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The Week Ahead

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Event risk to dominate markets next week

The month of May looks set to start with an eventful week that may generate significant volatility. (N.B.: Monday is a bank holiday in London.) First up, on Sunday, the EU has scheduled a press conference at which the final details of the Greek aid package are expected to be announced. The market will be looking for a 3-year deal totaling EUR 120 bio, at the minimum, as being sufficient to prevent a Greek default or funding crisis. Anything less and markets may express profound disappointment and take it out on the EUR. Markets will also pass judgment on the amount of deficit reduction being demanded of the Greek government, and just how credible its commitment is. The latest headlines suggest that an agreement is near, so we have to think the upside in EUR is going to be in play, at least in the beginning. Judging by still highly elevated peripheral Eurozone CDS's and bond yields, markets may simply conclude additional borrowing by deficit-riddled EUR members does not solve the long-term problem and quickly resume selling EUR. Given the still daunting deficit environment in Europe (see more below), we expect to see EUR/USD selling interest materialize in the 1.3400/50 area and will watch that level as a key resistance zone. The 1.3200/50 area is the critical downside support zone.

Downunder on Tuesday afternoon the RBA will announce its interest rate decision. A 3/4 majority of economists expect a 25 bp rate hike to 4.50%. The RBA statement will also be closely read for indications of further tightening down the road. AUD looks to have the most risk from a steady rate outcome (AUD/USD likely lower), but AUD appears to be more driven by risk sentiment than interest rate expectations at current levels.

US employment data will be in the spotlight next week, and the ADP report on Wednesday may garner more attention than normal, as it covers strictly private sector payrolls. Hiring of temporary government Census workers looks set to skew Friday's April NFP jobs report by about +125K, potentially accounting for more than half of the +200K consensus expectation NFP increase. The unemployment rate is expected to hold steady at 9.7%.

Thursday is Election Day in the UK and the results promise to be anything but straightforward (see more below). The most recent polls continue to suggest a hung parliament, which would then lead to coalition talks that could drag out for a week or more. The Civil Service will maintain government functions in the interim, but political speculation will likely keep GBP churning in the meantime. Overall, we're constructive on GBP once the election-related uncertainty is over and look to buy GBP/USD on further weakness down into the 1.5180-5080 area (see Weekly Strategy). The most Sterling positive outcome is for an outright Conservative majority, with the next most positive result being a Conservative/LibDem coalition. Any form of Labour-led government shifts the balance to a Sterling negative result.

Risk sentiment may falter further

This past week saw some extreme volatility across all asset markets, but by the end of the week, many recent range levels had held. The clear exception was gold, which is closing at new highs for the current advance. The demand for gold suggests all is not well in risk appetite-land and that in turn suggests that risk assets may see further downside in the near-term. In stocks, the S&P 500 posted both a weekly and daily bearish engulfing line as well as a close below the daily Kijun line. In FX, the JPY-crosses topped out before the end of the week and are showing signs of failure/rejection after attempts above the week's highs. In USD/JPY, a test above the top of the weekly Ichimoku cloud at 94.28 failed, potentially setting up a return to the cloud base around 91.90 next week. US Treasury yields also look to be extending their decline, closing at new lows (3.65% in 10 Year US notes) and below the daily Ichimoku cloud. A move higher in Treasuries/lower in yields is negative for USD/JPY and likely risky assets overall as it suggests safe-haven buying similar to what's driving gold.

GBP outlook depends on new government tackling the deficit

Tory party leader Cameron may have scored highest in the final televised leaders' debate ahead of the May 6 general election but opinion polls have continued to hint that he will fall short of winning an absolute majority. Disappointing for the markets is that with just days to go before the election a lack of clarity remains on how the budget deficit will be tackled. All the major parties have acknowledged it is a problem; none have provided sufficient detail as to how it will be dealt with. The performance of the pound over the next 6 months or so is set to depend on how the new government approaches the issue of the budget deficit; which at 11.5% of GDP could prove to be a poison chalice. The moderately better tone of the pound in recent weeks suggests that the market has become resolved to the prospect of a hung parliament. However, if this gives rise to post election bickering, sterling could suffer. The best case scenario for the pound would be a clear government majority when the polls close; Tory or Labour. On this scenario the squeeze higher in the pound could be sharp.

Greek woes will persist well past the weekend

The talks between the IMF/EU and ECB regarding the Greek support package are scheduled to be completed over the weekend. As a consequence the market has covered a few EUR shorts. Given indications that the size of the loans on offer will have ballooned well beyond the EUR 45 bln EU/IMF package that was on offer just a few weeks ago there is some reason for short-term relief. However, there is still a long way to go before Greece's ills are healed. The first concern is that the German parliament will not debate the topic of Greek aid until next week implying at least a week's delay before EU aid can be endorsed. This parliamentary debate could give the markets' cause for concern particularly since it comes just ahead of the May 9 regional elections in Germany and given that Greece is facing bond redemptions on May 19. The second issue is that Greece still has to prove it can live within its means and this will be a slow process. Since austerity will ensure Greece remains in recession this year, there is no guarantee that Greece will be able to tolerate continued belt tightening over the next couple of years. Yet without austerity, further tranches of loans from the EU and from the IMF may not be forthcoming. This means that while IMF involvement implies there may be no imminent threat of default from Greece, this risk and that of a potential EMU exit still persists further down the line. Meanwhile EU officials remain heavily obliged to try and stem fears of a default or devaluation in Greece since these fears would be consistent with an increase in contagion amongst the EMU region. Despite the inevitable round of positive rhetoric from the EU over the weekend, the EUR could remain under pressure for some time yet.

Key data and events to watch next week

The US has a plethora of top-tier events due up in the week ahead. Monday kicks it off with Personal income/spending, ISM manufacturing and motor vehicle sales. Factory orders and pending home sales are due up on Tuesday while ADP employment and ISM services are up on Wednesday. Nonfarm productivity, unit labor costs and initial jobless claims are on deck Thursday while Friday rounds out the week with the pivotal employment report and consumer credit.

It is another important week in the Eurozone. PMI manufacturing starts the week off on Monday while producer prices and German retail sales are up Tuesday. PMI services and retail sales highlight Wednesday. Thursday has the ECB rate decision and press conference along with German factory orders. German industrial production closes things out on Friday.

The UK has a busy week ahead. Monday is a holiday but Tuesday makes up for it with consumer credit, mortgage approvals, PMI manufacturing and consumer confidence. Thursday is the big day with the UK general election on tap along with PMI services. Producer prices round out the week on Friday.

Japan is very light with only vehicle sales on Thursday.

Canada has a light but important week up. Building permits and the Ivey PMI are due on Thursday while the employment report closes out the week on Friday.

There are some critical data points due down under as well. Australia sees home prices on Monday, the RBA rate decision on Tuesday and retail sales on Thursday. In New Zealand the only noteworthy release is the employment report on Wednesday.

DISCLAIMER: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase of sale of any currency. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.


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