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AUD/USD has hit a significant resistance level at .8660 and NZD/USD has hit resistance into the same fractal. We see upside on risk as limited from current highs. Although we could see higher levels, we see current levels and higher as opportunities to sell.
Even as US equities closed 3% higher, long-term oriented investors appear to be steering clear of equities, particularly with the risk of further rising risk aversion with the approaching earnings season. Q2 earnings could disappoint lofty investor expectations and keep risk-seeking at bay, which could dampen the recent support for the euro. UBS FX flow data also suggests that structural outflows from the Eurozone continue and we hold the view that euro rallies should be sold, particularly versus the dollar and the yen. Looking at 1.2700- 1.3000 area for selling depending on how technicals unfold.
Earnings across several sectors may not satisfy elevated earnings expectations. UBS equity strategy team have noted that, "While corporate earnings will likely continue to be robust through the year, we believe consensus expectations are lofty and could lead to earnings downgrades, reversing a trend that has been a key tailwind for markets in recent quarters." And more importantly, the corporate business outlooks may not satisfy investors' expectations. As an example, a major Asian technology company reported improved Q2 but the outlook for the second half of the year was more muted. This pattern may repeat itself in the US, which could cast some doubts on the sustainability of any potential stabilization in risk ahead of the start of the season.
When we look at FX flows, the trend of structural outflows from the Eurozone appears to be fully intact. The latest upswing in EURUSD was largely driven by speculative flows and without long-term oriented flows returning, any further upside in the single currency will likely remain limited, especially should the risk environment remain muted. And the divergence between structural and speculative flows remain indicative for upside movements to be corrective.. Altogether we therefore expect upside in the EUR to be strongly limited. Risk sentiment will likely remain unstable, and any stabilization in risk ahead of the earnings season short-lived. We also think the optimism for European bank stress test results will also dissipate quickly, which will put further pressure on the euro.
Source: UBS, Chris Lori, Bloomberg
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