Today’s widely anticipated European Central Bank rate hike is the latest catalyst in sustaining the multi-month rally in global bond yields, which will increasingly weigh on equities and risk appetite. Extended selling in U.S. equities could endanger the already shaky foundation in housing, rendering the making the medium-term dollar outlook generally negative.
A prolonged retreat in U.S. equities on the back of deteriorating U.S. data would boost hopes of a Fed funds easing and weigh on the U.S. dollar at a time when European, Asian and Canadian central banks pursue restrictive monetary policies. But if the U.S. data picture continues to improve, excluding housing, a prolonged rally in bond yields should place a drag on U.S. equities, in which turn a broader sell-off would add additional strains on U.S. consumers already struggling with rising gasoline costs, rising mortgage costs and falling housing prices.
The increasingly deteriorating technical picture in U.S. and European stocks is rendering the June outlook for equities to be bearish from purely technical terms. We showed in last night’s S&P 500 chart the negative crossover in the stochastics indicator suggesting a similar pattern to that of the developments prior to the equity correction of May-June 2006 and February-March 2007.
Trichet’s conference may not be enough for the euro
EUR/USD is little changed after the much anticipated 25-basis point rate hike from the ECB as the currency requires follow-through hawkishness from ECB president Trichet in the press conference just ahead today. Markets will watch whether Trichet will continue describing monetary policy as “accommodative” and warns against complacency towards inflation pressures.
But with foreign exchange players widely expecting the ECB not to follow through with a subsequent rate hike until late or mid-third quarter, the euro may fall under further pressure, testing the 1.3490s. The pair could especially suffer from a renewed bout of reduced appetite in global capital markets. EUR/USD upside capped at 1.3530, but we expect further retreat towards 1.35 and 1.3475-80.
USD/JPY extends losses, eyes 120.60 USD/JPY continues to struggle in line with the lack of follow-through buying in U.S. equities, whether it is inflation hawkishness or housing apprehension by the Fed. A relatively scarce U.S. data calendar this week is giving way to the 10-month highs in Japanese bond yields and their positive implications for the yen. Breaking the 121.20 support, USD/JPY eyes subsequent foundation at 120.60. Periodic bounces in USD/JPY have proven relatively abrupt after testing key support levels, but the ongoing hesitance in equities remains a source of pressure. A prolonged sell-off in U.S. equities would further threaten global risk appetite especially amid the latest bout of tightening monetary policies from Europe and Asia, thereby favoring lower yielding currencies such as the yen and Swiss franc.
GBP remains capped at 1.9960 resistance, further selling in store on Thursday
UK consumer confidence rose 9 points to 99 in May, hitting an 18-month high and rising for the fifth straight month. The report boosted sterling towards the 1.9955 high but steered clear of the 1.9960 resistance, which is the 61.8% retracement of the decline from the April 18 high to the May 21 low.
Although the Bank of England is widely expected to remain on hold tomorrow, the announcement effect is likely to weigh on sterling partly on a relief selling considering the BoE’s proclivity to surprise markets. A decision to hold rates unchanged is also likely to trigger sterling weakness against the yen and the euro. EUR/GBP faces interim resistance at 67.95, with subsequent target standing at 68.15-20 in the event that Trichet sustains his hawkishness during today’s press conference (due at 8.30 am EST). GBP/JPY faces interim support at 240.50, a break of which targets 239.75. Cable’s downside is seen extending towards 1.99 and 1.9870.
Aussie hits fresh 17-year highs on GDP AUD/USD surged to a fresh 17-year high at 0.8437 after Australia’s Q1 GDP jumped to 1.6% q/q from a revised 1.1%, beating expectations of a 1.2% increase. The year-to-year increase was 3.8% following a revised 1.1% increase in Q4. The Reserve Bank of Australia left rates unchanged as expected and will likely continue to do so for the rest of the year.
The GDP report will serve as a vital support for the Aussie during any bouts of carry trade unwinding that may emerge from the current retreat in global equities. Support seen holding at 0.8370. Upside capped at 0.8420 and 0.8440.
Ashraf Laidi Chief FX Analyst CMC Markets US 140 Broadway, 30th Floor New York, NY 10005 (212) 644-4220a.laidi@cmcmarkets.com
