After a week in which we had very strong performance in global and US equities, the big question this week will be how equities fare in the week after. Much of the positive sentiment came on the back of relief that Greece will not default in the short term, and that European leaders would release the next tranche of aid for the country.
With that huge risk factor out of the immediate path of traders – though some worries remain about the credit rating agencies still judging the ”voluntary” debt roll over as a selective default – the attention may now turn more to the fundamental picture.
The risk appetite trade will be front and center this week as we see if last week’s gains in equities are sustainable or if we experience a correction or pullback. Weaker fundamental data will give incentive to traders to take profit.
Will US Data Show Economy Exiting Soft Patch? How Does Market Respond to Another Month of Soft Job Growth?
In the US, the focus will be on whether we start to see some of the data showing improvement as the economy moves past some of the strongest headwinds that were aligned against it in the 2nd quarter. Traders will be looking for data to show better times ahead, that the soft patch was temporary.
Last Friday’s ISM manufacturing report gave us the first indication that that may be afoot as the index came in stronger than expected at 55.3, helping to lift expectations that the supply disruptions as a result of closed Japanese plants may have worked through the system.
Data this week will feature factory orders, the ISM non-manufacturing index, and our batch of employment reports including the ADP employment change on Thursday and Friday’s non-farm payroll data. The expectation is that the ISM services index eased slightly in June, falling to 54.0 from 54.6. A surprise reading here to the topside would undoubtedly help the theme of risk appetite, while a disappointing result can cast doubt on how quick the US can escape the 2Q malaise. The non-farm payroll report is expected to show the economy adding 87K jobs, a second straight month of soft job growth, which may have the effect of undercutting expectations around the economy – especially if we have a figure that disappoints to the downside.
Therefore we return to a more fundamental release driven trading this week compared to the more headline news driven trading we have had over the past few weeks.
EUR Should Be Supported by ECB Hike, But Greece Worries Still Loom in Background
If risk sentiment improves, that can help bolster the case of the EUR, which should be supported by the ECB hiking rates this week. We also have European ministers working on a second Greek bailout, which would guarantee funding for the country through 2014. While positive movement on this front can help the EUR, we started the week with jitters as S&P said that it would label the current bond-holder participation plan as a selective default.
Also on tap will be Germany’s factory orders and industrial production for May, two key readings on how the German manufacturing sector has coped with the Japan shortages. Factory orders are expected to show a 0.5% decline compared to a 2.8% increase in April, while industrial production is forecast to make up the 0.6% drop in April with a climb of 0.7% in May. Again, we are looking for positive data to help boost the risk appetite trade, while weaker data would benefit the risk-off trade and would argue for a correction of the recent equity gains.
Keeping an Eye on US Treasury Yields
For the US, another important factor is how US Treasury bond yields continue to react to the end of QE2. We have seen the 10-year yield reach 3.2% after a strong surge last week.
That creates some concern that bond markets have not responded well to the end of the easing program. For the USD one major worry is the continuing debate around the government federal debt ceiling. While some resolution is expected, tensions over the next few weeks can limit USD gains. Usually higher yields can attract foreign investment, but that is when yields are climbing on the back of expectations of economic growth and higher inflation, not as a result of yields climbing on a heightened risk premium. It will be important to monitor which way yields head this week just as it will be to monitor equities.
So it’s not a clear which way sentiment takes us this week, and it will be important to watch the various factors laid out above. If we do see a continuation of risk sentiment from last week, the EUR/USD would be poised to rally to the 1.47 area, however risk aversion can see the EUR/USD top off near its current levels and retrace some of the 450 pip rally we saw last week.
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