Carry Trade Theme to Continue, Central Banks and NFP in Focus
The funding currencies, Japanese Yen and Swiss Franc, rose sharply across the board last week as massive unwinding of carry trade positions on risk aversion in emerging markets, in particular after China’s stock market crash. The high yield commodities currencies were hit hard with AUD/JPY and NZD/JPY dropping 455 pts (4.75%) and 521 pts (6.10% respectively. Among the majors, Sterling was under most pressure, dropping sharply in GBP/JPY (-1058 pts, -4.45%) and GBP/CHF (-567pts, -2.34%) crosses, as well as weakening in GBP/USD and EUR/USD. After all, dollar and euro were indeed mixed in general though the pair EUR/USD rose slightly by 24 pts. Carry trades will likely to dominate the market in the coming week, in particular the Japanese yen. With five major central banks (ECB, BoE, BoC, RBA, RBNZ) scheduled to meeting this week, and with Non-farm payroll on Friday, much volatility is ensured.
The yen’s massive strength, and to a lesser extent Swiss Franc’s, were triggered as falling stock markets in the world, started with China’s stock market crash on Monday, prompted investors to unwind trades financed by borrowing these ‘funding currencies’. Such strength has triggered further covering on a domino effect. Dollar has received additional pressure on Iran nuclear jitter and after former Fed Chairman mentioned that “recession” is possibly in 2008. Technically speaking, both yen and franc should have made a significant medium term bottom in most crosses and even though some consolidations could be seen this weak, further strength is still expected to be seen in these two currencies as carry trade unwinding continues.
Economic data played a secondary role in last week’s price actions. Nevertheless, data from the US were mixed. Jan durable goods orders were a large disappointment, dropping sharply by -7.8%, with ex-transport orders tumbled -3.1%, much worse than expectation. Q4 GDP growth revised more than expected to 2.2% led by by smaller inventory accumulation, weaker growth in personal consumption expenditures and higher imports. Chicago PMI dropped further to 47.9 in Feb, much worse than expectation of 50.0. New homes sales dropped sharply to 0.94M in Jan.
However, ISM manufacturing index rebounded strongly from 49.3 to 52.3, much higher than expectation of 50.0, suggesting that the slowdown in manufacturing has possibly bottomed out. Jan personal spending and spending both rose strongly by 0.5% and 1.0% respectively. Core PCE accelerated mildly to 0.3% pushing yoy rate to 2.3%, indicating that inflation pressure remains and there chance for a cut from Fed in second half of the yea remains low.
The inflation data remained subdued as flash estimates of Eurozone HICP remains at 1.8% only, still below 2.0% target of ECB. However, M3 money supply continued to surprise the market by staying at 9.8% in Jan after Dec’s growth was upwardly revised to 9.8%. That has pushed the 3 months average from 9.2% to 9.7%. These two data will continue to give the ECB a difficult task in deciding further monetary policy actions In particular, as the impact of VAT increase in Germany is starting to be seen in economic data with Germany retail sales dropping sharply by 5.1% in Jan. Though, Manufacturing PMI were still steady in expansion zone above 50 in Feb.
Mixed data were also obtained from Japan. On the one hand, household spending rebounded strongly by 0.6% in Jan, much better than expectation of -0.4% fall. Unemployment rate also dropped from 4.1% to 4.0% but real wages were down a further 1% yoy. On the other hand, CPI inflation in Jan remains at 0%, dragging the yoy rate from 0.3% to 0.0% too. There is a chance that Japan is heading to another mild bout of deflation over the coming months.
Swiss data were supportive to the rally with KOF Leading Indicator ending the losing streak in Feb and rebounding to 1.79, suggesting a rebound should be seen in the Swiss economy in the second half. Meanwhile, Feb PMI also beat expectation by rising to 63.5.
There were little reactions to UK data too. Though, Manufacturing PMI rose to 55.4 in Feb, beating expectation of 53.0. CBI distributive trades just missed expectation of 20 and recorded a reading of 19. Gfk consumer confidence came it at -8.
