Citi's Take On What Yesterday's Market Action Means For FX, And What To Look For In Today's NFP

From Citi's Steven Englander

1) The euro was hit by three forces today:
        -- the Portuguese bailout was badly received from the get go
        -- the ECB was not 'strongly vigilant'
        -- ECB President Trichet's very strong endorsement of what was a very lukewarm Geithner/Bernanke restatement of the strong dollar policy
2) Risk correlated currencies were hit by:
        -- a sequence of extremely weak US and euro zone economic releases
        -- long-risk positions that have not been whittled down
        -- knock-on effects from even bigger moves in commodity prices
For the most part, investors did not seem panicked. Given how many risk pullbacks there have been this year followed by renewed risk buying, position cutting may be relatively limited. Bad news on payrolls could induce the volume moves to match the price moves. Through early this week CitiFX PAIN continued to show long positions pretty much across the board in risk-correlated currencies. No asset market is priced for a 0.5% downward revision to global GDP growth.
Some investors may be holding on, anticipating that reserve managers will come to the rescue, selling USD, buying EUR and the G10 smalls, and putting a floor under commodity prices. Reserve managers may have different incentives. They are much better off from 10% lower oil prices than from the diversification benefits of selling another couple of hundred million USD for reserves diversification. As long as they do not see each other selling USD they may choose to stand back, especially because their economic data has not turned down nearly as sharply as G10 has.
The string of bad economic releases is consistent enough and bad enough that a weak NFP number tomorrow is risk off and USD positive. The published range has a central tendency of about 155k to 225k. The most forecasts with a May 5 timestamp have marked down payrolls somewhat, but they still range around 175k, so there is reaction but not a panic economic downgrade. Citi is already at 160k. A number below 140k is weak, even taking into account recent information and would reinforce concern that economic slowing is for real.
In our overlay portfolio we have cut risk but not to the bone. Nevertheless, we are the least long risk we have been in many months. The short AUDCAD idea we put out yesterday is doing well (not as well as short risk outright but pretty respectable.) If there is a risk rout, the low liquidity European currencies are vulnerable as well. In the past we have seen that their positive long-term fundamentals do not generally outweigh positioning and liquidity, so they tend to underperform badly as well when risk is sold.
Net, net we remain concerned that investors are still positioned for a near-term bounce back in what might be a more fundamental pullback.


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