Playing for Tomorrow

The euro had firmed as European participants returned from a long holiday weekend.  However, the market lacked much enthusiasm and the euro ran out of steam ahead of yesterday's high near $1.3830 and has come back off toward session lows as London prepares to close. 

The short-term market appears to be preparing for tomorrow.   Three reports are slated for release that will likely provide fresh trading incentives.  Australia reports Q1 CPI.  A firm report, showing at least a 3% year-over-year rise is likely to see the risks increase of a rate hike.  Currently, the OIS has only about a 1 in 3 or a 1 in 4 chance of a rate hike.  

About a quarter of an hour after the Australian CPI data, HSBC will report its flash reading of China's manufacturing PMI.   It has been trending lower since last October and has been down each of the subsequent five months.    We suspect there is a good chance that Wednesday's report breaks the streak and that the Chinese economy is  stabilizing, albeit at lower levels.  

If this is true, the combination of the Australian CPI and China's flash PMI may spur another thrust above $0.9400.  It is breaking out of a wedge or pennant pattern today after holding the 20-day moving average (~$0.9320).   Previously, we have argued that the Australian dollar had carved out a head and shoulders bottom, which has a minimum measuring objective of around $0.9500.  This still seems to be a reasonable objective.  

The third data point is the flash euro area PMI.  We see risk that the composite reading softens for the second consecutive month.  After trending higher since Q4 2012, some consolidation at this juncture would not be surprising.  The manufacturing sector appears more vulnerable for a pullback in both Germany and France.  The strength of the euro can easily be blamed.   

Given the importance of the flash CPI reading at the next of next week for the May ECB meeting, we suspect that some of the late euro longs will look to square up, especially given the lack of upside momentum.  

Putting these three data points together suggests taking another look at the Euro-Aussie cross.  Recall a head and shoulder top pattern had been carved out between December last year and the middle of last month.  The neckline is near A$1.50.  The measuring objective is near A$1.42.  We had identified the A$ 1.4730 area as the first target, which is where it is currently trading.  It has been moving broadly sideways for the past few weeks, during which time it has traded as low as A$1.4655.  At this juncture, only a move above A$1.4830 would negate this call. 

That said, late tomorrow, or early Thursday in Wellington, the Reserve Bank of New Zealand is likely to hike its official cash rate by 25 bp to 3.0%.   It might be tempting to buy the Kiwi against the euro, but we are concerned that the market is too aggressively pricing in follow up rate hikes.  Instead, we see some risk of a less hawkish RBNZ, and this may weigh on the currency.