Markets Prepare to Measure Trichet’s Every Word

February 3 2011 by Spencer McKay in Forex Release |No Comments

With much of Asia enjoying the New Years holiday, FX price action was limited and volumes low. Other than the ECB rate announcement and subsequent press conference, traders have been focused on weather patterns in the Southern hemisphere and escalating protests in Egypt.

Cyclone Yasi hit Australia’s Queensland coast, prompting lots of great news footage but limited lasting damage before being downgraded to a measly category-2. While total damage is still unknown, we are hearing that local miners are already preparing to go back to work suggesting that extended suspension of the Australian commodity industry is unlikely. This is good news for the AUD bulls (and regional Asian, inflation worried central bankers) as the limited effect on growth will keep the RBA focused on the mid and longer term; not short term disruptions in growth or inflation trends. The pre-cyclone selling has quickly worn off as tomorrow’s monetary policy statement (MPS) will be released and we believe that the markets are overly dovish in their positioning considering the expected CPI forecasts – watch for another push above 1.0150.

In Egypt, the initially peaceful protests have turned violent, causing concern about potential disruption of service in the Suez Canal (as opposed to fears of regional contagion). There are reports that as a precautionary measure some tankers are big re-routed around the Cape of Good Hope. As expected, crude prices have reversed Monday’s unwind of Egypt risk premium with WTI climbing back to $91.76 and Brent’s unrelenting rise to $103.37. In the FX markets, the escalation did assist USD bulls in temporarily regaining some ground, but the overall risk aversion trade seems unconvincing.

In London, copper pieced the $10,000/ton resistance as industrial commodities continued to be accumulated on concerns over supply disruptions. While the events in Egypt are fascinating, we suspect that from a trading standpoint the markets will be primary focused on interest rate differential stories evolving around today’s ECB meeting (see Central Bank Preview). Considerable expectations for a hawkish Trichet have dominated market chatter. The combination of the latest Eurozone CPI print for January which printed at 2.4% y/y (well above the ECB target of 2.0%) and subsequent comments from both Trichet and ECB officials do suggest that the central bank will stand firm on its price stability mandate. The ECB press conference will be the main focus, with Trichet’s words certain to be measured for further hawkishness. We are in agreement that the ECB will decouple from the Fed’s monetary policy path; a scenario which will further diverge interest rate differentials and provide the EUR with fuel to rally further. However, the recent impressive EURUSD run has become slightly overstretched and despite yesterday’s minor pullback, we are looking for a deeper correction before the EURUSD can attempt a move towards 1.4000. A less than ultra hawkish Trichet today could provide that disappointment to trigger the corrections.

In other EUR news, S&P downgraded Ireland one notch to A-, holding the rating on negative outlook. This was expected, as both Moody’s and Fitch had already revised the credit ratings on Ireland’s sovereign debt one notch lower. Meanwhile, European Council President Van Rompuy announced that by March 25th the EU will be prepared to release a comprehensive solution to the sovereign debt crisis – with the optimistic statement adding to declines of sovereign CDS prices.

Taking a back seat yesterday was the US ADP report, but it will likely be discussed more the closer we get to Friday’s payrolls. ADP private payrolls for January were 187k vs. cons. 140k; after the devastating NFP figure last month (104k), models have been adjusted upwards. Recently the USD has reacted negatively to disappointing data, should the mother of all US economic indicators fail to hit expectations, Kansas City Fed President Hoenig’s “QE3”comments will be ringing in the markets ears and watch for everyone to abandon the sinking USD ship.

08:30 EUR German Bundesbank board member Dombret speaking
08:53 EUR German Services PMI Last 60.0 Exp 60.0
08:58 EUR Euro zone Services PMI Last 55.2 Exp 55.2
08:58 EUR Euro zone Composite PMI Last 56.3 Exp 56.3
09:28 GBP Services PMI Last 49.7 Exp 50.0 – Street Expects 51.3
10:00 EUR Retail sales Last -0.8 M/M 0.1 Y/Y Exp 0.5 M/M 0.2 Y/Y
12:45 EUR ECB Interest rate announcement Last 1.00 Exp 1.00
13:30 EUR ECB Press conference Trichet Speaking
13:30 USD Initial Claims Last 454K Exp 420K
13:30 USD Productivity Last 2.3 Exp 2.4
13:30 USD Labour Costs Last -0.1 Exp 0.2
15:00 USD Factory Orders Last 0.7 Exp 1.7
15:00 USD ISM Non Manufacturing Last 57.1 Exp 57.1
18:00 USD Bernanke speaking
22:30 USD Duke Speaking

