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FX & Gold-weekly outlook-March 11 – 15 – Italy’s downgrade shows Europe still faces grave risks

March 11, 2013

Two major events of the week were the ECB policy announcement that was followed by Mario Draghi’s press appearance and the US Non-Farm Payroll data. But Italy’s downgrade by Fitch Ratings is a reminder to the market that Europe still faces grave risks.
The ECB did not cut rates as per expectations, but this time nothing very impressive was delivered from Draghi. Probably, he may have sensed the calmed behaviour of the market. But it was a sensible ECB vote to avoid using its most effective monetary tool unnecessarily, as eurozone’s economic data continue to paint a clumsy picture hinting that the sufferings could linger on for a longer duration, which means recovery would either be too slow or may take a very long period to enter the positive territory.
More importantly, after the split Italian election results, Europe is once again faced with risk of political uncertainly, placing structural reforms and economy at risk. Italy’s downgrade to BBB-Plus from A-Minus with negative outlook by Fitch Ratings is a sign, indicating that the country could see another cut in its sovereign credit rating.
I think US payroll data was the biggest event of the week after a surprise jump in February numbers and jobless rate falling to 5-year low of 7.7 percent, as employment rose to 236.000. It should give a good boost to the Fed Chairman’s argument supporting his policy stance in Senate about 10-days ago, as he was grilled for his continued stimulus policy. Questions were raised on economic recovery and job conditions, which are now supportive of Fed’s stance.
This could be too early for the Fed to start thinking of a reversal of its stimulus plan, as it should carry on with its asset purchase plan until US economy stabilises and job condition improves substantially. Therefore, I will not be surprised if some of the Fed ‘Hawks’ prefer to stay on the sideline to see if this growth trend persists. The Fed can prolong with its asset purchase program, as there is no immediate threat of inflation.
Meanwhile, Europe faced with threat of recession and mildly recovered is still sitting on the edge of rope, as its economy is solely dependent on the German growth. There is no evidence of sustainable economic recovery in eurozone’s three other major economies that are struggling to implement structural reforms, which are a condition, set by the policymakers.
Although last week’s European economic data showed a minor growth, it is not enough to create new jobs and reduce deficit. Unfortunately, eurozone’s growth forecast has once again been lowered, dampening the sentiment. Draghi’s message was that the ECB was in no mood to cut rates, which could mean they will once again reassess all the economic happenings in its April policy meeting.
Despite all the bad news Spanish and Italian bond yields have showed some impressive strength, mainly owing to LTRO money payback that helped reduce the size of ECB balance sheet. Otherwise, there might be some other reason that may have helped bond yields and Euro to maintain strength. With a strong recovery in the US and a policy shift to maintain weak currencies by the UK, Switzerland, Japan, China and others, I doubt a strong euro will be sustainable for the European economy.
As per expectations, the Bank of England left its policy rate unchanged and did not go for expansion of asset purchase programme. The UK economy is still faced with a threat of injection of liquidity and recession as the economy is not responding well to the measures taken so far. The US job recovery may encourage the BoE policy members to reconsider more easing, as a weak pound sterling could be helpful, but is enough to meet the desired growth level.
In another interesting move, Japanese yen could not benefit from surprise growth in 4th quarter and came under pressure after the release of data that showed China reported trade surplus, exceeding expectations. Basically, it meant that China is more competitive against its Asian partner. In the past, I have several times mentioned that Yen also reacts to the US 10-year bond moves and after the US payroll data the US yield jumped to close at 2.05 percent, which makes the US bond more attractive that increases risk for a shift from Japanese Yen portfolio.

GOLD $1575.70 = This week, there is a minor risk that initially we could see an upward move if gold is able to break above $1595 levels for $16101-20 zones. However, a downside risk will increase once a clear break of $1560-65 is seen for a test of $1538 levels.
EURO @ 1.3003 = A break of 1.3090 is required for a test of 1.3150. I am expecting sale pressure on the up, but 1.2910-20 is a strong support level that needs to surrender at 1.2835. Range for the week: 1.2880-1.3210;
GBP @ 1.4922 = Choppy trading is expected as Cable has strong support around 1.4820-40. A break risk for 1.4770. On the up, a move beyond 1.5080 could help some more gain towards 1.5150. However, sellers will remain active on the up. Range for the week: 1.4820- 1.5180;
JPY @ 95.97 = Volatility could dominate as sellers of Japanese currency may appear at resistance levels, but the pace of yen weakness should slow down this week. Unless a break of 96.80-90 levels occurs, a risk of correction is a strong possibility. Yen needs to gain beyond 95.10 for 94.50. However, a break of support level risk for a test of 97.20. Range for the week: 94.20-97.50;
AUD @ 1.0231 = Buying of Aussie on dip to continue, as it is one of the favourite currencies for an investor. A strong support is at 1.0140 and only a break risk for 1.0080. However, a push beyond 1.0325 will encourage for 1.0375. Range for the week: 1.0080-1.0380.

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