Does the Bank want a weak Pound?

The Macro Trader’s view:

After a steep sell off against both the Dollar and the Euro in the wake of the financial crisis, the Pound began to bottom out during the 1st quarter of this year, as it became evident that other G7 economies were doing as badly as the UK, if not worse.

As the 2nd quarter evolved, and data began to steady, with the PMI services survey showing solid improvement away from the lows, expectations turned towards an early UK economic recovery, which was borne out by improving data coming from the housing market.

Where only a few months earlier, analysts were predicting the housing market correction would extend into 2010, suddenly the Nationwide and Halifax house price surveys were throwing out readings showing sporadic month on month price increases. While at first these were dismissed as a blip, subsequent reports have confirmed the housing market is in a recovery. However, the optimism over the UK economy took a serious knock when Q2 GDP released in July, came in much worse than expected, albeit a big improvement on Q1 and Q4 2008.

The Pound began to consolidate its recent gains, even though business investment showed unexpected weakness too. But what has worked against the Pound over the last 6 to 8 weeks is the Bank of England.

After initially announcing at the July MPC meeting, there would be no increase of its QE program, against market expectation, policy makers reversed their decision in August, but not only did they increase QE, but by double the amount expected; £50.0B instead of the £25.0B anticipated. This knocked the Pound against both the Dollar and the Euro, but worse was to come. In spite of a continuous steady stream of data showing the economy recovering, the August Bank of England quarterly inflation report, once more sought to play down the obvious, albeit fledgling, economic recovery, once again undermining Sterling.

More was to come, King has recently publicly flirted with the idea of reducing interest paid on Bank balances held at the Bank of England, as a means of forcing the Banks to stop hoarding cash and lend it. This hasn’t yet been implemented, and recent minutes show no discussion has been held, but the market having been surprised twice during the summer, took the rumours seriously and again the Pound suffered as such a move was considered another form of monetary easing.

However, after no surprises were sprung by the recent September meeting or minutes, the Pound again tried to recover, but once again governor King has popped up and in an interview has intimated the Bank would be comfortable with a weaker Pound. While this has merits for the much reduced manufacturing sector, it acts to drive up import costs, especially oil, which has enjoyed a strong rally over recent months, and acts to offset domestic disinflation.

King may see this as a means of holding deflation at bay, but the official CPI stands at 1.6%, against a target of 2.0%, so hardly deflation.

We judge the Bank is trying to hold down the value of Sterling as a means of providing monetary stimulus, while making UK assets look attractive for foreign investors, but for traders a strong Pound looks a thing of the past.
Mark Sturdy,John Lewis
Seven Days Ahead
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US Dollar Index – What the Bulls Need To Happen

The FX Trader’s view - Over the last few months the Dollar Index has been grinding lower, recently reaching a Fibonacci projection we had been looking at. However, there is nothing bullish about the daily chart yet – there are certain hurdles that bulls need to get round before a recovery phase can be trumpeted.

• MONTHLY CHART: The earlier breach of a bear channel top projection suggested to us that long term downward momentum was on the wane. When a new trend is trying to develop, a deep initial pullback is quite usual. Here the 76.4% level just above 75.00 offers support.
• DAILY CHART: Our Fibo projection has been tested/eroded now (on some other charts of currency pairs it hasn’t worked so well, except as a minimum target, not as resistance/ support). Immediate resistance is offered by the prior 77.428/77.688 lows. But bulls need to see a close above the s/term bear channel top projection at 78.25 just now, for an initial signal. Then, a further break through the 23.6% recovery level of the whole decline from Mar 89.624 high, just above 79.00, would provide bullish confirmation. We would then target the 81.466 Jun high area, which lies near to the 38.2% level (which relates to our Fibo projection).

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EUA Carbon Emissions – How Far for the Bears?

The Commodity Trader’s view - Since we introduced the EUA contract to the Commodity Specialist Guide in July the market has been recovering towards its May peak of 16.00. However, recently a clear break of uptrend has favoured the bears, but key support may not be far off.

