US Earnings Next Week Could Benefit Risk-Based Currencies 

Among the major market themes for the coming week will be the continuation of the US first-quarter earnings season. Currently, the market consensus continues to point to a slowdown in earnings growth or even a drop in net income for some firms. Indeed, earnings have already recovered at a very rapid clip since the financial crisis, suggesting reduced scope for additional growth.

Chart generated by author using data from Bloomberg

The more modest consensus estimates, however, open the possibility for some positive surprises. This could help lift risk appetite in the forex markets, which had been shaken over past weeks by disappointments on the macroeconomic data front.

The key highlights for next week will be earnings from the major TARP recipient banks – with Citigroup reporting on Monday, Goldman Sachs on Tuesday, Bank of America and Morgan Stanley on Thursday. Several of these banks could follow in the footsteps of JP Morgan and Wells Fargo, which both beat estimates on Friday amid a more benign environment for the financial sector. With improved sentiment in the capital markets during the first quarter, higher trading volumes, and a mortgage market benefiting from near all-time interest rates, the banks could report robust results.

Healthy reports from these banks could inject renewed confidence in the US economy, which had suffered from a weak March non-farm payrolls report and an uptick in new jobless claims this week. By fueling bullish sentiment during the week, the earnings could spark short-term rallies in the higher-yielding, risk-correlated currencies. Robust bank earnings on the back of strong lending activity, however, could also imply broad credit availability, weakening the case for a QE3. At a time when the Fed has been sending mixed signals about prospects for further easing, dampened expectations for more loosening could also be supportive of the US Dollar.

Aside from the TARP banks, we will see earnings from several bellwethers of global economic activity, business investment, and consumer sentiment. These include Johnson and Johnson on the consumer side, industrial giants GE and Ingersoll-Rand, and technology flagships Intel, IBM, and Microsoft. As with much of the US corporate landscape, earnings estimates for several of these firms have been pegged at more modest levels; as a result, there is scope for upside surprise. Should several of these earnings truly exceed expectations, markets could react as they did following Alcoa’s surprise profit - a pickup in risk appetite. Following disappointing Chinese GDP figures on Friday, a recovery in sentiment could bring about a meaningful temporary rebound in the higher-yielding currency pairs. Traders should remain alert, however, to developments surrounding the Eurozone and China, which may cut short any earnings-related bounce.