Growth uncertainties in US, Europe may lead to further currency swings, suggests RWC’s Alice Leedale

Alice Leedale, market strategist on RWC’s Absolute Return Bond and Currency Team, sees a number of risks to European and US growth in the near term, which in turn could see currency markets bounce around.

Core Eurozone politicians appear to be relaxing their stance with regard to the periphery. In theory this should be positive for risk but we have been here before only for the politicians to backtrack once they sense domestic disapproval.

Accordingly, the current mood is somewhat risk negative, although the risk-on/risk-off correlation rollercoaster that has dominated markets in recent years has not been as prominent recently. As such, despite an uninspiring performance in core rates, EURUSD sold off most of last week in sympathy with US stocks, and is now at the low end of its two-month range.

UK Q3 GDP growth beat expectations at +1.0% quarter on quarter, providing Sterling with a bit of a boost, but excluding one-off factors related to the Queen’s Jubilee celebrations and the Olympics, growth would have been closer to 0.3%.This is nothing to get excited about – the level of real GDP is still no higher than a year ago. Furthermore, the outlook for Q4 GDP is far less positive; business surveys are starting to deteriorate again and the Olympics effect is diminishing.

A speech given by Bank of England governor Mervyn King last week has muddied the waters with regard to the extension of QE at the BoE’s policy meeting next week. Previously the increase in the size of the asset purchase facility had been an almost unanimous expectation. Now though, doubts have crept in, particularly following the stronger GDP reading on Thursday. October’s PMI reports, out this week and expected to weaken further, will be key data points for the MPC before they make their decision on 8 November.

The markets’ attention has shifted across the pond, as the presidential election campaign moves into overdrive and worries about the US fiscal cliff gain more ground. The election is the first step on the road to resolving the fiscal cliff issue. If Obama is re-elected, a key question is what does he want his legacy to be? He could try to broker a deal, or risk a stand-off in the hope that the Republicans are blamed and he regains the House of Representatives at the mid-term elections.

Meanwhile, the slightly better than expected US GDP report revealed strong performances from domestic consumption and residential investment, as the economy continues to shift away from export-led growth. Indeed, regional manufacturing surveys and core capex orders released last week demonstrated weakness in the business sector, attributed to the slowdown in exports and uncertainty surrounding the fiscal cliff. The disappointing earnings season, with revenues particularly weak, suggests that US companies may no longer be the key engine of growth in the US economy going forward.

Onto bonds, the German 10 year did not manage to reach the high of the previous month, breaking the series of higher highs; 1.80% remains a buy zone. In Schatz, there is modest upside pressure in yield terms, but it will probably be capped around 0.2%. In price terms, we have topped out and look for ranges ahead, with any panic going forward to be on the downside. It is a similar story in the US 10 year yield where the highs of August and September were not tested. In price terms, the US 30 year futures contract remains in a tight range. With 10 year Swiss yields at 0.5%, it shows investors are still looking for safety.

In currencies, EURUSD seems to be replicating the same pattern seen at the beginning of the year through to April. USDCAD has been pushed higher by stops, we see 1.01 as a sell zone. AUD remains in ranges, but we still believe there is plenty of downside. Despite a sell-off on Friday, USDJPY remains in an uptrend, we see 79.00 as a key support level. In the US, while S&P 500 has come off its highs of 1,475 we see support at 1,395. The NASDAQ has core support at 2,880, so we would look for a bounce there; for any sustained down movement we would need to see a lower high. In Japan, the Nikkei 225 would start to look interesting above 9,236; a break could act as a confirming signal to sell JPY.


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