The Risk Today: EurUsd EURUSD’s rally is definitely showing some signs of fatigue; the fresh disruption in Egypt boosted the USD yesterday afternoon causing the pair to slide lower from its 1.3861 highs, before finding some firmer ground ahead of 1.3750. We would not be surprised or concerned to see a deeper correction ensue after today’s ECB conference; indeed it may be necessary to clear out some excess speculative longs before we can proceed toward the ongoing cup & handle pattern target of 1.4035. Expect first supports to come into play around 1.3767 (yesterday’s low), 1.3685 (lower edge of the 2-week uptrend channel), 1.3540 (24 Jan low), 1.3518 (100-day moving average), 1.3397 (20 Jan low), and 1.3245 (17 Jan low). In spite of our shift to a neutral-to-mildly bearish stance in the short-term, we still hold a very bullish bias over the medium-and long-term. Key levels to beat on the topside will be the 1.3861 high seen early yesterday, (61.8% fibonacci retracement of the entire sell-off from 1.5145 to 1.1876), 1.3975 (9 Nov high), the psychologically important 1.4000 level, 1.4085 (8 Nov high) and 1.4281 (4 Nov high).

GbpUsd GBPUSD’s bulls are still looking strong, having managed to pierce 1.6230 resistance this morning (yesterday’s high), and hit a new summit of 1.6244. Even a late afternoon round of USD buying could only suppress the pair as far as 1.6140 before willing buyers jumped in to drive the pair higher. Above us, resistance levels are few and far between. In fact, the next one is only eyed at 1.6300 (4 Nov high), with another long gap until 1.6460 (19 Jan 2010 high) and 1.6515 (7 Dec high). Given our views on EURUSD, there’s the possibility of a deeper correction ahead for GBPUSD before another leg higher kicks in, but we would certainly be using these dips as an opportunity to buy. Noted levels below us are 1.6140 (yesterday’s low), 1.6005-20 (sticky area of former resistance and lower edge of a 1-week uptrend channel), followed by the back side of our old downtrend at 1.5950. Other supports seen at 1.5823 (31 Jan low), 1.5751 (which caught the sell-off after the GDP release), and 1.5718 (13 Jan low).

UsdJpy After testing the lower edge of the current 3-week downtrend channel (around 81.30) earlier this week, USDJPY has managed to rebound somewhat –but not very far. Even the fresh violence in Egypt could only boost the USD as far as 81.85 against the JPY, so we are hoping for a bit more upside to present an opportunity to sell. Pockets of supply around 82.25 (31 Jan high), 83.00 (psychological resistance), 83.21 (27 Jan high), 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 on the first test. Should we break below yesterday’s 81.31 low, next support levels are seen at 81.20 (lower edge of downtrend channel), 80.95 (31 Dec low), 80.53 (9 Nov low) and 80.24 (31 Oct low) –but then we have nothing but thin air until the all-time low from 1995 at 79.75.

UsdChf USDCHF has definitely been one of the pairs most acutely affected by yesterday’s resurgence in the USD; sweeping the pair back through 0.9400 resistance to hit a high of 0.9442. For the time being, we maintain our view that another test of the 0.9301 all-time lows is on the cards, but this latest rally does make us wonder whether there might be a potentially bullish pattern forming on the hourly chart. Taking into consideration the last week’s price action, we may be on our way to carving out an inverse head and shoulders pattern with a neckline at 0.9455 and a target at 0.9580.For the time being, we hope this scenario does not play out, but if it does, resistance levels come in at 0.9480 (27 Jan high), 0.9520 (former support turned resistance), 0.9687 (14, 20 & 21 Jan highs), 0.9784 (11 Jan high), and 0.9850 (12-13 Dec highs). Should we instead continue on our merry way lower, 0.9331 is the low water mark on this downtrend, but we’d prefer to wait for the 0.9301 level to break before we initiate any fresh short trades. Once 0.9301 has broken, the risk-reward profile would look far more attractive, and the entry levels less significant compared to the sprawling downside below.

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