By: Kevin Sollitt
Last week’s theme (Risk returns despite no obvious structural improvements-danger ahead?) discussed the market’s frame of mind and the perhaps misguided notion that so-called risky currencies were the best value to be had out there in currency space.
The week began well for AUD, MXN & NZD but the reality of more so-so US data combined with electoral/political uncertainty in Australia & Mexico and weak economic stats from NZ resulted in a bout of risk aversion towards the end of the week, with further momentum to the move provided by a significant break of the 87.40 level in USD/JPY which led to more selling of Yen-paired crosses.
Strategically we remain long GBP/NZD at 2.12 with a trailing stop-loss of 300 pips from the current 2.15 which will breakeven on a worst-case basis. Although we narrowly avoided being stopped out of short NZD/USD we are happy to close this trade at a small profit at market because the USD now looks vulnerable and we have seen evidence of late that the market is happier selling USD on poor domestic data than it was a few weeks ago.
The EUR glanced at & breached 1.30 of course and speaking with contacts in New York City at the FX Week conference there was much speculation that many who sold the false break of 1.19 are still nursing some residual short positions. If that’s true (and nobody really knows) the one certainty is that the market will find the pain wherever it may lie, therefore with the EU stress tests underway with no immediate skeletons found in the closets our theory is that the EUR will test at least 1.32/1.35 very soon on what may be a final yet vicious squeeze before equilibrium returns at around the 1.27/1.30 level. Resistance likely at 1.32 given that it broke down from there on the initial announcement of Greek aid that so unimpressed players at the time.
Back to the week ahead and it seems Mr. Bernanke has yet another tough job ahead of him given the scent of blood that suddenly and seemingly surrounds the USD.
BB has to convince markets that Fed policies are working with an unconvincing backdrop of stubbornly high unemployment and slowing consumer spending-these two are surely related.
Mortgage applications are falling, despite nominal interest rates remaining at cyclical lows and according to the latest Michigan sentiment survey, the outlook is gloomy.
Not only are the above factors hanging over the fate of the USD but the debt held by two of the States’ largest creditors namely Japan and China is becoming less valuable to holders by the day with gradual but progressive Yuan strength driven by the end of the CNY: USD peg and the risk-aversion that has led to an awkwardly high and still rising Yen. One Chinese ratings agency last week ‘stripped’ the US of its AAA rating.
Importantly, continued future funding of the deficits may therefore become more of an issue if yield-seekers go elsewhere and Bernanke is unable to defend any potential exodus by raising interest rates due to the continued economic slump.
That said there are some small rays of hope bolstered a rebound in equity markets last week that received a boost from a positive performance driven largely by earnings, which outweighs some of the negatives, if only partially.
As far as the outlook for the USD, we remain slightly bearish and only cautiously bullish on the EUR, preferring to look under the radar for better risk/reward offerings.
With that in mind our current focus is Norwegian Krone, which has higher interest rates & sovereign ratings than the UK, US & most EU states.
Furthermore, USD/NOK has unduly suffered in our opinion over the past couple of days, squeezing back up from the 6.15 support region to an opening level of 6.28 in Asia today, EUR/NOK moving similarly from 7.91 to 8.11.
Given the fundamentals we think a long NOK position against any currency is the proverbial no-brainer if such a thing truly exists, with a caveat that this would be a strategic and medium term view, allowing some room to add.
Initiate short 50% at 6.28, layer-in a further 25% at 6.33 and 6.38 with a stop above 6.50, objective of a minimum 2:1 and trail stop down every 500 pips.