FX Calyon The Day Ahead : Close encounters of the grizzly kind

By Calyon Fixed Income Markets

Highlights

* Markets still feel wary which is providing support to the JPY and, to a lesser extent, the USD.
* A quiet calendar means markets looking toward corporate earnings and data later in the week.
* ECB's Trichet speech this morning may get a following, with such a light data day.

Close encounters of the grizzly kind

The expert recommendation “on a close encounter with an aggressive wild bear” is to assess the situation but not to run, to retreat very slowly and climb far up a tree if possible. The bear market that the FX market is contending with is not particularly aggressive so far, with US equities off less than 10% from their June peaks, but it appears our intrepid investors are still inclined to play it safe and not run but instead retreat slowly. We have seen declines in most majors against the USD over the last month (with the notable exception of the JPY), but the pace of depreciation has been modest and lacking in conviction. The mixed nature of the data and the languid shift in sentiment means this is a bear we are still viewing from a distance, and one we ultimately believe will wander away once those arguing in favour of a W-shaped profile are forced to bid a hasty retreat of their own.
Sadly, this looks unlikely to happen anytime soon. The ongoing frustration is that the data at this point of the cycle is incapable of resolving the debate, condemning us to this market death by a thousand paper cuts, long before the seasonal summer lull would ordinarily have kicked in. The global calendar for the week ahead retains this grizzly familiar tone. US retail sales will be stronger, but mostly due to the price effects of gasoline. US housing starts will be lower, but only because they had such a big leap the previous month. So too the Philly Fed, while the Empire manufacturing survey and industrial production will sing the well-worn tune of declining output but at a less pronounced rate. Nor is this pattern confined to the US. Germany's ZEW will likely post a gain, but a modest one in light of the slippage in equity markets. Japan's consumer confidence was up, but is still at a historically unpleasant level. The UK's housing data will show less attrition, but attrition nonetheless.

One wonders how long this might go on for, and the answer is that it could be for quite some time. Our forecasts for most major economies envisage anaemic growth during H2 09. If we are right, the data is never going to be sufficiently strong to completely quash the W-shape brigade, but nor will it be weak enough to vindicate their pessimism. Ideally, the clarity might come from somewhere other than the data, from corporate earnings perhaps. The Q2 09 US earnings season gets into full swing this week with many banks reporting as well as some big economic players. But it is hard to see how they can be any more certain about the outlook than the market at large, and their reported performance for Q2 will likely be mixed and open to as varied an interpretation as an analyst's pre-existing view dictates.

For those impatient for action even this week, today will likely be a disappointment in terms of data and earnings. We have already had Japanese consumer confidence, mentioned above, and the remainder of the day offers only Swiss PPI and the US monthly budget statement with no US corporate results slated for release. There will be some interest in Trichet's speech later today to see what kind of signals he sends on policy. Yet with rates likely to be characterised as appropriate and little obvious insight to be offered on the future path of non-conventional steps other than a commitment to do what is necessary, we think the EUR will be able to shrug it off. An article in today's UK Telegraph suggesting the ECB is not doing enough by way of QE, risking a break-up of EMU, is raising some eyebrows though last week another UK economics pundit said the ECB was doing too much QE not too little. Economists, as we know, seldom agree.

A difficult night for equities in Asia means the bear looks likely to remain in the ascendancy for now, which should retain the bid for safe-haven JPY and USD, the former not reacting to the announcement of an August 31 Japanese general election. In fact, amid the range trading which characterises most exchange rates at the moment, USD/JPY is trending lower and AUD/JPY and NZD/JPY are not far off showing a trend formation either. The only hindrance on JPY strength is likely to come from the threat of intervention. Japanese policymakers have already been quite vocal about “watching” currency moves, and the SNB has already set the precedent for action to counter excessive safe-haven bids. Still, the market will likely still want to test last week's low of 91.75 on USD/JPY to see if it provokes a reaction.

GBP continues to lose ground little by little to the EUR, and has given up earlier gains versus the USD. Talk in the UK media of potentially big losses when Lloyds announces its results later this month have not helped the mood. Still with the BRC retail survey and the RICS housing balance looming, we would not chase GBP downside too aggressively. Like the camper facing the grizzly bear, a quiet measured retreat seems the more likely path.

Daragh Maher Deputy Head of Global Foreign Exchange Strategy