Portugal’s financial position weakens, but the euro remains immune

We are back in a “risk-on” environment which is fuelling the usual suspects: stocks, the Aussie dollar and the pound, while safe havens like the Swissie and the yen fall. The dollar is mixed – weakening against the euro, the pound and the Aussie, but strengthening against the yen.

Oil and gold had a positive start to the European session. We expect these two assets to trade well in the next few months because while economic conditions have picked up driving risky assets higher, there remains considerable uncertainty out there: not least the end to QE2 from the Fed and the on-going Eurozone sovereign crisis that may result in a Portuguese bailout sooner rather than later.

Is yen weakness likely this time?

A break out in yen crosses has seen USDJPY crack 83.00, EURJPY above 117.00, GBPJPY above 133.00, AUDJPY above 85.00 and CADJPY has also cracking the 85.00 highs. Even though industrial production strengthened in February, this was before the quake and pre-quake data is likely to be dismissed by the markets going forward.

It is not known if today’s JPY weakness was due to intervention, we think it is more positioning readjustment with investors looking at the fundamentals and the relative growth and interest rate potential, which is edging higher in Europe and the US relative to Japan. Obviously a weak yen is exactly what the Japanese authorities want to help out exporters.

Going forward although growing number of Fed members are hinting that QE2 is coming to an end, a sustained bout of USDJPY strength will be dependent on the US keeping up its economic momentum and the Fed gradually normalising interest rates. Rates are expected to remain static in the US for the next year, however, if the economic data picks up – especially a fall in unemployment and an uptick in inflation expectations – then rates may have to rise faster than the market currently expects.

It’s too early to know if this is a shift in trend for the yen, but recent price action suggests there could be further downside to come. Combined with the prospect of forced yen weakness through intervention, it looks like the Japanese currency is on the back foot for the time being.

US jobs: back to normality?

As we head into the middle of the week the focus will settle on non-farm payrolls due on Friday at 1330 BST. The market expects the US economy to have generated 190k jobs in March, after a healthy 192k reading in February. The rally in stocks and USDJPY strength suggests that the market is pricing for a strong reading. This means that an upward surprise of 200k plus would probably be needed to fuel the rally to the end of the week.

Monthly job growth at this pace suggests a return to pre-recession normality for the labour market. It would also suggest that companies are confident about their future earnings power, which is good news for stocks as we move into the first quarter earnings season from next week.

Portugal reaches boiling point:

Things are coming to a critical point for Portugal. A report today suggests that the Iberian nation can’t afford to pay its upcoming debt redemptions of EUR9bn for April and June. This has been denied by Portuguese authorities but there is no denying that things have got worse for Lisbon. Its sovereign credit rating was cut to just above junk level by rating agency S&P yesterday. It is suffering a buyers strike in the credit markets and yields on its debt are once again soaring. The writing is on the wall for Portugal and a bailout is just a matter of time in this environment.

Tomorrow the results of further stress tests for Ireland’s banking sector are released. This is expected to show a further capital short-fall of EUR20bn, half of which is covered by bailout funds. Where the rest will come from we will have to wait and hear more tomorrow…

As usual the euro is immune to such uncertainty. This is largely due to 1, short-term interest rate expectations and the prospect of a rate hike by the ECB next week, and 2, Spain successfully decoupling from the other troubled peripheral states.

Elsewhere, the pound is clawing back some losses, but remains vulnerable to further set-backs based on the UK economic outlook. Right now though it is fairly supported around 1.6000. The AUDUSD crept higher to 1.0330 – it is now back below 1.0300 and recent price action suggests that investors are dipping their toe into the water before diving in and extending longs in the Aussie. As we mentioned yesterday, the Aussie is being driven by risk appetite and has diverged from rate expectations, so if there is a bout of risk aversion the Aussie might come back to earth with a bang.

Ahead today ADP private sector jobs will be the start of labour market March madness. The figure to beat is 208k.

Source: Forex.com

30.03.2011