Yen strength remains the order of the day in currencies, as the fallout in global equities extends on a combination of a slowdown in the U.S. economy and escalating concerns with the U.S. sub-prime mortgage market. Tuesday’s 2.0% declines in the S&P 500 and the Dow Jones Industrial Average index have triggered sell-offs of 2.8% in the in Hong Kong’s Hang Seng Index, 2.0% in China’s Shanghai Composite Index and 2.9% in Japan’s Nikkei-225. European bourses are all in the red this morning, which could further affect the open in U.S. stocks. Meanwhile, both the two-year and 10-year yields on U.S. treasuries have dropped below 4.50%, and the 10-year/two-year spread fell below -4 bps, bearing escalating signs of a normalizing yield curve and a looming Fed cut as early as May.
Tuesday’s release of the 0.1% decline in U.S. sales ex-autos and weaker than expected 0.1% rise in headline sales should further drag on U.S. first quarter gross domestic product (GDP) and raise questions on the softness of the U.S. economic landing. The importance of the weakness in retail sales signifies that the current equity market declines are a reflection of economic weakness and not solely a market event stemming from dried up liquidity. Indeed, the sub-prime collapse can very well be an economic event as millions of residents foreclose on their property and the U.S. construction sector sheds more jobs. In fact, Friday’s February payrolls report showed a loss of 62,000 construction jobs, a pace not seen in at least eight years. That justified our skepticism with the resulting market cheer to Friday’s jobs report.
Separately, the sub-prime issue could further erode market confidence after the New York Times reported that the state of Massachusetts has subpoenaed three Wall Street firms about their unrealistically upbeat recommendations on mortgage lenders now troubled by high-risk mortgages made to residents with poor credit ratings.
The broadening weakness of U.S. economic data comprises an economic argument to trigger further unwinding in the yen carry trade, in which point it will extend to other dollar pairs.
The only major data release from the U.S. is the 8:30 am report on the fourth quarter current account deficit, expected to have retreated to $200 billion from $225.6 billion, mainly due to a reduction in the quarterly trade deficit to $182.9 billion from $211.78 billion in third quarter. The decline in the current account balance may give the dollar a short-lived boost on fading external financing concerns, but it is also worth noting that the reduction in the trade deficit was enabled by the decline in oil prices.
USD/JPY may rise on U.S. current account, but 115.15 remains target
An expected decline in the U.S. fourth quarter current account deficit may provide the dollar with temporary relief, but the ensuing concerns of economic weakness and sub-prime fallout could renew further losses later in the day. Stocks may get a break on the relative scarcity of data in the U.S. calendar, but this could quickly turnaround ahead of Thursday’s busy round of figures. USD/JPY is seen capped at 116.50, followed by 116.90. Having broken the trendline support of 116.20 to 115.78 today, is likely to make a fresh attempt towards 115.80 and the March 7 low of 115.55. Key foundation stands at the 100-week moving average of 115.15. Weekly chart suggests further declines to as low as 114.60 by next week.
Euro eyes double trend line resistance
Yesterday’s EUR/USD chart showing two trendline resistance barriers at 1.3250 and 1.3275 remains valid, but may not be breached today due to the lack of sufficient data. The concentration of releases on Thursday may prove to be the catalyst for further run-ups. Continued flight to quality is likely to be limited to the yen crosses spilling onto euro weakness in which point could cap EUR/USD at 1.3220. The decline in gold prices reflects portfolio shifts from commodities resulting from increased unwinding of carry trades used to finance these commodity plays. The onset of further tightening in China’s monetary policy is also behind falling gold. Downside is seen stabilizing at 1.3180 and 1.3160—38% retracement of the 1.3073-1.322 move. Key foundation stands at 1.3145.
Sterling’s hit by high yield unwinding
Sterling’s losses mainly occur due to the unwinding of its high yield stature against the euro and the U.S. dollar. Gains seen initially capped at 1.9290, followed by 1.9330. Substantial resistance stands at 1.9380. Prolonged losses risking 1.9180.
We remain cautiously bullish in EUR/GBP after the cross has breached the 68.40 resistance to 68.67. Weekly chart suggests gains capped at 69¢, but daily chart suggests a retreat to 68.20¢ and 68¢.
Ashraf Laidi Chief FX Analyst CMC Markets US 140 Broadway, 30th Floor New York, NY 10005 (212) 644-4220
(212) 644-4222
a.laidi@cmcmarkets.com
