Risk Rally Extended Cautiously, Canadian Dollar Shone

Despite intra-week setbacks, risk markets managed to close the week on a strong note, with S&P 500 closed above 1400 psychological level. Most major currencies strengthened against dollar but euro didn't follow. Indeed, the common currency was the weakest one along with Swiss franc as Spanish 10-year yield is back at 6.9% level.

Weakness of the euro in crosses were more apparent as EUR/CAD dropped to new record low last week while EUR/AUD was close to corresponding level. A steep sell-off was also seen in EUR/GBP after BoE King cooled speculation of rate cuts. Meanwhile, Canadian dollar took turn to be the strongest one last week as aussie and kiwi were both dragged down by weak China trade data.

Technically, while the risk rally might extend further in near-term, we'd like to point out that risk of reversal, or at least a pull back, is increasing. S&P 500 is now quite close to this year's high of 1422.4 and is starting to lose some upside momentum in intraday charts. A similar picture is seen in the Dow which is approaching this year's high of 13297. A more important important development to note was CRB commodity index's selloff on Friday, after spiking to 306.54 on Thursday. And, bearish divergence condition was seen in the daily MACD of the CRB.

The loss of momentum in aussie and kiwi comparing with the Canadian dollar could also be taken as a sign of exhaustion in the market, in particular with AUD/USD now close to an important trendline resistance at around 1.068 level. The Dollar Index is also stubbornly holding on to its 55 days EMA. Hence, we'll tend not to participate in any risk rally this week and would patiently wait for signal to turn the dollar long instead.

In the US, Fed Chairman Bernanke acknowledged that many US citizens are still struggling "with difficult economic and financial conditions" although "some key aggregate metrics - including consumer spending, disposable income, household net worth and debt service payments - have moved in the direction of recovery."

In a pre-recorded video speech for a Massachusetts conference, Bernanke stated that macroeconomic indicators can "sometimes mask important information." He also suggested economists to make use of also "distribution of income, confidence about future employment prospects and the ability of households to deal with financial shocks" to gauge "the economics of happiness" of the people. The Chairman's concern may signal that the Fed would do more to ease the economic conditions further as most of the people are still "struggling."

Boston Fed President Eric Rosengren indicated a large scale easing program is needed to stimulate growth and the job market in the US. At an interview with the CNBC Rosengren, a voter in the FOMC in 2013, called for an "open-ended" QE program of "substantial magnitude." The program "needs to be substantial enough that it offsets some of the shocks that we're getting from abroad and some of the concerns that people have with how weak the world economy has been." His comments, together with Fed chairman Ben Bernanke's comments earlier this week, raised further hopes that the Fed would soon implement QE3 as a boost of the US economy.

In Europe, ECB's monthly bulletin noted that "several countries and financial fragmentation hinders the effective working of monetary policy." The central bank urged eurozone leaders to "push ahead with fiscal consolidation, structural reform and European institution-building with great determination." And, "governments must stand ready to activate the EFSF/ESM in the bond market when exceptional financial market circumstances and risks to financial stability exist -- with strict and effective conditionality."

Meanwhile, ECB governing council member Noyer also said that ECB has the capacity to "act within the terms of its mandate" and the operations will be of "sufficient size to have a strong impact on the markets". Noyer emphasized that the ECB is "ready to intervene very soon, prioritizing short-term debt markets."

S&P lowered Greece's CCC rating outlook to negative from stable. The rating agency noted that it reflects the "possibility of a downgrade if Greece fails to secure the next disbursement of the EU/IMF Program." And the rating agency noted that "deepening contraction" in Greece implies a "high likelihood" that additional financing of as much as EUR 7b is needed this year.

Also, it's reported that the IMF is pushing eurozone leaders to lower Greece's burden. In IMF's view, Greece's bailout program is hugely off-track and the organization could only release further funds if Greece's debt could be reduced to sustainable level. And that would involve lowering interest rates on loan to Greece, ECB and others to have another 30% haircuts.

