August managed to end on a reasonably hopeful note after the drubbing that started the month, but September has started on a decidedly downbeat note. U.S. and European data continue to point to stalling recoveries and the market debate over whether it’s merely a slowdown or the start of a double dip recession has been reengaged. While it’s too soon to say which way the outlook may break, both prospects are decidedly negative for risk sentiment. Looking ahead, there seems to be little light at the end of the tunnel either, as governments continue to pursue austerity and deficit reduction measures even in the face of slowing growth. Pres. Obama is set to deliver a long overdue job creation plan next week, but it’s unlikely to result in meaningful stimulus measures given the intractable opposition of House Republicans. While the Continent and Washington fiddle, risk appetite and financial markets seem likely to see further distress in the weeks ahead.
Risk assets responded in relatively predictable fashion this past week, with stocks and commodities falling from key technical levels, gold soaring, and JPY, CHF and USD strengthening against other major currencies. The S&P500 tested the upper level of a potential bear flag consolidation channel we highlighted two weeks ago at 1230. Price was also rejected from above the daily Kijun line and has since fallen back to test the Tenkan line at 1176, both signs the downtrend may be resuming. The base of the bear flag is at 1140, below which we would expect declines to accelerate. The CRB commodity index similarly failed above the 342 daily Ichimoku cloud top and has since dropped back below the cloud, though it held above the 335 Tenkan line on Friday. Gold and silver rallied sharply back to near recent highs as Eurozone debt concerns reignited (more below), but we are cautious due to a shift in thinking on additional Fed easing (also more below). Safe haven currencies performed well, but they have all run into key price/intervention levels: EUR/CHF tested 1.1000 following Friday’s NFP report; USD/JPY is holding above 76.00/50 as the new PM/former Fin. Min. Noda warns on additional JPY strength; and the USD Index ran into the bottom of its daily cloud at 74.76. We’ll be watching all those levels next week, and breaks through them will suggest to us a more material erosion in risk sentiment. Until then, our preference remains to re-sell risk assets on rebounds.
Eurozone concerns ignite again on Greece
The Euro was the biggest loser in the past week against other G-10 currencies, as incoming data pointed to further slowing in the core and tensions flared again over Greece as the week ended. IMF/EU auditors suspended their examinations of Greek progress on deficit reduction targets as it became evident Greece was likely to miss its 7.5% deficit target due to a deeper than forecast recession. But the auditors also pointed to deficiencies in the implementation of austerity measures, and markets quickly grew worried that the next installment of EU/IMF aid to Greece would be withheld. We don’t think that’s plausible, since the result would be a Greek default, which the EU powers-that-be have ruled out. Should they ( Germany ) renege on that commitment, it would open the door to speculation of which member would next be thrown overboard. We think Greece will ultimately get the next aid package late in September, but with a serious wet noodle lashing by EU/IMF auditors.
Even though we don’t think Greece will be denied further aid, it doesn’t mean markets won’t continue to question the EUR and push it lower. Indeed, beyond Greece there are multiple reasons to keep selling EUR. Slowing growth in the core and weak growth on the periphery remain obstacles to further deficit reduction, suggesting broader Eurozone debt concerns should plague the single currency for some time to come. That same erosion in growth is likely to see the ECB step back more explicitly from further tightening, and next Thursday’s ECB press conference could see a much chastened Trichet. Last, but certainly not least, in a development we have been watching for several weeks now, German yields have plunged, narrowing the spread between US and German 2-year yields to levels last seen in January. The spread suggests EUR/USD should be trading around 1.3100/50. EUR/USD has also dropped back under the cloud (1.4251 cloud bottom/1.4267 cloud top), and the downside should remain in focus while those levels hold. Finally, the Tenkan line (1.4367) looks set to cross down below the Kijun line (1.4302), and with price below the cloud, that would constitute a strong sell signal, possibly making next week a very bad week for EUR. We look to use 1.4250/1.4360 as levels to enter short EUR/USD positions if possible.