The Week Ahead: Risk Rally Getting Long in the Tooth?

Looking at the week ahead, we ponder the potential for this risk rally to finally face a consolidation. The Bank of Japan is on tap tonight and may have more to say than usual. US retail sales data is up tomorrow.

EU, Greece, and all that
While Greece has played “Deal or No Deal?” with the markets over the last week, we must remember that the threat here is for continued social destabilization in Greece and the prospect for Greek elections, possibly in the early April time frame. Please see our Chief Economist Steen Jakobsen’s piece on Greece and the Euro Zone. Meanwhile, the awkward EU/ECB framework has escaped any streamlining despite the recent fiscal compact and the open question is how the Euro Zone copes after the ECB’s next LTRO at the end of this month. And with French elections on tap for late April, we may be entering an awkward political limbo for a time until the victor of that contest is known. (It appears Hollande is the sure winner, but he has promised renegotiation of the fiscal compact that was agreed at the late January meeting.)

Markets this week
The risk rally is trying to slam back into full-speed ahead mode on the news of Greece finally agreeing to the bailout deal, but there are risks for the rally as it has gotten very long in the tooth. A couple of warning signs can be found in the likes of a divergent VIX (more pronounced than when we mentioned a similar development a couple of weeks back), very complacent sentiment readings, and light market volume. As well, economic surprise indices, like the one maintained by Citigroup, have yet to show signs of significant deterioration, something they nearly always do from the kinds of elevated levels we have seen in recent weeks.

Interest rates
Despite the strong rally in risk (which may in large part be driven by the perceived prospects for infinite quantitative easing...) the German Bund and US 10-year remain anchored to the 2.00 per cent yield area – can anything shake this market? The two interesting scenarios for bonds from here are further strong data that erodes the prospects for more QE or very weak data that tests whether the market will continue to pile into bonds as a safe haven.

FX
EUR/USD is trying to decide whether the squeeze to the 1.3300+ area was enough for now or if there is more ground to take back if . Have we lost sight of the degree to which the ECB has exploded its balance sheet and the next tests that await the Euro regardless of whether Greece revives or disappears into the Adriatic? Other big tests this week are in the JPY crosses as the MoF has been rattling its cage of late on its ability to intervene and with the BoJ up tonight. After a run down to the bottom of the range two weeks ago, last week saw the pair whipping back higher as interest rates rose. Intervention and the direction for long government yields are the two keys for the JPY this week.

AUD/USD tried above its long term resistance level at 1.0760 last week and will continue to correlate with risk appetite this week and beyond. Watch the Australian employment report Thursday. It is clear that the USD and JPY are the most sensitive currencies (correlated negatively) to further upside in risk appetite and the Aussie and Kiwi are the most. AUD/CAD and NZD/CAD are at interesting and excessive valuations and some traders may look at these pairs for steering clear of the US dollar in looking for a consolidation in risk appetite this week.

Commodities
Brent crude has rallied close to its highest levels expressed in pounds and Euros and is likely beginning to erode demand, something that might become increasingly evident as the bitter European cold eases further this week. Gold and silver may remain stuck in a range – interesting that last week’s announcement of a reduction in margin failed to spark a rally – and quite the opposite. The Q4 SEC filings for the GLD, the world’s largest physical gold ETF, will garner plenty of attention.

Economic calendar this week

Tuesday

* Bank of Japan meeting – considering the terrible Q4 GDP readings published on Monday, the BoJ may move to stimulate the economy further with additional QE measures. There is also considerable noise on the potential for the BoJ to become more explicit in its determination to beat deflation. Consider this Reuters article
* UK Jan. CPI/RPI – The Bank of England expects that these measures of inflation will fall sharply in the near term. A fall in energy prices would certainly help them do so even more quickly.
* Germany Feb. ZEW – a survey of expectations for economic growth. It bounced very strongly in January – but from near record lows. The bounce is expected to extend strongly for February
* US Jan. Advanced Retail Sales – the December numbers were very weak, could increasing gift certificate usage from the holiday season provide a pop or is the US consumer tapped out?

Wednesday

* New Zealand Jan. Non-resident bond holdings – considering the interest in in investing in New Zealand debt, the fall in this statistic to new lows since 2004 hardly makes sense – what are those capital flows buying in New Zealand?
* UK Bank of England Quarterly Inflation Report – has lost its import in recent years as a fall in inflation always seems around the corner. At least this time it appears to be finally happening.
* US Feb. Empire Manufacturing – the strength in the US manufacturing surveys in January rated a big surprise – let’s see if mean reversion sets in for February
* US Fed FOMC minutes of Jan 24-25 meeting – always searching for clues on what triggers QE3 or delays is, but we know that the Bernanke Fed is all about

Thursday

* Australia Jan. Employment Change and Unemployment rate – the market doesn’t seem particularly pre-occupied with the domestic economy in Australia as the Aussie trades on risk appetite and commodity moves, but at some point, domestic matters will matter and the employment report in December was terrible.
* Sweden Riksbank Interest Rate – looking for another cut to bring rate to 1.50% as EURSEK edges to its lowest levels in more than a decade. The idea that SEK is a potential safe haven hasn’t been tested by a serious sell-off in risk.
* US Jan. PPI – the core PPI ran up to its highest level since 2009 in December and the market seems to be betting that the Fed’s complacency on inflation is justified. The market is looking for a considerable drop to +2.7% YoY for Jan. from 3.0% in Dec.
* US Weekly Jobless Claims / US Feb. Philadelphia Fed Survey / US Housing Starts and Building Permits – these all looked good the last time around

Friday

* UK Jan. Retail Sales - expected weak.
* Canada Jan. CPI – the core CPI, unlike in the US, has been easing lower for a few months now
* US Jan. CPI – the core CPI in the US has risen to its highest level since late 2008 (currently 2.2% and expected at the same for Jan. data.) and the Fed must hope that it falls soon to retain credibility on inflation.