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Morning Adviser Europe 9/20/2010 5:57:00 AM

RBA Sees Inflation Basing

By Gareth Berry

FX markets were relatively quiet during the Asia session with Japan on holiday. Equities were broadly flat, after a similar finish in New York on Friday. Gold approached but could not breach last week's record high, and is trading at $1280.60/oz at the time of writing. The dollar made no further progress against the euro despite the re-emergence of European sovereign risk concerns on Friday. EURUSD traded 1.3035-1.3084, and USDJPY 85.64-85.83. The University of Michigan consumer sentiment index fell to 66.6 in early September (cons 70.0) from 68.9 in August. Our US economists note that the entire decline in the index reflected weaker sentiment among respondents with income greater than $75,000. By contrast, sentiment among individuals with income below $75,000 improved. The decline in sentiment among "upper" income respondents likely reflects concern that their taxes could be rising in 2011. Headline CPI was in line with expectations but core prices were slightly softer than expected at 0.0% m/m (cons. +0.1%, prev. +0.1%). Our US economics team expects core CPI inflation to hold at about a +1% y/y pace through to the end of this year, rising to +1.3% y/y by end-2011. The FOMC's latest policy decision is due on Tuesday, and our US economists believe the economic outlook has not deteriorated enough to warrant any additional monetary easing at the meeting.

EUR

Targets : EURUSD 1m 1.28, 3m 1.15 Sovereign bond yields of Ireland and Portugal rose sharply on Friday, after a headline in an Irish newspaper warned that Ireland was "perilously close" to calling in the IMF. The government described the article as "a local misinterpretation of a research report", and the IMF said it does not foresee its assistance being needed in Ireland. Both ECB Governing Council Members Nowotny and Mersch opined on the future of the ECB's liquidity tenders, a topic that has proven to be a significant driver of the euro in recent weeks. Nowotny noted that some parts of the Eurozone banking system are "addicted" to ECB liquidity, and that the problem should be solved primarily by governments. Mersch said he saw "no need to hold onto full allotment", noting that "short term rates can be very easily controlled via competitive tenders". Reuters, citing a German newspaper, reported that German banks will need to raise ?50 bn in fresh capital to comply with the new Basel III capital proposals due to come into force by 2019.

JPY

Targets: USDJPY 1m 85, 3m 95 With Japan on holiday, USDJPY was relatively quiet and range bound on Monday, suggesting the BoJ has not been active in FX markets since Wednesday. Speculation is mounting that a bill aimed at incorporating an explicit inflation target into BoJ Law could soon be presented to Japan's Diet. We are sceptical of claims that a change to the Law is imminent on two counts: first, parliamentary time in the immediate future is likely to focus on agreeing the terms of the budget for the coming fiscal year; second, a change to BoJ Law would require the approval of both the upper and lower houses of parliament. With no party holding a majority in the upper house, at the very least this would likely complicate and delay the passage of any such bill. The next parliamentary session is expected to begin in early October.

SEK

Targets : EURSEK 1m 9.35, 3m 9.30 Sweden held a general election over the weekend, with media sources indicating that the ruling coalition has maintained its lead over the opposition but has fallen short of an absolute majority.

AUD

Targets : AUDUSD 1m 0.90, 3m 0.85 RBA Governor Stevens offered a relatively hawkish assessment, noting that. "the fall in inflation over the past two years won't go much further." However, he did acknowledge that the global growth outlook was uncertain and that although global growth will be "reasonable" next year, it would not be as strong as the current year. Stevens also identified three key risks to Australia: a deeper than expected slowdown in China, a US double-dip, and the return of market turmoil.

CAD

Targets : USDCAD 1m 1.02, 3m 1.02 Finance Minister Flaherty said Canada's fiscal stimulus measures would expire as planned in March 2011. We issued a trade recommendation on Friday to buy USDCAD at 1.0260, targeting a rise to 1.0650 with a stop at 1.0050. We expect a return of risk aversion in the short term and note that uncertainty over global growth prospects will likely keep the BoC in a wait-and-see mode for the time being.

FX Technicals

USDJPY 86.70 resistance EURUSD NEUTRAL Need a break above 1.3334 to trigger bullish trend. Support holds at 1.2919 USDJPY NEUTRAL Following the recovery through 85.93, model has turned neutral. Next resistance is at 86.70 ahead of 88.12. Near-term support lies at 85.20. GBPUSD BULLISH Pressure on 1.5731; next resistance lies at 1.5999. Near-term support comes in at 1.5449 ahead of 1.5297 USDCHF BEARISH Clearance of 0.9933/18 would expose 0.9786 next. Near-term resistance comes in at 1.0278 ahead of 1.0466 AUDUSD BULLISH Upside potential capped at 0.9850. Near-term support is at 0.9309 ahead of 0.9196. USDCAD NEUTRAL 1.0509 and 1.0108 mark the key near-term directional triggers EURCHF NEUTRAL Recovery clears 1.3345 thus exposing 1.3482 Fibonacci level next but snapback to support at 1.3163 breakout high keeps tone neutral. EURGBP NEUTRAL 0.8532 and 0.8142 mark the key directional triggers. EURJPY NEUTRAL Break of 114.74 would put odds in favour of positive tone. Next resistance at 116.68. Support holds at 107.73 ahead of 105.44 key low *NOTE: The trend for each currency pair as defined in the table is determined by our proprietary model and is independent of our discretionary interpretation of price action