• WEEKLY CHART - CONTINUATION: The 38.2% recovery level has proved a tough hurdle to pass, and remains first key resistance on this long term chart. However, we think that shorter term weakness will prove temporary and we have identified two key support areas – see below.
• DAILY CHART – DEC-09: The break of uptrend and small channel base were clear bear signals – currently s/term rallies are still viewed as temporary. A close below the old 13.00 38.2% pullback level will be the next bear sign, but the first of two key supports then lies not far away – the 12.00 area which encompasses the 50% pullback, bear channel base projection and a Fibo projection just below. We would expect at least temporary support from this. Lower down lays 10.22/9.93 (another Fibo projection and 76.4% level) – this becomes next bear target if the 12.00 area fails. In the Guide we have tried to sell on suitable rallies towards the 14.66 02-Sep low, but have not had the satisfaction – but currently we are still sellers on suitable rallies.

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EUR/GBP Bulls Bolstered By Break of 88.00 Barrier

The FX Trader’s view - Bulls in EUR/GBP have taken their time to emerge, much of Jun/Jul/Aug marked by a consolidation phase. We had tended towards a positive resolution of this, and there is scope for this cross rate to move higher shorter term.

• WEEKLY CHART: The 38.2% pullback level was violated earlier this year, suggesting that the 2009 bear move had more to go. This can still be the case but, shorter term, good support has emerged from the rising support line, and we must go with the trend. Check out the Daily chart for more detail.
• DAILY CHART: After good support was found from the 0.8700 Jul high area temporary resistance came from our first target around 0.8800/15 – included a 38.2% level and falling resistance line. There has now been a clear break above and the next hurdle at 0.8945 has also been overcome – we weren’t sure if this would be, but the current chart structure shows no immediate sign of bull fatigue. Next stop? The dual retracement area of 0.9072/0/9100, which coincides with old Feb/Apr highs at 0.9072/82. Combined with the bear channel top projection above, at 0.9150, this area should be tough to crack (but a clear break would force us to reassess medium term bear risk).

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The S&P – how much further?

The Macro Trader’s view:

The recent rally in the S&P 500 really is looking like the birth of a new bull market. This, after a period during which the market rallied on scattered signs that the recession might be ending, interspersed with corrections lower as other data suggested a false dawn. Now data has begun began to point more firmly towards economic recovery.

The Fed has tried to play down these early signs by talking up the downside risks to the economy that remain. It has also pledged to keep monetary policy at exceptionally low levels for an extended period.

But over recent weeks the housing market has shown clear improvement, indeed the last two New Home sales reports showed a month-on-month increase in excess of 9.0%. Just as the housing market led the US and global economy into recession, traders and economists are have been looking to it to lead the economy back to growth.

But two other key ingredients needed to fall into place before they could be certain:1. The Business inventory cycle has yet to turn, and2. Consumer demand which accounts for over two thirds of GDP needed to turn too.

As regards consumer demand, this week the US retail sales report turned unambiguously bullish. A strong report was anticipated on the back of the US government’s cash for clunkers scheme, but the report exceeded all expectations. The headline report came in at +2.7%, but of greater importance, the Ex-Autos report came in at +1.1%. This signals the consumer is spending money and the economy is not only on the mend, but as Fed Chairman Bernanke said yesterday ”the economy is likely already out of recession”.This is great news for stocks as corporate profits should begin to strengthen and drive equities higher.

Indeed, if any further evidence was required that the economy is bouncing back, that came last week in the shape of the US trade report: the trade deficit came in much wider than expected driven by a record increase of imports. This shows demand is strengthening and, as the economic activity begins to pick up further, we judge the trade deficit will grow too.

In all the equity markets look an exciting place to be and we think the rally is only at an early stage.

The Technical Trader’s view:

MONTHLY CHART

The full majesty of the monthly chart is really to be found in the creation of a massive trading range.