The Canadian dollar remains weak throughout the week and data released hasn’t provided any support. Jan PPI surprising dropped by -0.1% mom, pushing yoy rate from 3.6% to 2.8%. Though, Q4 GDP were stronger than expected and grew 1.4%, beating consensus 1.3%.
The Week Ahead:
While carry trade will continue to remain the dominant theme of the markets this week, there are some important economic events that will likely trigger further volatility. The US economic calendar will start with ISM non-manufacturing index on Monday, which is expected to retreat slightly from 59.0 to 58.0 in Feb. However, much focus should be on Tuesday’s Q4 labor costs revision and Friday’s Non-Farm Payroll and Trade Balance. Q4’s unit labor costs is expected to revise up from 1.7% to 2.9%. meanwhile, Non-farm payroll report is expected to show stronger job growth in Feb by increasing 123k with unemployment rate remaining at 4.6%. Trade deficit unexpectedly widened back to above $60b level in Jan and is expected to narrow slightly to -$60b in Jan.
ECB meeting will be the main even in Eurozone. ECB is widely expected to raise rate by 25bps in 3.75%. Focus will, again, be on the press conference. Focus will be on Trichet’s comment on the inflation outlook, in particular, with inflation remaining below ECB’s 2% target. There are some possibilities that ECB will revise down the inflation forecast. Other data from the Eurozone include Service PMI on Monday, retails sales and GDP revision on Tuesday, and Germany factory orders, industrial production and trade balance.
BoE is widely expected to keep rates unchanged at 5.25% and hence the meeting will likely be a non-event. But still there are some important economic data scheduled to be released. Services PMI was a disappointment in Jan as it retreated more than expected to below 60 level at 59.2 and Feb’s reading will be closely watched. Industrial production and manufacturing production will be featured on Friday too.
RBNZ to lift the Overnight Cash Rate 25bps to 7.50% this week and the accompanying statements will likely imply that further rate hikes remains likely. Meanwhile, but BoC and RBA are expected to keep rates unchanged at 4.25% and 6.25% respectively.
Sharp decline in EUR/JPY last week has confirmed that a medium term top is formed at 159.63 with price actions from 153.67 to 159.63 as a diagonal triangle and with bearish divergence condition in daily MACD and RSI. From a short term angle, initial downside target of 153.67 (50% retracement of 147.71 to 159.63 at 153.67) was met. And hence, risk of a short term recovery has increased, in particular with deeply oversold condition in 4 hours RSI. However, above 155.19 resistance is needed to indicate that a short term low is formed first. Otherwise, further decline is still in favor.
Break of 115.19 should bring stronger rebound to 38.2% retracement of 159.63 to 153.59 at 155.90 or above. But upside should be limited below 157.28 cluster resistance 61.8% retracement of 159.63 to 153.59 at 157.32) and bring another fall.
In the bigger picture, we’re treating the whole year long rise from 130.60 as resumption of the long term up trend with first wave ended at 143.60, subsequent correction ended at 137.167. The third wave up could have ended at 159.63 already after meeting 161.8% projection of 130.60 to 143.60 from 137.16 at 158.19. The current fall from 159.63 should represent the fourth wave correction of the whole rise from 130.60.
Having said that, we’d expect such correction from 159.63 to target the lower channel line (143.60 to 159.63, 137.16, now at 150.89) and complete there to resume for another rally to above 159.63 before finishing the whole rise from 130.60. However, sustained break of this channel and 38.2% retracement of 137.16 to 159.63 at 151.05) will dampen this view and suggest that much deeper decline is underway. Meanwhile, a strong rebound to above 157.28 cluster resistance will indicate price actions from 159.63 is developing into sideway shallower sideway consolidation instead of a deep correction and should bring retest of 159.63 high.
Shing-Ip Tsui is the founder and CEO of
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