Spain, Italy events among key factors affecting bond, currency markets this week, says RWC

RWC’s Absolute Return Bond and Currency team has given its views on key events as they may play out in markets this week – including the impact of political events in Spain and Italy.

   • Events in Spain and Italy are likely to be enough to hold the bond bears back this week

   • The outcome of the monthly non-farm payrolls lottery was received positively by markets

   • BoE Governor-elect Mark Carney appears before the TSC – will he disappoint a market which appears to be gearing up for aggressive action?

   • The issues in Europe are for now being largely ignored at the convenience of a long overdue trend in foreign exchange

   • USDJPY targets remain at 95 and 100

Macro

Europe
   • The ECB meet this week and as there are no expectations for a change in policy it will be down to the press conference. It is likely that Draghi will have to field questions surrounding euro strength, tightening of EURIBOR following the LTRO repayment, and why lending to the private sector continues to fall.

   • Euro strength has the potential to be a key topic with EURUSD shooting through the highs of 2012. While this can be interpreted as a sign of improving confidence in the eurozone, it will also make conditions harder for peripherals suffering competitively compared to Germany.

   • We have said this before, and will say it again: the economic data in Europe is still dire. PMI surveys, despite improving slightly last month, are still below 50 and point towards another negative quarter of growth, confidence surveys remain at very low levels, and financial conditions remain tight.

   • Allegations against the Spanish PM Rajoy raise questions about the government’s credibility, and ex-Italian PM Berlusconi has upset the apple cart by saying he will cancel PM Monti’s property tax, allowing his centre-right coalition to gain ground on the centre-left. These unfolding events are likely to be enough to hold the bond bears back this week.

   • There is an EU Leaders’ Summit at the end of the week, where Cyprus and the European budget for 2014-2020 will be discussed, but while the Eurozone crisis is on hiatus these summits are not generating the kind of excitement that they did last year.
US

   • The outcome of the monthly non-farm payrolls lottery was received positively by markets, as upward revisions to the Nov and Dec readings yielded a 3 month average of +200k per month.

   • At the same time, the unemployment rate – the Fed’s espoused employment target – ticked up to 7.9%, signalling that the QE taps will stay open for some time to come.

   • Interestingly, the dollar rallied against the other major QE-countries, Japan and the UK, and received a further boost from the much better than expected ISM manufacturing reading later in the day. US 10 year yields reached a nine-month high.
UK

   • A quiet week in the UK saw Sterling recover some ground against the US dollar before giving it all back following the non-farm payrolls reading. The pound’s slide against the euro continued, reaching 0.87 on Friday, as eurozone sentiment improves and safe haven flows reverse.

   • The BoE’s MPC meet this week. With improved risk sentiment and decent broad money growth figures, the chance of further easing seems low. A possible exception is the announcement of the reinvestment of upcoming gilt redemptions.

   • BoE Governor-elect Mark Carney appears before the Treasury Select Committee on Thursday – his first official appearance in relation to the role. The meeting will be closely watched for his thoughts on the future of monetary policy in the UK. Will he disappoint a market which appears to be gearing up for aggressive action?

Price

   • USDJPY targets remain at 95 and 100, the significance of 95 is that it was the high of 2010 and is the level most easily achieved in this trend. A move through to 100 is likely to attract more two way volatility given the significance of the 100 level to the media and regional countries with price sensitive export markets.

   • This is a general move in the Japanese yen and there is little point in going through the list. EURUSD is still pushing on 1.40 and taking EURJPY with it towards 140.00. It is also worth watching Singapore dollar vs. Japanese yen with targets at 80 on a blow out.

   • The issues in Europe are for now being largely ignored at the convenience of a long overdue trend in foreign exchange, with undervalued European equities and high yielding peripheral European bond markets becoming an attraction for investors.

   • In emerging market currencies US dollar / Mexican peso still targets a push through 12.55 for 12.00, US dollar / Indonesian rupiah targets 51.30, and US Dollar / Israeli shekel should push down to 3.60. Australian and New Zealand dollars should stay positive to range-bound for now, with the Norwegian krone and Swedish krona staying steady to strengthening.

   • US yields continue to push higher with the 30 year leading the way on a steepening curve with targets still at 3.50% and in the 10 year T note at 2.20% with a push back over 2.00% a significant event, although let’s be clear this push up in yield has been a very “sporadic” move and is not as yet a clear trend with the short end of curves anchored.

   • Bunds are also likely to suffer with 1.80% an objective through 1.73% resistance. Italian and Spanish bonds are likely to attract a fresh wave of buyers if yields push back up and two way volatility increases.

   • Gilt yields should push up to 2.20% in line with a weakening Sterling and the price action on the gilt contract remains soft for a decline towards 114.00 on the March contract.

   • Oil stays strong with $120 a target on Brent and $100 on WTI, reflecting economic recovery, but base metals stay mixed. Gold is drifting marginally lower, but is unlikely to trigger a major flight of the bulls until we break and close below $1625, with gold still viewed as the “other currency”.

   • Equity markets stay positive and it’s important to look at this area as it has clear implications into capital, bond and FX flows. The Japanese equity markets are approaching some multiyear levels with the Nikkei 225 pushing 11,404 the highs of 2010 which would in turn target 14,473 and the implications for a global recovery and Japanese yen weakness are immense.

   • The strength in the euro is reflected by the strength in the German DAX which still targets a push through to all time highs at 8151 and then 9000. As far as China is concerned a push through 25,000 is logical in the Hang Seng and despite the avalanche of negativity in the UK the FTSE 250 marches on for 15,000 fuelled by a very weak currency by historical standards.

Flow

Euro strength and verbal intervention
   • Euro strength and an effective tightening of financial conditions in the Eurozone will not help the stuttering economy.

   • The weekend saw some comments from the French Finance Minister on recent euro strength and Draghi’s comments at this week’s ECB meeting will be watched.

   • Repatriation flows are still euro supportive.

   • The euro is vulnerable to the current Spanish and Italian political chicanery.

The euro has been something of an enigma this year with appalling fundamentals swamped by a tightening of financial conditions and flows out of other currencies in the race to debase. Apart from verbal intervention there is not much the ECB or politicians can do (apart from another rate cut) and with the potential repayment of LTRO 2 at the end of the month we will potentially see a further tightening.

 

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