Note too, within that range, the power of the rally that drove the market up through the 38.2% Fibonacci resistance at 1012-18.

Look closer still.

WEEKLY CHART

The creation of a Head and Shoulders Reversal at the lower boundary of the trading range is the current driving force behind the current rally.

Note well the minimum target of the Head and Shoulders pattern (adjusted for the log scale) – just short of the 1253 low resistance, and close by the Neckline of the H&S pattern that drove the market down in the first place.

For choice we feel that the band1201 -1253 would be a good profit-taking area. As this is being written we are currently trading 1063

Mark Sturdy, John Lewis
Seven Days Ahead

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Sugar’s Recent Key Reversal Week Tempts Bears

The Commodity Trader’s view - At the beginning of September, following a significant bull run, a sharp sell-off produced a Key Reversal Week, heralding the end of the likely end of the bull phase and start of a medium term bear phase.

• WEEKLY CHART - CONTINUATION: The Key Reversal Week is clear – the risk is now to the downside. Note how the old 19.73 2006 high exactly coincides with the 38.2% pullback level on the Oct chart below – some sort of support is likely at/above here.
• DAILY CHART – OCT-09: After the bull run failed at our Fibo projections the recent trading below the 23.6% pullback level and 21.22 21-Aug low provided a further bear signal/trigger. As noted above, the 38.2% pullback coincides with the old 2006 high – a future support area. S/term rallies are likely to be corrective/temporary only, ahead of another bear leg –first potential resistance lies at/below the 23.33 12-Aug high.
• In the Commodity Trading Guide we are sellers on rallies, and currently favour the 23.00 area (ahead of that 23.33 high and a 61.8% bounce). Stops ideally will be around 25.00, just above 24.85 high. Partial profits targeted at 20.00, stops then tightening to cost to improve risk/reward. In the Mar contract this equates to 24.50 entry, 26.50 stop, 21.00 initial target.

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UK Gilt market’s uncertainty

The Macro Trader’s view:

‘The Gilt is a government bond market that is dogged by an unprecedented build of peacetime debt, supported by the Central Bank.’ Discuss.

Since the highs made at the end of August, fuelled mainly by the Bank of England’s series of QE policy surprises, the gilt has corrected lower during September. This has been due in part to the release of further data which has emphatically supported the UK economic recovery argument but also it has fallen because of raised questions over the need for QE.

Indeed, only this week UK manufacturing output, industrial production and the NIESR GDP estimate have all pointed towards the UK finally emerging from recession after the disappointment of the Q2 GDP data earlier in the summer. And yesterday’s NIESR estimate fuelled a heavy sell off in the Gilt as it turned positive. Though that was reversed today.

Why, you may ask, would the NIESR estimate cause a selloff? Surely if the build up of debt has been a function of the recession, any sign that it is now ending, will result in the deficit coming back under control and thus eventually restrain debt levels.

The problem is that the debt build-up has been so large that any recovery cannot cure the problem by itself. If correction was left only to recovery, inflation would result, with much higher yields, further compounding the problem.

What is needed is a clear plan to cut spending supplemented by some tax increases, but that isn’t likely until after the next general election due in 9 months time. But for now, traders are unwilling to aggressively sell the Gilt, due to the Bank of England’s presence in the secondary market, holding it up. That is in spite of the normal response to economic recovery accompanied by low interest rates, expansion of the monetary base (QE) and an enormous fiscal stimulus would be to begin driving yields higher in anticipation of inflation.

The gilts have a Teflon quality, bestowed upon them by the Bank of England’s Quantum Easing program which resists such moves. So the government is afforded the luxury of lower yields than would otherwise be expected.

Our view of the gilt is that it is a market waiting to be sold. The selling in earnest will begin once the Bank’s QE program is concluded. By then, recovery will have become an established fact and the outlook for inflation clearer.

And that will pose a significant and premature threat to the economic recovery because the Bank of England is not prepared to tighten in a timely and aggressive manner so as to counter a loose fiscal stance.

