Calyon FX the day ahead : Struggling for direction

By Calyon Fixed Income Markets Research

Highlights

* Despite positive Q2 earnings (so far) FX markets are still struggling for direction.
* US data likely to be on the soft side with the Empire manufacturing survey slipping and IP growth negative. Another rise in UK unemployment should hamper GBP bulls.
* BoJ kept rates on hold at 0.10%. New Zealand FinMin rhetoric favoured a softer Kiwi.

Struggling for direction

Despite positive Q2 results from Intel and Goldman Sachs, the latter posting a 33% rise quarterly earnings, exceeding expectations, equity markets posted only modest gains, with the focus shifting to worries about whether other US banks reporting their Q2 figures this week will be as robust. The sluggish stock markets had the usual impact of underpinning the USD as once again the markets swing back and fro between risk aversion and economic optimism. This pendulum of uncertainty looks set to remain for some weeks, if not months to come, leaving the FX markets struggling for clear direction.

In the short term, and given that there is no major Q2 earnings reports today, the macro data may exert a little more influence over currencies. After the rise in PPI, the risks to US CPI seem skewed to the upside. But these risks are based on higher energy prices rather than a pick up in demand and are unlikely to be taken as confirmation of any activity pick up. Equally, whilst the Empire manufacturing survey is forecast to rise to its highest level since last August the index should still point to merely a slowing down of the manufacturing contraction rather than recovery, with June's IP data expected to post an eighth consecutive decline. Overall the numbers should prompt an increase in nervousness about the pace of recovery, despite Geithners recent comments signalling that the recession may end in months, and encourage a safe haven flow back to the USD. The major gainers versus the USD over the past 5 days have been the JPY and CAD which have returned around 2.2%. Hence it looks like USD/JPY and USD/CAD will be most vulnerable to renewed risk aversion on the back of the data, with the former set to edge above 94.00 and the latter back above 1.1400. The CAD may also suffer across the board if factory sales post the expected decline in May.

A slew of sluggish economic data does not however signal that the global economy is about to relapse in to a deep recession, but it is a clear indication that the recovery will be gradual. Indeed, European sentiment was tempered by a decline in the German ZEW index yesterday indicating that investors were becoming sanguine, or perhaps more realistic, about the pace of German/European activity. The ZEW suggested that their index implied that Germany may not grow at all in H2 2009 and remained on track for the expected 6% contraction in GDP in 2009. Today's final CPI is unlikely to diverge from the snap estimate, showing CPI at -0.1% YoY. Whilst base effects and higher energy prices should push up inflation later in the year, sluggish demand looks set to keep price pressures in check. We expect the Eurozone to underperform US growth both this year and next, contracting 4.5% this year versus the US's -2.8% and growing only 0.2% in 2010 compared to 1.5% in the US. Hence, whilst our longer term forecast envisage some benefit for EUR/USD from a more sustained increase in risk appetite in H2 09 and 2010, the cross is only forecast to reach 1.42 by the end of the year. Indeed a re-evaluation of specific European risks, focussed on Eastern Europe, banking sector, or just the general economy may make it harder in the short term for EUR/USD to convincingly break above the 1.4000 level.

Elsewhere another rise in UK unemployment may quell GBP bulls and act as a reminder that the economy remains vulnerable. Recent data on retail sales and the housing market has been positive, but a fresh record high in the ILO unemployment rate, albeit a lagging indicator indicates that earnings and demand should remain muted. Further, whilst the BoE decided against adding to its QE programme at last week's meeting, comments from Deputy Governor Bean and new MPC member Posen suggest the door is still open to further asset purchases if required. Sterling sentiment has been robust during the first two days of this week making gains against other G10 currencies except the CAD and AUD; a poor employment report could see some of this advance unwind.
The BoJ kept rates unchanged at 0.1%, but whilst is signalled that financial conditions were stabilizing it still revised down its FY 2009 GDP forecast to -3.4% from -3.1% and extended its credit easing programme to the end of Q4. A gradual recovery still points to an unwinding of recent JPY strength against most other currencies. Perhaps the exception to this will be the BZD, where the Finance Minister appears to be trying his hand at verbal intervention, stating that he would prefer a lower NZD given the current account deficit, the deteriorating fiscal position and fundamental backdrop. His stance is somewhat counter to comments from the RBNZ Governor Bollard who recently floated the idea that New Zealand would be one of the first economies to move away from recession.

Stuart Bennett Senior FX Strategist