Waiting for Trichet

FX Update: Waiting for Trichet

Yesterday's ugly US equity close saw the usual fall-out in FX-land with commodity currencies much lower and the JPY to the strong side as well, but overnight the pressure seemed to ease considerably and these moves were at least partially reversed, despite no particularly positive developments elsewhere. Chinese equities closed virtually unchanged from yesterday's new lows for the cycle, bonds remained generally bid, copper made a strong new low, and complete lack of trust in all currencies saw gold tack on further gains from yesterday's rally and thus challenging the all time highs for the cycle.

EURGBP and the sovereign risk.
Speaking of lack of faith in currencies, Fitch ratings was out again today with a new round of rather sour warnings on the UK's debt situation, saying that the UK fiscal situation is "formidable". There is nothing at all new in the statement - as if the market doesn't know this - but traders took profit on short EURGBP trades nonetheless after the recent impressive run to the downside as the EuroZone worries are spreading. If we have a look at Western European CDS prices (bets on the likelihood of sovereign defaults), we note that generally all CDS prices have headed higher of late, but it is remarkable that CDS prices for France have recently crossed above those for the UK - likely as the market fears the fall-out on French banks from defaults, considering its banks have by far the most exposure to the troubled peripheral countries' sovereign debt. Belgium is also reaping plenty of negative attention for its political situation heading into an election, as (wonder of wonders) none of the parties seem to be campaigning on a platform of austerity, even as the bond market is sending a strong warning. An auction of Belgian 10-year debt saw yields at about 100 bps above Bunds - about 50 bps higher than the spread just last week.

Chart: EURGBP and CDS Spreads
It's not just the periphery any more. While the focus has been on the EuroZone "periphery" of late, the chart below shows that it is not just the worry is how the periphery affects the core. Now, one of the key core EuroZone countries, France, boasts less creditworthiness than the UK. The black line showing the spread between UK and French CDS prices helps us to understand why EURGBP broke lower below the 0.8400 level recently as this spread continued to show relative deterioration in France's creditworthiness due to its banks' exposure to the PIGS countries. As long as the pressure runs this way on sovereign debt spreads, the latest uptick in EURGBP will simply represent an opportunity to sell once again.

Chart: USDJPY
Once again, we point out the divergence in the behavior of USDJPY and the bond market, as the latest rally in bonds (and thus, fall in yields) has failed to hold USDJPY consistently lower, a topic we have discussed before. The market may be looking at the sovereign risk angle here as well due to Japan's world beating public debt load, and the spread remains at the top of the range (in favor of the USD), though there has been no break out. Or there could be a risk premium on the JPY due to the appointment of the new prime minister Kan, who is seen as a weak JPY proponent. In the short term, however, one would expect any further rally in bond prices to see a capitulation lower in the pair. The 200-day moving average just saved the pair from a sell-off on Monday, a fresh challenge of that suppot might see a capitulation and test of the 89.00 area support. If risk makes a comeback and bonds sell-off (not the favored scenario for the moment), on the other hand, JPY crosses are likely to jump higher, in which case we focus on that recent high and then the 93.15 area weekly Ichimoku cloud level.

Looking ahead
There are nuances out there in this market besides the risk on/risk off picture, as we discuss above in the EURGBP and USDJPY trades, though the risk picture is still the most important at this point as long as markets remain nervous. On that account, it is interesting to note the 1.0515 line in the sand for USDCAD in today's trade, and the recent 0.8220 resistance in AUDUSD as important levels to watch tactically while the equity markets decide whether to follow up on their challenge of the May lows for the cycle.

On the economic calendar, we have some interesting Home Loan data out of Australia overnight, though it is a bit dated as it is from April. Tomorrow features the UK Trade Balance and the Fed's Bernanke out testifying to Congress on the economy. The big focus later for the week is on Thursday, as we have a trio of central banks announcing rates/policy: the RBNZ, the ECB, and the BoE. The ECB press conference will be extremely important for Trichet after his disastrous performance the last time around when he lost the market's trust. Is there anything he can say or do to shore up confidence?

Economic Data Highlights

• New Zealand Q1 Manufacturing Activity out at +0.9% QoQ vs. +1.3% in Q4
• UK May BRC Retail Sales Monitor out at +3.0% YoY  vs. _0.2% in Apr.
• Japan Apr. Adjusted Current Account Total out at ¥1380B vs. ¥1424B expected and ¥1773B in Mar.
• Australia May NAB Business Conditions fell to 6 from 8 in Apr.
• Australia May NAB Business Confidence fell to 5 from 13 in Apr.
• Norway Q2 Consumer Confidence fell to 15.8 vs. 17.5 expected and 17.4 in Q1
• Switzerland May Unemployment Rate out at 4.0% vs. 3.9% expected and 4.0% in Apr.
• Germany Apr. Trade Balance out at 13.4B vs. 15.0B expected and 16.9B in Mar.
• Switzerland May CPI out at -0.1% MoM and +1.1% YoY vs. 0.0%/1.2% expected, respectively
• Germany Apr. Industrial Production rose +0.9% MoM and 13.3% YoY vs. +0.7%/+12.4% expected, respectively
• US May NFIB Small Business Optimism rose to 92.2 vs. 91.0 expected and 90.6 in Apr.
• Canada May Housing Starts out at 189.1k vs. 202k expected and 201.8k in Apr.

Upcoming Economic Calendar Highlights

• US Weekly API Crude Oil and Product Inventories (2030)
• US Weekly ABC Consumer Confidence (2100)
• US Fed's Hoenig to Speak (2100)
• UK May BRC Shop Price Index (2301)
• Japan Apr. Machine Orders (2350)
• Australia Jun. Westpac Consumer Confidence (0030)
• Australia Apr. Home Loans/Investment Lending (0130)
• Japan May Machine Tool Orders (0600)