The Technical Trader’s view:

MONTHLY CHART
The long-term chart has very clear parameters. The second failure at the 124.95 High is clear. And the support from the 116.08 Prior High sets the range. For the moment the smaller range remains intact.

DAILY CHART
But when the daily chart is examined subject to those parameters, some uncertainty enters.
The double bounce of the 116.05 Prior High was bullish.
But the short-term test will be the support from the two prior Highs where – we are right now.
That is of course a possible neckline of a Head and Shoulders Reversal.
Watch carefully to see if it holds. If it doesn’t, expect a rapid retest of the 116.05 lower boundary. Watch and wait for clarity.

Mark Sturdy, John Lewis
Seven Days Ahead

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Fibonacci Projection in EUR/USD Finally Reached

The FX Trader’s view - For many weeks in the FX Trading Guide we have had a Fibonacci projection marked in on the Daily chart at 1.4545. It has been reached/modestly exceeded this week and we are now waiting to see what reaction now occurs – we have been assuming that a final bull leg was unfolding.

• MONTHLY CHART: The old rising support/return line appears to be having some residual influence as resistance here. Also note that the 61.8% level has been retested now. We have been viewing recent strength as corrective/temporary ahead of another bear run.
• DAILY CHART: We have been thinking that the somewhat choppy bull leg from 1.3747 Jun low was a final one, prior to a medium term bear phase. Our initial target/projection for this, at 1.4545, has been reached now, with nearby 1.4620 61.8% level (admittedly previously eroded last Dec) offering a potential hurdle too. S/term we must await the reaction here – an initial bear sign would be a break/close below the 1.4175 01-Sep low, which would imply a false bull break of the small channel top had been seen. We could then calculate retracement levels. In the meantime the s/term bulls have to be respected, which is why we have maintained a bullish stance in the Guide for the time being.

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A Shorter Term Target in Gold

The Commodity Trader’s view - A recent, initial bull break in Gold price has been much trumpeted (the 2008 peak has yet to be breached, note). Keeping excitement tempered we currently focus on a shorter term bull target, whilst also keeping in mind what is required for the bull picture to go awry.

• WEEKLY CHART - CONTINUATION: The recovery from just above the 76.4% level of the 2006/2008 upmove initially stopped short of the 1014.60 2008 peak. This now looks vulnerable, but the test then is whether price can hold above here.
• DAILY CHART – DEC-09: In the Commodity Trading Guide we had previously said that the multi-month triangular pattern implied that the market was building up for a directional move. The close above the 993.60 03-Jun high was a s/term bull signal. If this is the start of a medium term upmove then there is time enough to suggest appropriate targets – meanwhile we keep an eye on the shorter term resistance area of 1031/40 (‘869.50/993.60’ equality target extended off 907.60 low, a Fibo projection, and bull channel top projection). S/term resistance would not surprise here. The falling return line (old triangle top) and 972.70 04-Aug high offer first support, but a close below the 950 area is needed to cast serious doubt on this bull signal. Speculative dip buyers may favour the 975 area, stops around 945, targeting 1025 for partial profits and raising stops to cost to improve risk/reward.

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Gold at the final frontier?

The Macro Trader’s view:

Readers of the Seven Days Ahead’s Macro Trading Guide will know we have been frustrated long-term bulls of this market, forced onto the sidelines as observers while a protracted 6 months period of sideways trading played itself out.

But over recent days the market has rallied convincingly, almost to a point where a run at the previous highs seems possible. Yet again, we have been caught out by failed rallies in this market on several occasions over recent months, and this has made us cautious.

But what has stirred the Bulls this time, and could something more durable develop? Until recently a familiar pattern was expected to emerge in the markets whereby stocks rallied on recovery hopes and bonds began to weaken, before developing into a bear market as recovery emerged and strengthened towards the year end.

But that pattern has been tested. The sell-off in equities over recent days can be attributed to the heavy selling in China at the start of the week: traders took fright when the long-term ruling party in Japan was dumped out of office. In neighbouring Asian countries such as China many feared the loss of the post-WW11 status quo. We think those fears will abate and stocks should recover.

