– EUR to correct further before resuming rally
The EUR correction is in full swing as headlines from Spain and Italy are leading to some upward pressure on the Eurozone risk premia. Spanish 10y yields are some 22bps higher as the Spanish opposition (Socialist) party has called on PM Mariano Rajoy to step down on allegations of corruption. Spanish bond auctions (Thursday) may need to generate a decent result to ease the bond market tensions. Meanwhile, Italian yields are up 14bp with polls showing Silvio Berlusconi closing on the lead enjoyed by Pier Luigi Bersani’s centre-left. Our European economists still see the centre-left as likely to win the lower house, but it seems increasingly unlikely that they will win a majority in the upper house without the support of Mario Monti’s group. The ECB policy announcement later this week poses further risk to the EUR as we expect Mario Draghi to err on the side of caution in response to the likely questions surrounding the tightening in the eurozone liquidity conditions, upward pressure on short-term rates, the rise of the EUR and the situation surrounding Cyprus. Overall, the EUR correction should not surprise at this point since much of the recent ‘good news’ is already priced in. That said, we believe a broad range of investors (FX reserve managers included) are still underweight EUR and will be tempted to buy the dip. Our recently revised forecast sees EURUSD gaining to 1.40 by Q2. Our immediate positioning on the EUR has moved to neutral as we saw our (in the money) stop on EURCHF triggered at 1.2300 (a gain of 2%), and EURSEK stop triggered at 8.5650 (entry/breakeven level). Our overall bias however remains to look for EUR buying opportunities on pullbacks.
– RBA kept rates unchanged; we stay long AUD
RBA kept rates unchanged but the tone of the statement was pretty dovish, resulting in a knee-jerk lower AUDUSD postannouncement. The RBA left the door open to cut – stating that that inflation allows scope to ease further if necessary. A brighter external outlook was cited, in particular, they noted signs that China growth has stabilised at a fairly robust pace. However, they remain cautious that financial markets remain vulnerable to setbacks and expect domestic growth to be slightly lower than trend this year. The focus shifts to the Chinese and Aussie domestic economic data later this week. We expect Aussie retail sales tomorrow and employment (Thurs) to bounce back from negative readings, while we look for an acceleration in Chinese’s January exports to 14.8% YoY, while the January CPI, should slow to 1.9% y/y (both on Friday). We stay long AUDUSD entered at 1.0390, targeting 1.0850. We highlight too that going long AUDNZD cross looks like a pretty attractive way to play for a recovery in AUD this week; spot is close to the bottom of one year channel, with support kicking in at 1.2265. While we were bearish AUDNZD two weeks ago when spot was above 1.2500, it has since already converged to interest rate spreads.
– GBP recovery to continue
EURGBP has seen a pullback from 0.8700 to 0.8575, while GBPUSD has edged higher above 1.5750. Both remain among the most misaligned pairs in our STEER short-term valuation model, which suggests a GBPUSD fair value around 1.61 and EURGBP below 0.85. This week’s BoE monetary policy announcement is likely to be overshadowed by incoming Governor Mark Carney’s address to the Treasury Select Committee. Markets reacted to Mr.Carney’s earlier comments highlighting the scope for further central bank action, but in the absence of a particularly strong message on the possible policy shifts (e.g. nominal GDP targeting) GBP could see a positive reaction. On the data front, our UK economist expects a better-thanconsensus rebound in the January services PMI from 48.9 to 50, a result also restrained by the weather effects. Over time, we still expect the UK economy to outperform the eurozone’s this year, which suggests a reversal of the cyclically-sensitive EURGBP cross. We see EURGBP at 0.80 and GBPUSD at 1.75 by Q3.
BNP Paribas