Alcoa kicks off US earnings season

Earnings season started last week in the US and, as always, Alcoa was the first to announce. Fourth-quarter earnings results from the aluminium giant were weaker than analysts estimated. The company reported a loss of $277m in the last quarter of 2009, bringing its total loss for the year to $1.15bn, Alcoa's worst result since 1992.

Alcoa's share price fell over 10% on Tuesday on the news, but its impact on the market was fairly muted. It is a component of the most famous index in the world, the Dow Jones Industrial Average, but it is the lowest weighted stock of the 30 that make up the index.

Much of the other news in the markets last week could have been perceived as rather negative for equities, but the price movement argued to the contrary.

Early in the week the Chinese central bank announced it would be tightening the reserve requirement ratio for banks, increasing the proportion that banks would have to set aside by 0.5%. Reducing the banks' leverage in this way is a sign that the Chinese central bank is worried about inflation and that it believes the economy is coming out of the danger zone it was in last year.

The Chinese benchmark index, the Shanghai Composite, traded choppily all week, with moves greater than 3% in both directions, but made no real net headway. As such, it could be concluded that there is a relatively even divide of opinion on the effects that this will have on the market.

Some argue that this is a positive signal from the bank, a sign that economic stability has been achieved, and that high GDP growth rates will be the norm again. Others contend that the recovery is still far too fragile for monetary tightening. This camp argues that deflation is still the principal risk and a tightening of monetary policy will damage the recovery, causing equity prices to tumble.

On Thursday, the ECB announced its latest interest rate decision and, as expected, made no changes. The ECB has arguably a much more complicated task in setting interest rates than its counterpart in the UK. The ECB's main policy lever, short-term interest rates, is applied across all economies in the eurozone. In the 'naughties', rates were kept low due to economic difficulties in Germany; however this greatly assisted the inflation of the Irish bubble.

Countries such as Greece, Portugal, Spain and Ireland are today staring down the barrel of the ECB's gun. A premature rate rise from the ECB could kill or seriously injure the economic prospects of these nations. This is why there is a strong likelihood that the ECB will be slower to tighten rates than the UK.

EUR/GBP decline begins

With the equity markets continuing to meander and the commodities markets remaining extremely volatile, we turn our attention to the currency markets for a good trading opportunity.

EUR/GBP has been in a steady downtrend since the start of October and its last "peak" at £0.905 at the end of December acted as good resistance at the start of the year. This resistance has helped the currency pair to fall to £0.8915 at the time of writing. The technical picture resembles that of a "descending triangle", with a pattern of lower "peaks" and solid support line on the downside.

For the technical trade to work, the support line between £.8930 and £0.8950 needs to be broken. We feel this line will be tested in the next few days, so positioning a short on EUR/GBP now offers good risk/reward as a breakout of the support line could lead to a sharp move lower. Trailing your stop loss behind the price would also be sensible if the market holds firm at the support level.

Sterling has had some positive economic news with industrial production coming in higher than forecast. This raised expectations that the UK will come out of recession in Q4. Andrew Sentance of the Bank of England's monetary policy committee also made some "hawkish" comments last week, suggesting the Central Bank shouldn't extend its quantitative easing programme any further. This lifted expectations of a rate hike this year, boosting sterling.

The ECB kept interest rates at 1% as expected. Even though there were no startling statements from ECB president Jean-Claude Trichet after the announcement the euro did weaken somewhat.

Last week Germany reported that recovery in the eurozone's biggest economy had stalled in the final quarter of 2009. There was also data showing that troubles in Spain and Greece are still prevalent. This makes it all the tougher for the ECB to raise interest rates any time soon.

This convergence of both technical and fundamental reasoning indicates a trading opportunity. However, care must be taken to manage risk as the currency markets are still extremely volatile.

Paddy Haran and Vinay Sharma, Delta Index