Casey Zak's Mighty Blog

1.  AUD Cash Rate Monday 10:30pm: Negative for AUDUSD.  A rate cut seems likely here.  Talk out of the RBA has been much more dovish than usual in the past few weeks, and the rate statement should be very dovish as well.  This call will be revoked if AUDUSD runs down well before the meeting in anticipation.

2. CAD Overnight Rate Wednesday 9:00am: Negative for USDCAD.  The loonie has weakened sharply in recent weeks due to negative economic reports.  I think an interest rate cut is almost worked into the rate at this point, but I don’t think it will be forthcoming.  Carney believes that keeping the rate at 1% constitutes “holding rates low”.  The rate has also been at that level for more than two years.  A change on Wednesday is unlikely.  The accompanying rate statement should be heavy with talk of the sequester and “risks to global growth”.  But such worries are already in circulation.

3.  BOJ Conference Wednesday PM / Thursday AM: Negative for USDJPY.  Yen weakness has been almost entirely engineered by new promises of easing.  This conference will contain no such new promises.  Further, it is Shirakawa’s last conference before Kuroda is ushered in.  Shirakawa is a hawk compared to Kuroda, and he may sound some cautionary notes for his successor.

4.  ECB Press Conference Thursday 8:30am: EUR negative.  As I’ve noted recently, there is a widespread mistaken belief that the OMT program provides unlimited and unconditional support for sovreign bond buying.  This is not true, and Draghi is likely to make this abundantly clear after the Italian elections.  This may be another, “OMG, really?” moment for markets, as they come to understand something they should have figured out long ago.  Further, anything else likely to come out of the ECB here — our economies are in the tank, inflationary risk is down, etc — is likely to press the Euro down.

5.  Japan Current Account Thursday 6:50pm: Positive for USDJPY.  This pair just always seems to rally after the current account.  A positive reading is expected, which would signal that easing is beginning to take root (Nikkei goes up, USDJPY goes up).

6.  Dollar positive all week.  The dollar has been weakened for years by QE, and it finally looks like an end to QE is near.  Combined with fiscal tightening in Washington, this should work to push up the dollar for several months to come.

After completely missing the immediate impact of the Italian election, many big bank analysts seem determined to sugar over its long term impacts as well.

Paul Richards at UBS said that the extreme moves following the elections were:

A good reminder to the market about how complacent we took the Italian elections – myself included.

Apparently complacency is an official policy at UBS.  Richards confidently notes that:

you still get Draghi’s backstop – the OMT program.

That is just flat out wrong.  OMT is linked to austerity through an official policy called “conditionality”.  If the new Italian government rejects austerity policies (as it seems likely to do), then a preliminary condition for OMT is violated.

I’ll put it another way: the single most important financial impact of the Italian elections was to put the OMT guarantee in jeopardy.

If UBS is out to lunch, the other big banks seem to be having a full on Euro bacchanal.  A quick roundup:

Italy’s Situation Barely Even A Mini Crisis But Where Does This Leave The Euro -  JP Morgan

Risk Reward Favors Long Euro Here; Possible Grand Coalition In Italy A Positive Catalyst – Barclays

Converging Parallels: What’s Next For Italy – Credit Agricole

All three analysts seem convinced that Italy’s elections mean next to nothing, that an effective ruling coalition will self-assemble in short order, and that the outcome of these events will be Euro positive.  This is like leaving the dog and cat alone in the house and assuming they will cooperate to the benefit of the furniture.

These accounts are also in conflict with, well, the news.  If these idiots read the news, they might have heard Bersani say this:

I want to spell it out clearly: the idea of a grand coalition does not exist and will never exist.

So the forseeable future looks to feature no effective government and total political gridlock in Italy.  It is possible the Euro could gain for other reasons next week, but I would not expect Italian news to be anything but Euro negative.

Negative report, CAD weakens, positive for USDCAD: MISS

Friday’s Canadian GDP report came in negative just as expected, at -0.2%.  The USDCAD rapidly dropped 25 pips.  The problem with this call was that the negative report was already “baked into the cake”, as there was a 100+ pip rally  in USDCAD in the prior 24 hours.  Part of this seemed to be anticipation of the weak report, and part was due to a broader rally in the dollar.  With such a leading rally to set up this event, I would simply have withdrawn any prediction for how the rate would react.  As this blog develops, updating predictions like this will be a more regular practice.

Below are charts showing the response.  First is a chart focused on the 8:30am announcement, then a chart showing the leading rally.

Bernanke should reiterate his own dovish policy intentions, pushing a bid under US equity markets and a sell on the dollar: MISS

I was more or less right on the content of Bernanke’s testimony, but absolutely wrong on the reaction.  It seemed like there was so much negative sentiment after the Italian elections that traders just pounced on any excuse to push risk assets down.  US markets slid only a little, but AUDJPY slid about 130 pips while Bernanke spoke.  Most of this was from an appreciating Yen, following on the radical move of the previous day.  Most of the move quickly reversed, but still — this one was wrong.

