FUNDAMENTAL: The data deluge begins…

The markets are gearing up for a busy Wednesday, while Tuesday’s declines in global stock markets was mostly a technical move, for the rest of the week the fundamentals are in focus and things could start to get interesting.

Viva Espana

Spain has been the unlikely positive surprise during the last 24 hours. Firstly, an unexpected drop in the unemployment rate (still only 2.5k, but better than nothing, right) and secondly, a jump in the Spanish service sector PMI reading for last month back into positive territory at 51.5 from 49.7. However, Italy moved in the other direction, dropping from 50.5 to 47.2, the lowest level since May, France was also a weak link dropping to 48.0 last month from 48.8 in October. This throws into doubt the prospect of Italy and France exiting recession in the last quarter of this year and highlights the fact that the weakest economies in Europe are experiencing a non-linear recovery, where growth rates are erratic and the pace extremely slow.

Germany to the rescue

However, at least the currency bloc has Germany. The exporting powerhouse is doing pretty well domestically, with the service sector PMI rising to 55.7 from 54.5 in October, the highest level for 2.5 years. This (along with the Spanish effort) helped the overall Eurozone’s Nov service sector PMI to rise to 51.2 from 50.9 in Oct, suggesting that the Eurozone could still see growth in Q4, although there may well be vast regional divergences.

EURUSD had staged a mini recovery early in the European session, and was only mildly knocked off course by the disappointing Italian and French PMI data. It has also been bolstered by a break in EURGBP above 0.8300 after weaker UK service sector data, which has helped the EUR crosses generally. Looking ahead, the ADP report and US Non Manufacturing ISM could be the biggest driver of the dollar crosses on Wednesday as we look for signs of the labour market recovery gaining momentum ahead of Friday’s payrolls. While a December taper from the Fed seems like a long-shot, January is in view (the only hindrance could be the changing of the guard at the Federal Reserve), but one thing is for sure, although tapering is likely to be gradual, it may well be a one way street, which could be bad news for bond traders.

So where are the market opportunities this week?

We think there may be room for some downside in EURUSD if the ECB continues to be worried about 1, the sluggish recovery and the vast regional divergences in growth rates and 2, the prospect of Fed tapering putting upward pressure on European interest rates. During this year we have seen how the Treasury market is still king in global equities, and when Treasury yields move higher they can push up global yields, defying national domestic fundamentals. To stop the latter from happening, we may see the ECB reinforcing its dovish forward guidance at this week’s meeting, which could weigh on the EUR.

We mentioned yesterday that EURUSD had diverged from the German – US yield spread and its ability to hover close to 1.36 seemed to be defying gravity. Today’s PMI data misses for Italy and France have failed to take EUR off the boil, and instead we may need to see positive data out of the US to knock EURUSD off its perch. Key supports lie at 1.3525 – the low from Tuesday, then 1.3440 – 100-day sma.

UK data: the good run had to end sometime…

The pound has been heading south today as we lead up to the BOE meeting and the Chancellor’s Autumn statement (bad scheduling from someone at Treasury). The trouble for the pound bulls is that sterling could become a victim of its own success. The service sector PMI for Nov fell to 60.0 from 62.5 (still a strong number) but GBPUSD has dropped 30 pips on the news as the market prices in the prospect of the rocket-fuel boosting the UK economy starting to run dry.

Key supports for GBPUSD include 1.6320 – low from 29th Nov, then 1.6305 – 200-hr and 21-days smas, below here opens the way to 1.6260 – from 27th Nov. A GBPUSD decline could start to accelerate if the BOE starts to sound concerned about the pace of sterling appreciation, which may threaten the 2% inflation target; if this does occur either on Thursday or with the BOE meeting minutes later this month, then we could see GBPUSD come off the boil quickly. Added to that, the positive economic data surprises will have to come to an end at some point and data misses, even at high levels, could weigh heavily on sterling.