The Week Ahead: July 15-20, 2012

It is a relatively light week for economic data out of Europe next week and therefore markets will be paying close attention to ongoing developments on recent measures to contain the region’s debt crisis. Details continue to emerge regarding Spain’s sought after bailout package. This week’s announcement raised hopes that the first €30B of aid for Spanish banks will be provided this month. At the government level, Spain was given an extra year to reach its budget deficit target. Spanish 10-year yields have declined after spending time above the 7% level and will be closely monitored as Spain sells bills on Tuesday and bonds on Thursday. A renewed flare up in yields may put added pressure on the EUR.

The European Stability Mechanism (ESM), Europe’s permanent rescue fund, will also be in focus as it goes through the ratification process. Of note, Italy’s parliament while vote on the ESM this coming Thursday. The debate in Germany regarding the constitutionality of the ESM persists and though progress can be a positive for the euro, the overall firepower of the fund continues to raise concerns.

The German ZEW survey for July is likely to be the main economic release in the week ahead which also sees the release of EZ June CPI (expected to remain at 2.4% y/y) and May trade balance (anticipated to narrow to a surplus of €5.0B from €6.2B). The risk is for an unexpected drop in CPI which could spark increased speculation of further rate cuts by the ECB. Germany’s sentiment indicator, which showed a negative print last month for the first time since January, may weaken further indicating a deteriorating outlook which could weigh further on the common currency. The euro has grinded lower against most of the majors and looks set for further declines. We maintain the view that the path of least resistance is to the downside and favor selling rallies in EUR/USD.

Bank Of Canada To Hold
On Tuesday, July 17, the Bank of Canada (BoC) will meet to decide on monetary policy and announce interest rates. We expect the bank to keep rates steady at 1.00%. As this is largely anticipated by market participants, the key focus will be on the tone of the accompanying policy statement. Despite a better-than-expected June employment report which showed a surprising tick lower in the unemployment rate and improvements in housing activity, we expect the bank to soften its hawkish tone.

Since the last rate announcement early in June, data has showed CPI slow by more than expected to 1.2% y/y in May and the June Ivey PMI fell below the 50 threshold for the first time since July 2011, and indication of contraction. Activity in the US economy – which is closely tied to that of Canada – has deteriorated of late and is likely to be of concern to the BoC. Slowing global demand, an escalation in the EU crisis, and a dovish response by major central banks are externalities which may cause the BoC to soften its hawkish tone. Furthermore, the Bank’s Monetary Policy Report (MPR) will be released on Wednesday and may show that bank revise lower its economic forecasts as we have seen done by official institutions in the US and around the world.

A more dovish tone by the Bank of Canada would likely weigh on the Loonie as the bank shifts away from its tightening bias. With USD/CAD currently facing support around the base of the daily Ichimoku cloud which is around 1.0125, there is the potential for a rebound in the pair. The key level to the upside is the daily Tenkan line and top of the cloud which converges around the 1.0230/40 level. Also of note, the 30-day rolling correlation (based on a daily % change) between USD/CAD and crude oil has reached the lowest level in over 5-years this week and currently stands at -0.84. This suggests that fluctuations in oil prices have had a strong inverse relationship with the USD/CAD pair. 

Paying Attention To Intermarket Analysis…
With markets being as volatile as they’ve been over the past few weeks, intermarket analysis has never been more important. For those of you unaware of what we’re referring to, intermarket analysis is the study of several markets at once such as stocks, bonds, commodities and currencies rather than each one in isolation. Thus, it may help trader’s pinpoint market reversals or confirm a trend earlier based upon their respective price movements. With that said, below we have highlighted a few of these markets to keep an eye on in the current trading environment. Should the technical levels in the noted markets below get breached (higher or lower), than be on alert for a similar type movement in many of the high beta currencies – AUD, NZD, CAD as well as the perceived safe havens – USD and the JPY.

USD Index: Technical developments earlier this week suggested the greenback’s gains could continue as it broke above the key 83.50 level which saw the convergence of the August 2010 and June 2012 highs. However, today’s pullback warrants close attention as the break above the aforementioned highs was not confirmed by the daily Relative Strength Index (RSI) – Thus, forming a potential bearish divergence with price. This could set up a potential test of the 82.70-90 area next week and ideally this should prove supportive, yet if it gives way then a move towards the January prior highs, around 81.75, could ensue.

EUR/USD: Since the beginning of July the euro’s technical outlook has decidedly shifted to the downside, as witnessed by the formation of lower highs and lower lows (definition of a downtrend). One of the major decisive blows for the single currency came this week when it broke below the June low around 1.2285/90, to a new 2-year low. That said, nothing moves in a straight line and corrections, as witnessed today, should be expected. The next key resistance levels to watch early next week are: 1.2285/90 (June low), 1.2330/35 (this week’s high) and 1.2365 which is the 38.2% retracement of the 6/29-7/13 decline. On the other hand, should the downtrend resume then keep an eye on these critical levels: 1.2150/60 (6/29/10 low and this week’s low), 1.2135 is the 50% retracement of the all-time highs and lows since the euro’s inception and lastly the psychological/option/barrier related 1.2000 level.

S&P500: Tested down into the psychological 1325 level yesterday and then recovered into the close, forming a Hammer candlestick in the process (typically identified as a bullish reversal pattern). Interestingly, it also found support into the daily Ichimoku Cloud as well as 50-day sma. Next week it looks poised to retest the 100-day sma around 1360 and then potentially even make a run at the July highs near 1375. Should this 2-day rally reverse, the important level to watch on the downside is 1310 which sees the convergence of the 200-day sma and end of June lows.

U.S. 10-Year Yield: At the end of last week yields broke below 1.55%, which was a level that proved supportive throughout much of June and the beginning of July.  This nearly led to a test of the All-time low around 1.438% on the back of a very strong U.S. 10-year auction on Wednesday. Presently, it is trading around the psychological 1.50% and we believe a 1.44-55% range could emerge over the next few days/weeks.

Gold: The precious metal bounced off trendline support around $1555, drawn from the May 16th low, over the past 24-hours and has since rallied. Currently, it is trading back within the daily Ichimoku Cloud ($1586-1605) and sees immediate resistance into the 55-day sma around $1595. Interestingly, since mid-May gold has been making higher lows and lower highs. Typically, this would be identified as a triangular consolidation pattern, however it also appears this price action could be a head and shoulders pattern. Under either scenario it suggests close attention should be paid to the aforementioned trendline/neckline support near $1555, with only a break above $1640 invalidating this downward bias.

Oil (WTI): Has seen a slight upward bias after strengthening significantly into the end of June. Last week it reached the 38.2% retracement of the May-June decline around $88.50 before correcting back lower. Next week this level should also see the 55-day sma and bottom of the daily Ichimoku Cloud. Thus, it could prove difficult to surmount upon a potential retest. Importantly, daily RSI still remains below the key 60/65 level and as such implies the downtrend should remain intact. Should this be the case, pay close attention to the $83/84 level which sees the 21-day sma, daily Kijun line and this week’s low converge and would likely be a trigger to further declines.

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