FX Research : Run Forrest, run

by Calyon Fixed Income Markets Research

Run Forrest, run…

In an ideal world for forecasters, markets would behave like Forrest Gump and, having set off in running in a given direction, decide they may as well keep running this way. Unfortunately, this is not an ideal world with little real direction at the start of this week other than the hangover of the previous week's soft US non-farm payrolls data and a lacklustre overnight showing in Asian equity markets. Any time the market appears to be running in one direction, something seems to trip it up. The post-NFP USD strength through yesterday morning was undone by the better than expected US non-manufacturing ISM reading. This looks set to remain the pattern of the week with little potent data on offer suggesting that a given mini-trend will remain in play until it encounters a contradictory signal. Sadly, in this range trading environment, Forrest would likely have suffered severe injuries after so many trips.

Nonetheless, our preference for the week ahead is for mild USD strength, but a distressingly dull economic calendar today offers little real directional impulse. Industrial production in the UK and factory orders in Germany are both expected to record reasonable gains on the month, but remain deeply mired in negative territory on a YoY basis. This has become a familiar refrain for markets, but one which no longer promotes the kind of risk-chasing behaviour evident when we received similar data three or so months ago. The markets are greedy, and they want something more than a less horrific backdrop in second-tier data.

The problem, as ever, in carving out a lasting trend is that no currency stands out as particularly attractive. The USD may benefit from the unease in equity markets and ebbing risk appetite but few will want to go aggressively long given the looming G8 summit. We do not subscribe to the thesis that the diversification story is a justifiable reason to sell the USD on an ongoing basis. Diversification has been happening for many years during periods of both a rising and falling USD. Furthermore, the lack of an immediate alternative and the dilemma for existing holders of USD assets of diversifying without hurting their own interests are big constraints. But we do accept that in directionless thin trading, chatter on the sidelines of the G8 summit will be a threat to the USD. But what to buy? The EUR remains vulnerable to doubts about Eurozone growth and the banking system's health. A number of ECB members have been expressing caution, reminding markets that we are still in the middle of a crisis. Instead, EUR/USD seems content to languish around the 1.40 level, and there is little reason to expeect this will change today. Nor does GBP offer an especially lucrative opportunity to capitalise on any USD diversification chatter as it struggles to cope with the market's justifiable expectation of an expansion of the QE programme at the BoE meeting on Thursday. But at least the UK data remains reasonable with better manufacturing numbers overnight. We may well look for some short-term upside opportunities on GBP once the central bank meeting is out of the way. For now, we would look for yesterday's low of 1.6093 to hold on GBP/USD. If it does not, the market may get 1.5800 in its sights.

The AUD will struggle to make headway so long as markets remain nervous about global growth. And domestically the RBA's signal that the door is open to further upside also diminishes the currency's appeal. Like the EUR, it will likely hold shy of a key level, in this case just under 0.8000 against the USD. The NZD will likely echo AUD moves for now, unable to capitalise on a very encouraging improvement in business optimism during Q2 09. The CHF will not be bought aggressively with the SNB lingering. And the mixed bag of equity performance in Asia overnight is simply not providing the markets with clear signals – a frustrating state of affairs but one which should let Forrest catch his breath.

Daragh Maher Deputy Head of Global Foreign Exchange Strategy