Return Of Risk Appetite Leads To Correction In EUR/USD And USD/JPY

Daily Forex Fundamentals | Written by KBC Bank | Oct 29 08 09:09 GMT |

Sunrise Market Commentary US Treasuries only moderately lower despite surge in equities Volatility remains sky-high in many markets, including the Treasury one. Today, attention goes to the FOMC meeting with markets counting on the Fed to use their bazooka. German yields decline, despite equity rebound Despite the equity rebound, German yields set down a strong performance, as yields declined further. As a result, German 10-year yields fell below US 10-year yields for the first time this year. German bonds do however also outperform their European counterparts, as the spread between German and Italian 10-year yields widened to above 100 bps. Return of risk appetite leads to correction in EUR/USD and USD/JPY Investors sold yen and to lesser extent dollars for euros to book profits, as equities rebounded. The Sunrise Headlines US Equities rallied late on Tuesday ahead of the FOMC rate decision today; Dow/S&P ended 10.8% up, but market technical pictures appear to be behind the move. Asian stocks rise too led by the Japanese after speculation that the BoJ is considering a rate cut. The International Monetary Fund, European Union and World Bank agreed on a $25.1 billion rescue package for Hungary to restore investors' confidence in its economy hit by the financial crisis. The Bank of Japan will consider cutting rates after the surge in the yen that batters exports and to protect its economy from the global financial crisis. The Central Bank of Iceland raised its key interest rate from 12% to 18% as a condition of the loan agreement with the IMF. British finance minister Alistair Darling noted that governments must adapt their economic policies to tackle the fallout from the financial crisis by saying 'just as markets change, so should policy'. Crude oil ($ 65.05) rebounds on speculation the Opec is planning to cut output again. Today, the calendar contains German CPI, US durable orders and the FOMC rate decision. Currencies: Return Of Risk Appetite Leads To Correction In EUR/USD And USD/JPY EUR/USD On Tuesday, EUR/USD tried to move again from the cycle lows set on Monday, but didn't succeed until late in the session when a violent equity buying spree pushed equities to an outsized 10.8% (S&P) gain. The eco data didn't impact trading: US data were awful, as both consumer confidence and the Richmond Fed manufacturing surveys showed record low values, emphasizing once more that confidence in the economic outlook is at rock-bottom levels for both households and firms. Housing prices declined further, but not more than expected. In EMU, the reports showed a similar picture with weakening French consumer and producer confidence. However, eco data aren't the prime driver behind the market. The market doesn't discriminate currently between countries on the basis of their relative growth performance. It reasons from the perspective of a global recession and a financial crisis and their impact on government reactions to these. However, the global recession and financial crisis causes also a sharp re-positioning which means in FX terms closing carry trades and repatriating the money towards the funding currencies like yen and to lesser extent the dollar. Equities held up better than was recently the case and also the oil price more or less stabilized, given some sort of support to the euro and keeping EUR/USD close to the 1.25 mark for most of the day. It was a late session surge of equities that triggered a euro rally, as equities are the benchmark to gauge the risk appetite of investors and that temporary gave the green light. Crude oil similarly got a boost in late session. In a daily perspective, EUR/USD closed at 1.2682, up from the previous close of 1.2494. There was no specific trigger behind the late session surge. Of course, the market was hugely oversold. Some mention the hopes for a rate cut today, but as this was already well discounted, it isn't a very good argument. However, we consider it as an internal market technical move. Did hedge funds need to cover shorts (to book profits) after being squeezed in shorting VW (and losing big)? Overnight, equity trading was very volatile in Asia (cf. yen part), but at the time of writing, the bulls seems to trump the bears and as a consequence, EUR/USD is a little bit higher, trading just above 1.27 from an intra-day high of 1.2627. At the start of Asian trading, when equities surged on the back of Wall Streets' gains, the pair hit a 1.2839 high. So, price action shows that the pair trades off equities and the risk aversion/appetite theme. Today, the calendar contains the US durable orders. We expect the durables to be weaker than the 1.1% M/M fall consensus expectation, but that shouldn't have much impact. It is well known that the economy is in dire straits and whatever the durable report reveals, it wouldn't change that assessment. The FOMC decision is more important. The market firmly discounts a 50 basis points cut and that is completely discounted. There are some stories in the media that markets are looking for something more substantial. We doubt whether the Fed will deliver that. The Fed seems convinced that currently interest rate policy is less important than other policy levies, like fiscal policy, liquidity policy, and should be conscience that by cutting rates big, it rapidly nears the zero bound for rates which would make monetary policy making much more difficult. Therefore, we think they go by 50 basis points, but with the risk that they choose for 25 basis points combined with a very soft statement. Why that may look to be negative for equities and thus positive for the dollar, we are not convinced that it would hit equities sharply. The 25 billion $ rescue package for Hungary, released overnight, is a dollar negative. We advocated that a prolonged period of sub par growth and a deflationary environment is more supportive to the dollar than to the single currency. This is also the main reason for our EUR/USD negative view longer term, which remains intact. Shorter term, there might be reasons for the euro to get some respite. The steep decline of the single currency in recent weeks, the re-assessment of the ECB rate outlook (markets now discount a 2.5%-2.25% official rate in mid-2009) and tentatively the return of more normal conditions in the equity markets might be dollar negative. Very short term, the focus is on the FOMC meeting, might have offered dollar bulls a pretext to book profits, but didn't they do it yesterday? A 50 basis points rate cut may still be somewhat dollar negative and the IMF package for Hungary is another negative, but we don't think it will change the longer term (positive) outlook for the dollar. In