FOREX TRADING

The US dollar slid across the board in the Wednesday session as improving risk-appetite dragged the currency lower versus the euro and Canadian dollar. The global equity bourses traded higher with the Shanghai Composite index leading the advance, surging by nearly 2.8% while Germany’s DAX index edged up by almost 2%. Crude oil also rallied, popping higher by over 3.4% $74.45-per barrel while spot gold eased slightly by 0.6% to $1,229-per ounce. Meanwhile, the US equity bourses also traded higher with the Dow Jones, Nasdaq and S&P 500 improving by almost 1%.

Amid a quiet day of US data, traders looked to Fed Chairman Bernanke’s Congressional testimony before the House Budget Committee and the Fed Beige Book for market direction. Bernanke described the impact on US growth from the ongoing Eurozone deficit crisis as “moderate” but stressed that the housing and labor markets will continue to weigh on the economy. He expects GDP around 3%-4% this year and said he doesn’t anticipate a double-dip recession but cautioned that it cannot be ruled out though. (more…)

In a speech in Asia, Bernanke laid out some of his thoughts on the economy as on monetary policy.

Key highlights from his speech included:

1. The recovery is "moderate paced."
2. "There seems to be a good bit of momentum in consumer spending and investment. My best guess is we’ll have a continued recovery [but] it won’t feel terrific." In other words, there will not be a double-dip recession.
3. Fed will raise interest rates before the economy returns to "full employment."
4. Unemployment rate will remain "high for a while."
5. Banking sector is not "completely healthy" and lenders remains "cautious" in providing credit.
6. The ECB stabilization package is "a lot of money" and that policy makers "are committed to avoiding default in Greece."

The speech helped markets rally slightly overnight, before markets retreated on worries over the UK debt and a slide in the EUR/CHF.

Fears of a double-dip recession in the globe and in the US rose in recent weeks as investors and economists worry about the spill-over effects of the Euro-zone sovereign debt situation which has fed declines in equity markets. The disappointing May non-farm payroll report also increased concerns that job creation in the private sector is slowing. On Wednesday, Bernanke will be in front of Congress testifying about the state of the economy and the budget.

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Yet we again we’re faced with a market and various analysts screaming about how risk is back on. And again I suggest that this phenomenon is likely to last for approximately the next 5 minutes…

Yes, we had the Hungarian PM refuting comments about a default overnight… So what? Let’s say they don’t default; that still doesn’t repair/improve their overall negative macro fundamentals does it? Nor does another significant fall in the S&P overnight help, determine that risk is back on, in my view. In fact if anything it serves to confirm that we are indeed headed lower on both equities as well as the various ‘Risk’ currencies.

Overnight the only real star seemed to be the AUDUSD which got a small boost from the RBA’s Jillian Broadbent commenting that the recovery in Australia is ‘V’ shaped and that things are set to continue higher. Conversely, we saw particularly poor consumer confidence data out last night suggesting that the man in the street is seeing quite a different picture. For now that leaves this cross confined to its recent range of 0.8230/50 down to 0.8080. On the day I’m hearing of various (almost insignificant sized) stops dotted around and above 0.8240/50 with real and solid offers coming in around the 0.8280 level. I remain a seller of rallies in this cross and look for those offers mentioned at the 0.8280 level to confine any upside which might be exposed after the stops are triggered.

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Last week, stock markets plunged heavily after Hungary announced that the economy is in a ‘grave’ position from the huge deficit and debt their nation was under, the market decline continues today despite Hungary reversing their role saying there was no danger of default.

A former finance minister of Hungary and Orban’s chief of staff, Mihaly Varga said that the nation’s targeted deficit of 3.8% of GDP approved by the IMF and EU was ‘attainable’ when austerity measures are applied. The European Commission projects that the deficit of the nation will expand to 4.1% of GDP this year.

The European Union and Moody’s Investors Service analysts’ support Hungary’s government stance that they are not in a tight situation like that of Greece.

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Last Friday’s softer than expected US employment report weighed on sentiment in the financial markets which, earlier in the week, had shrugged off ongoing eurozone concerns. Today at 09:30 sees the release of the June eurozone Sentix index – a gauge of investor optimism – which is expected to show a second consecutive monthly fall, having declined to -6.4 in May.

Also due today at 11:00 are German factory orders for April, which we think may have posted a small monthly rise (though the market consensus is for a slight fall). In the annual comparison, factory orders have rebounded strongly and are up about 25%. However, as the chart shows, there are tentative indications from the German manufacturing PMI survey that the pace of growth in orders may have peaked.

