FX Research : Are you feeling sleepy...?

By Calyon Fixed Income Markets Research

Highlights – developed markets

* Manufacturing PMIs dominate the calendar, but mixed results on the data front are preventing currencies from establishing any trends.

* We favour buying EUR against the USD, JPY and GBP from a technical perspective, but such a stance will need upbeat readings from the US ADP and ISM releases later today.

Are you feeling sleepy...?

In order to induce a soporific state of mind, hypnotists of old used to ask patients to concentrate on a watch swinging ‘to and fro' on a chain. For financial markets, it is the ‘to and fro' of the data that risks inducing feelings of torpor as it fails to deliver a single-minded signal that might have dragged currencies out of their trading ranges. Yesterday provided two classic examples, with GBP rallying first on strong housing numbers before succumbing to a downward revision to GDP. Later it was the USD, losing ground after marginal upside surprises on house prices and the Chicago PMI before being boosted by a very disappointing print on Conference Board consumer confidence. For the most part, it felt like a case of back to square one.

The frustration going forward is that we had hoped this week's more interesting slate of data might finally give the FX market renewed direction. There has been a decided side-ways feel to currencies over the last couple of weeks, in part because the debate over the future trajectory of the US economy remains in the balance. The Tankan survey has at least resurrected the familiar story of things being bad, but not as bad as before. The headline readings for both the manufacturing and non-manufacturing sectors may have shown less improvement than expected during Q2 09, but the outlook for the third quarter was more upbeat than forecast.

The wrinkle for this growing optimism remains whether the US economy's final demand can match the gains already seen in the sentiment surveys, yesterday's relapse in consumer confidence notwithstanding. Consumer behaviour clearly lies at the heart of this debate and yesterday's decline in confidence shows that the deteriorating labour market can still have a potent effect on future spending plans. Chastened USD bears may therefore be reluctant to anticipate too much of an improvement in non-farm payrolls this Friday, at least until they get more clues from today's US data. The ADP release may have questionable signalling power, but it will still enjoy a market following, with a -394K drop anticipated compared to the more sizeable 532K drop in May. The employment component of the ISM will also be scrutinised. But it would be wrong to be overly fixated on simply the employment side of the equation. The headline ISM is also a good benchmark of the wider economic cycle, and is already at a level which the creators of the index believe is consistent not with contraction but with expansion (rubbishing the convention that 50 marks the critical point).

Europe too has its PMIs, though in the Eurozone this should be a straightforward re-run of the flash estimates released last week. The greater interest may fall on the UK manufacturing PMI which has moved 10-big figures higher in the last few months and is expected to improve further in June to 46.4. GBP/USD is just managing to hold above 1.6400 at the time of writing, but any upside surprise would provide a more meaningful catalyst for a push back towards yesterday's high of 1.6744. Nonetheless, it is worth noting that our technical analysis signal has flipped from being a buy to a sell overnight, though still within a range.

An interesting dilemma for the currency market has been conjured up by comments from the Fed's Yellen overnight. She sounded a cautious tone on the outlook for the US economy, stressing that the Fed was in no rush to embark on its exit strategy given there is no threat to inflation currently. For the FX market, one could either buy the USD on the grounds that her cautiousness is consistent with a safe-haven bid or sell the USD on the grounds that rates are not going up anytime soon. For now, we have more sympathy for the first line of logic. Interest rate differentials and relative growth considerations may reassert their influence over markets in quarters to come, but with policy tightening such a distant prospect not just in the US but elsewhere, it is hard to envisage them being a driver for now. Indeed, correlations between exchange rates and interest rates remain low over the last month (with the noted exception of AUD/USD).

So we remain consigned to gauging risk appetite. A mixed bag in terms of equity performance overnight in Asia provides little direction so technicals may dominate the morning trade before we see the US figures later in the day. For EUR/USD, EUR/JPY and EUR/GBP, our signals suggest buying within the range, a stance supported by this morning's upside surprise on German retail sales which rose for the third consecutive month. USD bears will hope the good news can continue.

Daragh Maher Deputy Head of Global Foreign Exchange Strategy