The BoE inflation report for August revealed the gloomy economic outlook anticipated by policymakers. The GDP growth forecasts were revised lower while inflation is expected to fall below +2.0% from mid-2013 to 2015. The 'unusually uncertain' economic outlook is mainly due to the sovereign debt crisis in the eurozone and whether officials would implement sufficient measures to resolve the crisis.

After presenting the quarterly Inflation Report, BoE Governor King said that "major of the conditions necessary for a recovery are in place" and further rate cut could be "counter-productive" if it could damage some financial institutions. His comments cooled expectation for rate cut from BoE.

As expected by the majority of analysts, the BOJ ended its August meeting with no change in the monetary policy, i.e. keeping the uncollateralized overnight call rate at 0-0.1%, the asset-purchase fund at JPY 45T and the lending facility at JPY 25T. As both the Fed and the ECB refrained from delivering more easing measures in August, it has become less urgent for the BOJ to act this month. Yet, it does not mean that the central bank would stand on the sideline for the rest of the year. We believe the next trigger for the BOJ to act would be after the Fed's QE3 announcement, a move expected to send the Japanese yen further higher.

Canadian dollar was supported by BoC Governor Carney's comment that the Canadian economy is in a "very different place" than other advanced economies and may hike interest rates if the economy continues to grow above trend. The comment suggested that BoC is still leaning towards a tightening bias, in sharp contrast to other major central banks which are talking about additional easing.

The expectations overshadowed the weak employment data and maintained the Canadian dollar as the strongest currency last week. Canadian job market unexpectedly contracted -30.4k in July versus consensus of 10.0k growth. Unemployment rate also rose to 7.3% as expected.

Inline with market expectations, the RBA left the cash rate unchanged at 3.5% in August although inflation has softened in recent months. The central bank decided to take a wait-and-see mode for two months in a row following two consecutive rate cuts in May and June, by a total of -75 bps. Despite signs of economic recovery since the last reduction and the lack of indication of further rate cut by the central bank, we believe the bias of interest rates is skewed to the downside and we look for further easing later this year.

In its quarterly monetary policy statement, RBA raised 2012 growth forecast to 3.75%, up from May's projection of 3.0%, but expects slowdown in the second half. Meanwhile, CPI project for 2012 was also raised to 2.5%, up from prior projection of 2.25%. Also, the central bank expect inflation rate to be in top half of its target range throughout 2013, with help from carbon tax.

The new projections now raised the possibility that RBA is done with its current easing cycle but the development in Europe would remain key. Meanwhile, RBA also warned that the "persistently high level" of Australian dollar exchange rate may "be more contractionary for the economy than historical relationships suggest". And "important risks revolve around exchange rate developments".

Employment data from Australia was solid, with 14k growth in July comparing to 10k. Unemployment rate also dipped back to 5.2%. The growth number erased nearly half of June's -28.3k contraction. RBA Stevens noted in the statement earlier this week that domestic growth will be "close to trend" while the job market has shown "moderate" growth in employment. In contrast, New Zealand's job market unexpectedly contracted -0.1% qoq Q2, comparing to expectation of 0.4% growth. Unemployment rate also unexpectedly rose to 6.8%.

Deterioration of the sovereign debt crisis in the eurozone and the economic slowdown in the US hurt China's export demand in July. China's trade surplus narrowed sharply to $25.15B in July from $31.72B a month ago. Export growth declined to +1.0% y/y, compared with +11.3% in June, reflecting weakness in global economic activities. Import growth also dropped to +4.7% y/y from +6.3% in June.

As the July trade data disappointed, the RMB would likely stay around $6.3 as not to hurt exports further. The set of Chinese economic data for July indicated that slowdown in the world's second largest economy continued in the second half of the year. Previous easing measures appeared to have done little to boost economic activities, as shown in the July data.

Going forward, we believe the government would add more easing measures in terms of reverse repos and RRR cut. However, the more appropriate and likely timing would be in August as inflation has probably bottomed in July. The central bank would probably feel less comfortable to ease aggressively as inflation rebounds.