Chart: German factory orders are up more than 25%y/y, but the PMI survey suggests orders growth may have peaked

Hungary makes waves

Risk appetite headed south ahead of the US employment report on new developments in Hungary, that were at least hinted at yesterday by a spike higher in EURHUF on an "informal" visit from the IMF to Hungary. Now suddenly it has come to light that Hungary’s finances are a shambles after the new center-right PM Orban took power on May 29 and now is out suggesting that the country is in a "grave situation" because the previous government lied about the state of the economy and cooked the public books. More news on specifics is expected this weekend, and the news is not likely to be pretty, as the previous administration was obviously up to no good, and as the PM will likely try to firmly pin as much of the situation on his predecessors as possible. The situation is reminiscent of Greece, with important differences – Hungary can devalue its currency and can more easily default than Greece – the question is how it handles its mortgage debt – much of it denominated in Swiss francs – and whether the country gets another IMF bailout or ends up in some kind of default. EURCHF broke below 1.4000 in today’s trade – but are CEE defaults a CHF positive? More on this in the future. In any case, the situation puts a damper on the entire EM complex as it reminds how fragile these economies are when a crisis hits.

Chart: CHFHUF

During the go-go days of the great global credit bubble, when risky assets of all stripes were appreciating almost regardless of fundamentals, it seemed a no-brainer for Hungarian citizens to finance their home purchases in Swiss francs, where interest rates were very low and the currency was weakening, while Hungarian rates were far higher and HUF was strengthening. During the middle years of the decade, up to 80% of mortgages were financed in foreign currencies. The chart below shows how much more expensive those mortgages have now become from currency appreciation – some 33% or more from 2007 lows in CHFHUF.

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The US employment report will be watched closely and a robust report would reinforce confidence that the US will out-perform the Euro-zone. There will also be some additional speculation that the Federal Reserve will need to tighten policy sooner than expected. Nevertheless, the overall risks suggest the dollar will find it difficult to gain much support from the data given that a strong figure is priced in. Overall, there is still the probability for medium-term Euro losses to at least 1.20 against the dollar. With position adjustment a feature on Friday, the Euro should be able to hold above 1.21 with a potential squeeze higher to at least 1.23 later in US trading where Euro selling will offer value again.

The Euro was unable to hold above 1.23 against the dollar in Europe on Thursday and had a steadily weaker tone during the day as the currency remained trapped by negative confidence surrounding the Euro-zone area. (more…)

The confidence in the euro zone is negatively affected from the debt crisis that exists in Greece, Spain, Portugal and Italy which is exhausting the economic recovery of the euro zone. From the debt crisis, the economic outlook confidence index slipped worse than expectations.

Business climate indicator for May improved to 0.34 from 0.23 beating the estimated 0.20. The industrial confidence improved to -6 from -7 while services confidence dipped to 3 from the prior and projected reading of 5 and 6 respectively.

Consumer confidence stood unchanged at -18 while economic confidence also for the same period, in May fell to 98.4 from 100.6 which was also what the markets were estimating.

Confidence is sabotaged in the nation as government’s started applying austerity measures to reduce spending and increase savings, as a way to narrow the deficit which is weighing on the outlook of the euro zone.

Also the weaker euro versus the dollar is increasing import prices therefore the end user pays more for a good or service, which also weighs on confidence levels and is reflected in crippled consumer spending. (more…)

• US Equities dropped late on Friday, after Fitch Ratings downgraded Spain’s debt to AA+ from AAA, but said the country’s outlook is stable. The Dow/S&P fell by 1.20% led by financials. This morning, most Asian shares reversed their opening losses.
• Rating Agency Fitch removed Spain’s AAA credit rating, lowering it by a notch, on expectations that the moves to cut the nation’s debt will slow its economic growth.
• France admitted yesterday that keeping its top-notch credit rating would be a stretch without some though budget decisions, following German hints that Berlin may resort to raising taxes to help bring down its deficit.
• US Federal Reserve Chairman Bernanke said this morning that the world economy depends ever more on emerging markets to maintain strong domestic growth and economic and financial stability.
• Japanese factory output rose less than expected in April, suggesting that growth in manufacturing will slow in the coming months as the benefits of robust exports to fast-growing Asian economies may be moderating.
• The UK economic recovery is underway, but the country faces heightened threats from the worsening crisis in the euro zone and upheaval in global financial markets, the British Cambers of Commerce said.
• India’s economy grew an expected 8.6% in the first quarter from a year earlier, driven by robust manufacturing sector on the back of government and consumer spending.
• Chinese Premier Wen Jiabao warned this morning that global economic growth remained vulnerable to souvereign debt risks and the possibility of a second downturn, while saying his own country’s growth remained on track.
• Today, the eco calendar contains the euro zone M3 money supply and credit growth data, the European Commission confidence indicators and first estimate of euro zone CPI.