Bonds too have rallied at a time when a sell-off would have seemed more appropriate. That is because traders have received a rare steer from the world’s leading Central Banks: at the Fed’s recent Jackson Hole retreat, policy makers made it clear that tightening monetary policy wasn’t on their agenda.

With official forecasts for recovery expecting a tepid or timid recovery after the worst financial crisis/recession in living memory, Central Banks are relaxed about short/medium term prospects for inflation. They argue the opening up of large output gaps in all the leading economies will keep inflation under check.

They argue this despite the unparalleled expansion of fiscal deficits resulting in an explosion of debt in many of the major economies, especially the US.

So, with inflation neutered for now as a threat, and the Central Banks aiming to keep policy at current exceptionally low levels for an ‘extended period’, bond traders are reluctant to sell, and some short-term government bond markets look bullish.

But for those traders and investors who are not so relaxed about government deficits, and the US fiscal deficit which is set to explode as a matter of policy, Gold might just be the alternative safe haven they need.

The Technical Trader’s view:

WEEKLY futures cont. chart
The drama of the Gold market lies in the astonishing refusal of the market to pull back from the 1980 high of $873.

The attempted sell-off of 2008 found good support at the Prior High of $732. The moves of 2009 have been largely sideways. But in so doing, a Continuation Triangle has been created.
Look closer …

DAILY CHART
The Triangle may have completed – certainly the initial breakthrough move was in massive volume – but we need a confirming close above the upper diagonal, or better, the Prior High at 974.30.
Note too, the tiny Bull Head and Shoulders pattern inside the triangle.
This may be the beginning of something big…the minimum move implied by the Triangle if it completes? About $135…

Mark Sturdy,John Lewis
Seven Days Ahead

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USD/CAD – A Recovery from Fibonacci Support?

The FX Trader’s view - In early June a recovery attempt proved short-lived, with a new downtrend low made at the start of August. This was just above a long term 61.8% retracement level and support is emerging here. It is worth considering recovery possibilities now.

• WEEKLY CHART: The Jun/Jul bounce found clear resistance from near the 1.1759 Jan low. Subsequent weakness has found support just above the 1.0585 61.8% retracement. In the FX Trading Guide we have pointed out initial evidence of a positive divergence on the weekly RSI – are bears tiring?
• DAILY CHART: So far, the breach of the 1.0782 01-Jun low has proved short-lived. Initial resistance has come from around a 38.2% bounce level –also note the 23.6% level of the whole 1.3063/1.0630 decline just above 1.1200. A recovery through this would be s/term positive, and at least enough to put bears on the sidelines. Ultimately a further recovery above the 1.1465 76.4% level would be needed to strongly suggest that a medium term recovery phase was underway.

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Cotton Pullback Risk Has Improved

The Commodity Trader’s view - Cotton prices recently recovered almost 50% of their 2008 losses, with price action becoming choppier on the approach to this level. Signs of bull fatigue have started to show, but we must wait for more confirmation before becoming outright bears.

• WEEKLY CHART - CONTINUATION: Reviewing the price action on the Weekly chart we could say that a wedge-type pattern had been forming on the approach to the 63.10/64.04 key resistance area (Jun-08 low and 50%). Sometimes breakouts from these patterns (and triangles too) prove deceptive (i.e. is the recent bear break valid or is the wedge still forming?). For now, we assume an initial bear break, with tough resistance, in any case, remaining overhead.
• DAILY CHART – DEC-09: In the Commodity Trading Guide we took as our initial bear signal a close below the 57.99 27-Jul low. But a further breach of the bear channel base projection around 56.00 is needed for bear confirmation. At this stage there is a good chance that s/term rallies are corrective/temporary only, ahead of a further bear push. Currently note resistance offered by the old rising support/return line (underside of wedge) at 61.50 just now, ahead of the 63.50 76.4% rebound area.

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