure based on incoming data. The question that now stands is how sensitive the Fed is to these shifts, so individual Fed positions need to be monitored.

With no economic release in the US today, markets will be watching UK data. A strong industrial production number will further erode any remaining expectations of the BoE enacting further asset purchases (tomorrows UK Inflation Report will provide additional insight).

07:00 EUR Germany: Final CPI, % 0.1 (1.3) exp, 0.1 (1.3) P
09:30 GBP Visible trade balance, £bn Sep -8.0 exp, -8.2 prior
09:30 GBP Industrial production, % m/m (y/y) Sep 0.4 (3.5) exp, 0.2 (4.2) prior
09:30 GBP Manufacturing output, % m/m (y/y) Sep 0.3 (4.9) exp, 0.3 (6.0) prior
14:00 USD Wholesale inventories Sep 0.6 exp, 0.8 prior
14:30 EUR Irish Central Bank Governor Honohan speaks
16:30 NOK Norges Bank Deputy Governor Qvigstad speaks

The Risk Today: EurUsd EURUSD’s dramatic collapse has continued without pause this week as the liquidation of longs dragged us down to lows of 1.3837 overnight –taking the losses since last Thursday’s 1.4281 high to almost 450 pips. The symmetrical triangle pattern we had been tracking on the hourly chart is unquestionably negated by this sell-off, and from here we return to a neutral bias in the short-and medium-term. The next level of support eyed on the downside is the 1.3807 low from 29 Oct, with further pockets of demand expected at 1.3735 (27 Oct low), 1.3700 (20 Oct low) and 1.3635 (5 Oct low and 38.2% fibonacci retracement of 1.2588 –1.4281). Expect rallies to be slowed back up through 1.4000 psychological resistance and 1.4085 (8 Nov high).

GbpUsd GBPUSD held out valiantly in the face of the USD-resurgence last week, but we fear the break of the 3-week uptrend channel yesterday may scupper this phase of the rally in the short-term. From here the key support levels on the downside are eyed at 1.6000 psychological pivot and 1.5960 (2 Nov low) so expect decent bids to keep the pair buoyed above there. We do still like GBPUSD higher in the medium-term, but should we be underestimating the depth of the current correction, it’s worth noting the subsequent supports at 1.5875 (29 Oct low),1.5771 (50-day moving average), 1.5730 (27 Oct low), 1.5650 (20 & 22 Oct high), and 1.5600 (22 Sep low). On the topside expect pockets of supply to linger around 1.6155-70 (back of former uptrend channel and 8 Nov high), 1.6299 (4 Nov high), and 1.6460.

UsdJpy The face-off between USDJPY bulls and the upper edge of the major downtrend channel yesterday did not yield a break-out scenario to the topside, and subsequently the pair has eased back below 81.00 and is heading toward the near-term support at 80.60. For those who got short around 81.20 as per our report yesterday, we still feel that the ideal placement of the stop is just through 81.60 (3 Nov high), but for the more cautious player, it could certainly be reasonable to set a stop for only half the position at 81.60+, with a stop for the other half slightly lower down around 81.35 (upper edge of downtrend). Given the tight ranges of late, we’d expect 80.60 to be a key support on the downside so would be looking to take profits off the table towards there. Until either the bulls or bears stamp their authority on this one, our medium-term view is completely malleable. For the bulls, a break above the current downtrend channel (81.35) is a minimum requirement to initiate a reversal, but they will face decent supply back at 81.60, 82.00 (ceiling since mid-Oct), 82.35 (12 Oct high) and 82.55 (8 Oct high). For the bears, it will be necessary to break into fresh lows to entice players back into the short trade; we are waiting for a return to 80.25 (31 Oct low) before we consider shorting again and really, we’d prefer to see a break below 79.76 (the 1995 all-time low) to bolster our conviction.

UsdChf The CHF is faring very well against the USD-rally; since USDCHF touched a low of 0.9550 on 5 Nov the pair has certainly rallied, but the bulls only managed to push it around 130 pips before being capped by offers around 0.9685. We think this represents a decent level to take out some small short positions, looking for a return to the 0.9540 support level. Over the medium-to long-term we feel Swiss fundamentals warrant a return to the all-time low 0.9464 (seen on 14 Oct), and without the fear of SNB intervention we’d predict that a break into new lows would attract yet more sellers to accelerate the move to the downside. Pockets of supply at should clutter any extended moves to the topside; we note nearest resistance levels at 0.9685 (as previously mentioned), 0.9760 (former pivot), 0.9820 (3 Nov high) and 0.9970 (1 Nov high).

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