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U.S. Review

Some Good and Not So Good Data This Week

• The panic that gripped global markets over the past two weeks appears to be easing a bit. It helps that the economic data coming out of the United States suggest a sustainable recovery is now well underway. On the positive side, consumer confidence rose more than expected in May. The April durable goods orders and the May Richmond Fed survey confirmed that the U.S. manufacturing expansion continues to gain traction.
• Less good was the slight and unexpected downward revision in Q1 U.S. GDP growth, and U.S. home price data that reveal home prices beginning to roll over again.

Two-Speed Recovery Continues

The U.S. economic recovery continues to show its Dr. Jekyll and Mr. Hyde sides. Perhaps that is a factor behind the schizophrenic stock market behavior of late. An “unbalanced” or “two-speed” recovery remains the current state of affairs. This is disappointing to the bulls that have been rampaging on Wall Street since March 2009, trumpeting the strong return of corporate earnings, while whispering the recovery is looking stronger than the consensus had expected. There were plenty of reminders this week that the bulls’ case for a normal or robust recovery from deep recession remains a long shot.

On the labor market front, initial jobless claims refuse to drop to levels that would suggest a swift return of a normal private sector payroll growth during an economic recovery. The four-week moving average of initial jobless claims, a more stable indicator of job trends than the weekly number, has risen for two consecutive weeks now, even though initial claims dropped by 14,000 to 460,000 in the latest week. Initial claims have clearly been trending around the 450,000 level for months now, when we would like to see them slip back to the 350,000-400,000 level that often characterizes a normal labor market during economic expansion. Thankfully, other employment indicators are not quite as scary. The monthly payroll data have indicated positive job growth for four consecutive months now. The household survey data are indicating an even stronger return of job creation, although one third of those new jobs are part-time. Indeed, we expect the May jobs report that is to be released next week will reveal even more job gains than in April, though much of the strength will likely be from temporary census hiring.

We also got confirmation that despite Herculean efforts to support the housing market through homebuyer tax credits, mortgage modifications and record low mortgage rates, the ability to stabilize home prices at current levels appears fragile. The Office of Federal Housing Enterprise Oversight (OFHEO) released its monthly purchase-only home price index report for March, showing an increase of 0.3 percent from February after a string of three consecutive monthly declines. However, this home price index is still down 1.9 percent from a year ago. By contrast, the seasonally-adjusted national Case-Shiller index revealed renewed weakness in home prices in the first quarter. The Case-Shiller index plunged at an annualized 5.05 percent rate in the first quarter, even though the year-over-year figure improved to a 2.13 percent home price gain. In the wake of the homebuyers’ tax credit expiration and the rise in the U.S. foreclosure rate, further declines in national home prices can be expected. (more…)

News and Events:

Risky assets continue to come under heavy selling pressure. During today’s Asian Session, the pressure was bought on largely by the EURUSD sinking down to 1.2234, from Friday’s 1.2672. While no single news event triggered the selloff in risky assets, the increased tension between North and South Korea sure didn’t help investor confidence. Asian stock indices are considerably lower with the Hang Seng down 3.41%. In the Eurozone, weekend news and events continue to wreak havoc on the EURUSD. The Spanish government announced it would take over CajaSur, one of Spain’s largest savings banks, and additional consolidate another 3 regional banks. In addition, the IMF stated that Spain required significant structural reforms and acutely identified Spain’s problems of ‘ a dysfunctional labor market, a deflating property bubble, a large fiscal deficit, heavy private sector and external indebtedness, anemic productivity growth, weak competitiveness and a banking sector spotted with pockets of weakness.’ Look for EURUSD weakness to continue. Onto GBPUSD, the 2nd estimate of UK Q1 GDP will be released today and the market is expecting a revision to +0.3% from +0.2%. Any positive adjustment will be good news for the GBP and for policy-makers. On the intellectual circuit, comments from MPC Posen alluding the current UK environment to early-90s Japan were a bit forbidding. However, what is encouraging is that Posen stated that the UK would learn from Japan’s policy errors and not precipitate a ‘lost decade’ by tightening prematurely. The combined worry across various markets has pushed LIBOR USD funding costs to rise about 50 basis points for the first time in 11 months. We don’t expect this trend to reverse in the near term and risk-correlated currencies should continue to lose relative value in the near-term. Something to take note of is that markets seem keen on reacting violently to poor news while remaining quite muted to any positive headlines. In the coming days, we’ll continue to watching market reactions to headlines in order to assess risk sentiment and confidence. (more…)

Euro-zone sovereign debt concerns continue to weigh on global asset markets, with the revelation that a Spanish savings bank had been taken into government control adding to the negative sentiment. Equity markets were again trading on the backfoot, with US stocks posting their fourth loss in five days, while Libor spreads continued to edge higher. In the US dollar markets, the spread between 3-mth Libor and the OIS rate widened to 29bp, its highest since July 2009, as fears that the debt problems in the Euro-zone could precipitate a wider global liquidity squeeze continued to mount. The euro came under renewed downward pressure against the major crosses, to end around $1.24, with the US dollar finding general support following the release of a much stronger-than-expected 7.6% gain in April existing home sales.