Italian Elections press Euro down to begin week: HIT

Heavens what a slaughter.  The Euro ran up a bit today (Feb 25) as markets thought maybe the Italian elections would work out after all for Bersani.  Then the exit polls came out showing total gridlock and the need for new elections.  Yikes.

The Euro plunged from $1.33 to $1.305 in a few hours.  Worse still, the Yen plummeted from a Sunday peak around 94.25 to as low as 90.85, the biggest drop I’ve seen in a very long time.  Add this up and the Euro/Yen went from 125.25 to below 119 at one point, roughly a 5% drop.  That is a crisis level reaction.

Carnage in chart form below.  EURUSD first, then EURJPY:

5. USDJPY jumps after new BOJ governor named during week — HIT

Okay, I was wrong on the guy, but I had the right idea.  Iwata was named deputy governor, and Kuroda becomes the next governor.  But boy was I right about the impact.  USDJPY jumped by about 100 pips and traded around 94.25 just after the open in Japan.  My basic logic here is that this appointment had been delayed, which suggested a radical appointment coming from Abe.  Rumors were it would be Iwata, but Kuroda is still a radical appointment.

Unfortunately this was not really a tradeable “prediction” for most people as the news came out before Sunday open.  Interestingly, the gains have largely faded since the appointment, which starts to make the Yen look more attractive (to short, that is).  I’d wait until the Italy news is digested before jumping in, though.

1.  AUDUSD bump from HSBC PMI data release:  MISS

The HSBC PMI number came in at 50.4, lower than the previous 52.3 or the expected 52.2.  I’ll admit that this was purely a momentum-based guess that went sour (China had been picking up steam for a few months).  Here you can see the consequences: a drop of about 40 pips in a minute.  Some of that could have been avoided by a well placed stop, but still an ugly call.

It’s worth noting the subsequent 20 pip recovery up until midnight, though.  I have noticed over time that not only does AUDUSD move more sharply with Chinese PMI data than with any other currency, but the movement also tends to reverse substantially from its extreme point reached shortly after the event.  The rest of the uptrend after midnight is piggybacking off a sharp up move in the Euro (more on that later).

For the week of Feb 25 — Mar 1, there are 5 major events where I’d feel comfortable calling the direction of subsequent price action.

1.  HSBC China Flash PMI Sunday 8:45pm: Should be positive.  Look for a good upward spike in AUDUSD, although temporary and probably within an overall downtrend.  The release of the official figure on Thursday at 8:00pm should provoke a similar response.

2.  Italian Elections Sun/Mon:  Should press the Euro down to begin the week.

3.  Bernanke testimony 10am Tuesday:  Bernanke should reiterate his own dovish policy intentions, pushing a bid under US equity markets and a sell on the dollar.  I’d actually play this as long AUDJPY.  The Aussie should strengthen and Yen weaken with a US equity rally.  There will also likely be some questions about currency wars and the weakening Yen, which Bernanke should mollify by saying, “All nations should be free to pursue appropriate monetary policy” or something like that.

4.  Canadian GDP Friday 8:30am:  Negative report, CAD weakens, positive for USDCAD.

5.  Japan selects new JCB Chairman: Timing unknown.  This has been delayed for some time.  I think Abe wants Iwata.  If that comes out, it should trigger a big runup in USDJPY as the Yen weakens further.

The Euro is now in deep oversold territory, having dropped about 5 cents against the dollar in the last 3 weeks.  Nonetheless, the price action during this downtrend does not seem to have factored in much political risk from Italy.  If we decompose the downtrend into responses to major news events, the entire downtrend can be explained by four main events: the simultaneous rise of Berlusconi and scandal of Rajoy breaking on Feb 4, Draghi’s comments on Feb 7, a negative GDP surprise on Feb 14, and the FOMC minutes on Feb 20.

Only the first event on Feb 4 was related to Italian politics, and that relation is ambiguous.  Rajoy’s bribery scandal broke the same day, and the Euro was also long overdue for a technical pullback.  Even if this were purely a response to Italian politics, much of the drop was recovered the following day.

The remaining 3 events — Draghi’s comments on Feb 7, EUR GDP misses on Feb 14, and the FOMC minutes on Feb 20 — were all powerful fundamental events that can move markets on their own.  Their impact was not confused by other simultaneous data releases of comparable magnitude.   And they all had nothing to do with Italian elections.

Given that the Feb 4 Italian downturn in the Euro is conflated with other forces, and the remainder of the recent downturn can be explained away by other suitably major macro events, the Euro does not appear to have priced in a significant risk of political gridlock in Italy.  In sum, of the 5 cents drop in EURUSD over the last 3 weeks, nearly all of it was in response to events other than the Italian elections.  These elections are likely to be very bad for Italy, in all probability leading to political gridlock.  Here’s a nice article by Nicholas Spiro which makes the point at some further length.

My expectation is that markets will finally take this seriously on Monday, and could well push the Euro down towards $1.30.  Election results should start trickling out around 10:30am Monday, and outcomes should be known by mid-afternoon.