The positioning squeeze on stale short Euro and long Aussie trades continues as the markets mull how much QE3 is priced in and what Bernanke may or may not hint at this Friday.
No news squeezes Euro shorts in European session
EURUSD posted new lows in Asia below the psychologically key 1.2500 level and new 4-day lows as well (the non-psychologically key 1.2450/65 area remained intact), but as is often the case with breakouts in Asia, this one didn’t hold and once the pair crossed back above 1.2500, there was no looking back for much of the European session, at least. It seems with bond yields at the periphery remaining suppressed and the interminable wait for the end of summer and the next round of event risks, it’s hard for the Euro bears to regain their conviction. Note as well the EURGBP cross rally, which is a barometer on the degree to which EU-related tail risk has been unwound lately.
EURUSD Outlook
In past weeks, I have said that I was willing to tolerate a 1.2500/1.2600 countertrend move in EURUSD as positioning had previously shown the risks of a squeeze. In the coming couple of weeks and considering the potential event risks in the pipeline, the recent highs are important resistance. If these don’t hold, the focus will shift to the previous highs at 1.2750 and possibly even the 200-day moving average, now descending down below 1.2900. But further out, my basic assumption is that the driver for Euro strength near term is a product of positioning reduction and unwinding of bets on EU tail risks, as well as a slowing of flight out of the Euro Zone. Eventually, however, the Euro may find downside against as least the USD once again, as considerable monetary profligacy will be required to keep the Euro Zone together more or less as is, and if not, well then we’re looking once again at the resumption of pricing in tail risks. Near term, a sharp move back through 1.2450 offers a technical sign that the highs may be in for now.
Aussie home sales
Meanwhile, a weak home sales activity report from Down Under overnight continued to test the mettle of crowded Aussie longs after the initial shock of last week’s HSBC flash Chinese Manufacturing PMI. As one of the favourite crosses in recent weeks has been short Euro and long the Aussie, it makes sense to see EURAUD as one of the biggest movers during this Euro squeeze.
Looking ahead
This is the last week of the summer and we remain in a market regime characterized by remarkable complacency, a theme I have been discussing for many weeks now. Complacency remains, but there are signs of nervousness around the edges. For example, among risk indicators, the VIX is divergent (failing to tick lower even as the equity indices were resurgent over the last couple of trading days. ) In FX, the Aussie is looking vulnerable in many places and the USDJPY rally attempt has now failed and volatility is picking up over the last couple of trading days. A couple of other risky bond spread indicators have also widened over the last several trading days. This could merely be about position squaring ahead of the onslaught of event risks in coming weeks, but it’s certainly worth noting.
The most critical focus this week remains on the Jackson Hole Fed Conference, at which Bernanke is scheduled to give a speech this Friday. USD bears and risk bulls are looking for some kind of repeat of the famous 2010 Jackson Hole conference that saw Bernanke dropping clear hints on the imminent arrival of QE2. It is clear this time around that the situation is somewhat different, as inflation fears are simmering and threatening to break out again (even if it is inflation of the cost push variety, i.e., driven by food and energy price rises) and several Fed officials are on a different page from the Bernanke and Yellen-led dovish contingent.
Next week will feature both of the US ISM’s on Monday and Wednesday and then the employment report Friday. Meanwhile, the ECB will be meeting on next Thursday, the 6th, while the other major EU risk is the German constitutional court ruling on the ESM on 12 September. It’s safe to say that the summer doldrums are likely to yield to fireworks of one kind or another in the coming three weeks.
With that in mind, stay very careful out there.
Economic Data Highlights
Australia Jul. HIA Home Sales out at -5.6% MoM
Japan Aug. Small Business Confidence out at 44.8 vs. 46.6 in Jul.
Germany Sep. GfK Consumer Confidence Survey out at 5.9 vs. 5.8 expected and 5.9 in Aug.
Switzerland Jul. UBS Consumption Indicator out at 1.55 vs. 1.59 in Jn.
Sweden Jul. Trade Balance out at +3.7B vs. +7.5B expected and +8.2B in Jun.
US Jun. S&P/Case-Shiller Home Price Index out at +0.94% MoM vs.+0.45% expected
Upcoming Economic Calendar Highlights (all times GMT)
US Aug. Consumer Confidence (1400)
US Aug. Richmond Fed Manufacturing Index (1400)
US Weekly API Crude Oil and Product Inventories (2030)
John J Hardy,
SAXO BANK