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U.S. treasury notes are trading between gains and losses while euro-area government bonds are higher. Yields are responding to the news from Germany where regulators banned certain types of short sales, but the impact is changing as the day wears on. Initially the defensive measure appeared far-more damaging to already fragile sentiment and raised concerns that government efforts were flailing in the face of failure. The euro reached its weakest point since April 2006 reflecting added market anxiety, but has subsequently rallied back to positive territory for the day. The reduction of perceived risk is lessening demand for the safety of U.S. government securities, while the confusion surrounding dealings in European government debt is creating a bid over there.

European bond markets – An auction of 10-year German debt was oversubscribed, but the agency held back one quarter of the issue today. The fact that yields had slumped to 2.78% this morning made the offering unappealing while the financial watchdog’s ban on short sales of specific instruments left dealers wondering how to hedge new issues. Euribor futures shed two basis points as cash markets edged higher. (more…)

After strong April US industrial production figures on Friday, especially in the manufacturing segment, we expect the Empire manufacturing survey to indicate that trend continuing into May and should provide insight into the strength of the Philadelphia Fed survey later in the week. US industrials have been leading the pack relative to first quarter earnings surprises, with 80% of companies beating consensus estimates, according to data compiled by Bloomberg. However, repeating those same levels of profitability for the full year may prove more challenging, especially if unit labour and material costs rise.

Markets will be looking to see if strong appetite at last weeks two UK gilts auctions, supported by renewed confidence in the government’s efforts to tackle the deficit and flight from Euro denominated assets, carries over into today’s longer dated auction. Last weeks gilt auctions on Tuesday and Thursday had strong oversubscription levels of 2.49x and 2.47x respectively. Prior to last week, gilt auction oversubscription levels over the past year have ranged between 1.6x and 2.1x.

Chart: Empire manufacturing survey points to coninued strong US industrial production

Market Outlook:

Tactical view:

• EUR crosses stay offered; counting on stocks for GBP relief
• USD, JPY outperform in risk averse world

The USD continues to attract solid buying interest as confidence in the EUR and GBP wanes. With risk reversals still heavily skewed towards USD calls, the outlook for the dollar index remains uniformly bullish even as the probability of a Fed rate hike this year fades. Economic data has been playing second fiddle in recent weeks and until the picture for risk assets clears up and EU debt fears subside, we think macro data are unlikely to be critical for price action near-term. The high correlation with equities continues to weigh on GBP but with the BoE now also reasserting its influence, we see no immediate escape for GBP from the clutches of the sterling bears. April retail sales and CPI data, and the MPC minutes will keep GBP on a knife-edge next week.

Recap

The positive knee-jerk reaction to a Cons/LD government quickly petered out and saw the market re-establish short GBP positions vs the principal G10 currencies except vs the EUR. GBP/USD dropped below 1.45, and following a dovish BoE QIR, the cross is now slowly gravitating towards the 1.40-1.44 area. Buying of EU peripheral debt by the ECB briefly underpinned the EUR, but selling resumed as the Ascension Day holiday pushed peripheral spreads wider again over bunds. EUR/USD slipped below 1.2500 and now threatens 1.2330, the Oct-08 low. The JPY and USD were the best performers in the G10 as a probe into US sub-prime mortgages and lower commodity prices caused equities to resume their decline, spurring a flight-to-quality. The CAD held up remarkably well considering the fall in crude oil below $75 to a 3-month low, but looks well placed to draw support from the outlook for higher interest rates.

Economic data continues to be a sideshow to the jitters in equity and sovereign debt space. The BoE kept Bank rate unchanged at 0.50% and the APF at £200bln, but in its quarterly Inflation Report it warned of downside risks to growth as public spending cuts in the EU and the UK threaten to hit demand. The BoE also sees CPI below 2% target in two years time based on the implied futures curve for interest rates. Manufacturing production rose a much stronger than forecast 2.3% m/m in March, fuelling speculation of an upward revision to Q1 GDP later this month. Jobless claims fell in March by 27,100, and the ILO unemployment rate held steady at 8%.

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