London Open Update: Range Trading as Alcoa, China Boost Sentiment

The big news overnight was the China trade surplus, which was much bigger than expected for December at $16.52bn, vs. $8.8bn expected. This increases the chances that China will experience a soft landing after its most recent slowdown, which helped to boost the Aussie and other commodity currencies and also had a positive effect on the euro.

However, there are a couple of things to note about this. Firstly, the trade balance was boosted by weaker imports, which grew by 11.8% vs. exp of 18% last month. If imports continue to slow this could hurt Australia’s economy and the Aussie, since China is its biggest trade partner. Secondly, EURUSD jumped as high as 1.2796 before attracting sellers just below 1.28 on reports that Ireland may need another bailout or private sector haircuts. The report in the Irish Times was actually quoting Citigroup economist Willem Buiter, who actually said that the EU/ IMF would rather Ireland re-negotiate its terms and get a lower interest rate on bailout terms than subject private sector bond holders to losses, but this market is jumping on the back of the most meaningless utterance when it comes to the Eurozone.

This was enough to see the euro drop 50 pips, where it found good support at 1.2750. At the same time the Aussie hardly moved, which highlights the isolating position the euro finds itself: it is getting hit on the back of weak European news when other risky currencies have barely blinked an eye in recent days. The divergence in “risky” assets is fascinating and is being driven by the dichotomy in the global economy with a strengthening US on the one hand and a weak Europe on the other. As long as the US manages to continue to do well then so should China, which is good news for the commodity bloc. Likewise, if the euro continues to get used as a funding currency then some of this should seep into other risky assets like commodities, stocks, gold and high yielding currencies like the Aussie. So going forward EUR/AUD could be he cross to watch in FX.

However, a lot of this “good news” for risk depends on the US maintaining its momentum. This makes this Thursday’s retail sales data from the US extremely important. Retail sales ex autos and gas are expected to rise by a fairly healthy 0.4% in December, boosted by holiday discounting. Consumer confidence data released on Friday will also be vital to sustain risk sentiment as it will help to determine the strength of the US consumer. Thus, these economic signals are likely to have more of an impact on the market in the coming weeks and we could see some relative value overtake the risk on/ off theme that has dominated markets for months.

Shifts in the FX spectrum should make a relative value long EUR gold vs. short $ gold trade attractive in the medium term as euro-priced gold should strengthen as the euro suffers, while $ gold weakens as the dollar does well. This is something we are looking at in the medium-term. The spread has started to widen (euro gold out-performing $ gold) since August 2011, but it remains below its May 2010 peak, which suggests that there could be further to go, see chart below.

We expect markets to trade in a fairly tight range today as we wait for Thursday’s main events: the Spanish and Italian bond auctions and the ECB and BOE meetings. The ECB shift to a dovish stance that was confirmed at the Bank’s December meeting was a game changer for the single currency and that is when it started to lose traction so Draghi’s comments are crucial for the future direction of the currency and whether the new euro-carry trade has legs.

News from Fitch that it would conclude its review on Euro-area ratings by the end of this month and that France was unlikely to be downgraded this year, while Germany was safe and Austria was in no immediate danger caused a bounce in the euro back above 1.2760/ 70, but the 1.2730-1.2800 range is likely to persist at least until the Merkel/ Lagarde meeting at 1900 GMT that could help sentiment if it discusses shorter-term measures to ease problems in the currency bloc. Yesterday, Merkel and Sarkozy discussed fiscal union in depth, which is good in the long-term but won’t bring down sovereign yields any time soon and so keeps the euro under pressure.

EURGBP is also finding support at 0.8250 although we continue to believe that 0.8200 is not too far away. The Aussie is making hard work of 1.03, if we get a boost in sentiment from strong US data later this week then we could see it jump back to 1.0350 then to 1.0425 2000-day sma resistance.

Strong Q4 corporate results from aluminium producer Alcoa helped to boost sentiment in European stocks today, since it suggests that global demand isn’t that bad that could lead to some other upside surprises during earnings season. Strong results may be able to boost SPX 500 through resistance at 1,280 towards 1,300 – a key psychological level.