this context, we still favour a sell euro-on-up-ticks, preferable when EUR/USD is closer to 1.3259. From a technical point of view, EUR/USD over the previous month tumbled from the 1.4866 reaction high to levels below the 1.24 mark early this week. High profile intermediate supports like the longstanding daily uptrend line since 2002 (today in the 1.4050 area), the previous low at 1.3882 and the 1.3259 10 Oct reaction low were all taken out with remarkable ease. 1.2481 (the Oct 2006 low), under test in recent days, remains the first high profile support on the charts. EUR/USD needs to return above the 1.3259 reaction low to get a first indication that pressure is easing. However, yesterday's move constitutes an outside key reversal/bullish engulfing move that might be an indication of a medium term low in place. Confirmation is needed though and we shouldn't forget that the markets are not functioning normally. EUR/USD: At last some correction, but how far will it go? Support comes in at 1.2627 (today low), at 1.2549 (break up hourly), at 1.2465/56 (daily envelop/Bollinger bottom), at 1.2331 (new reaction low). Resistance is seen at 1.2832/42 (daily envelop/today spike), at 1.2929 (23% retracement from 1.4866) and at 1.3003 (4th wave hourly) and at 1.3095 (MTMA) The pair is in neutral conditions USD/JPY On Tuesday, USD/JPY rallied higher, following two very nasty sessions in which the pair plunged 7 yen lower. Indeed, USD/JPY opened the session somewhat below 93, but moved higher when the Nikkei rallied in the second half of Asian trading session. The pair took a breather in the European and early US session, but staged a powerful follow through rally later on when US equities found the way up. Better equities coupled with yen overbought conditions and some 'wild?' rumours on a BoJ rate cut were a nice pretext to book profits. USD/JPY closed at 98.03, up from 92.78. Overnight, Japanese equities traded very volatile. At first they rallied more than 7% higher (Nikkei), losing nearly at their gains at mid-session, only to stage a late session rally, ending the day up 7.7%. However, USD/JPY reacted less outspoken. The pair gained modestly on the initial move higher of equities, but rapidly lost ground again, even before equities hit the skids. Of course, yesterday's huge yen losses and the volatility in equity trading convinced many that the risk aversion trade that benefited the yen in the past shouldn't be buried yet. There is no reason to expect the yen negative carry trade to resume anytime soon. There were also messages that Japanese exporters stepped in to sell dollars to lock in USD/JPY levels of closer to 100. The rumours of a BOJ rate cut are probably only that, rumours. Indeed, we think it wouldn't at all restore optimism in the economy. It took the BOJ so long to get away of its zero rate policy that is closely associated with the deflation decade. Going back to zero could have a devastating impact on confidence. The current problem of a strong yen isn't a problem of too high rates and we doubt it would help weaken the yen. On the charts, global market stress hammered the pair through the 103.50 range bottom two weeks ago and the pair set a new reaction low at 90.93 last Friday. Longer term, the break below the March 2008 USD/JPY low means that little key support is seen before the all-time (April 1995) low at 79.75. Recently, we were not fond of buying yen on the argument of extreme stress, as the yen may rapidly lose ground if the financial markets stabilize and yesterday's move shows the argument isn't totally unfunded, even if we admit that in a longer term perspective, the yen did very fine and was the world outperforming currency. Therefore, we still don't want to run after the yen and don't feel eager to buy into the yen. From a technical point of view, the picture is however clearly bullish with a triple top on the charts with targets that stand below the 79.75 all-time low. Short term, USD/JPY may correct higher with a sustained move above 98.98, the medium term moving average needed to bring the pair in more neutral territory. USD/JPY: tries to rebound with break above 98.98 needed to call off the downward alert Support stands at 95.97/66 (break up hourly/daily envelop), at 94.91 (reaction low hourly), at 94.07/93.81 (break-up hourly/Bollinger bottom), at 91.88 (yesterday low) and at 90.87 (last week low/year low. Resistance comes in at 98.98 (MTMA), at 100.01 (Bollinger midline/ daily envelop), at 100.77 (50% retracement). The pair is in neutral territory. News US: Consumer confidence crashes in October Consumer confidence plunged from an upwardly revised 61.4 to 38.0 in October, while the consensus was looking for an outcome of 52.0. Both sub-indices declined sharply with the present situation falling from 61.1 to 41.9 and expectations dropping from 61.5 to 35.5. Consumers were especially more pessimistic about the labour market and business conditions. Consumer confidence reached now its lowest level since series began in 1985 which clearly illustrates that the financial crisis has a big impact on consumer sentiment. The Richmond Fed manufacturing index plunged to its lowest level since series began in 1993. The headline figure worsened more than expected, coming out at -26 in October (from -18). Details show that all sub-indices worsened led by sharp declines in new orders (-35 from -23), shipments (-24 from -16), order backlog (-40 from -24), capacity utilization (-27 from -15) and average workweek (-14 from -2). The number of employees fell from -13 to -15 and wages dropped from -2 to -4. Looking at prices, prices paid declined from 3.85 to 3.66, while prices received were higher (2.06 from 1.68). After the NY and Philly Fed, the Richmond Fed is the third regional survey showing a sharp deterioration in business confidence, which raises fears that manufacturing ISM will also worsen significantly. The S&P Case Shiller house price index came out in line with the expectations, falling 16.62% Y/Y in August. The July figure was upwardly revised from -16.35% Y/Y to -16.32% Y/Y. The three months annualized figure deteriorated from -8.43% to -9.25%, but is clearly below the low of -24.9%, reached in March. Although the bottom is not yet in sight, it is important to note that the pace of the decline slows further which indicates that signs of stabilization may not be too far away. Other: CBI reports unchanged volume of sales In the UK, the CBI distributive trades (retail) survey reported an unchanged sales balance of -27 in October. The less volatile three months average improved from -36 to -33, but remains very weak. Although the CBI reported an improvement in sales in recent months, there are no reasons to become more optimistic about the UK economy. 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