US Dollar May Gain as European Stocks Follow Asia Lower on Bernanke Speech

Key Overnight Developments

• Japan Unveils New Stimulus as Imports Decline, Merchant Sentiment Disappoints
• Australian Current Account Gap Widens as Exports Cool, Business Confidence Gains

Critical Levels



The Euro managed a modest rebound against the US Dollar but the bulls failed to build meaningful momentum and prices oscillated in a 40-pip range above 1.4830 for much of the overnight session. The British Pound slipped 0.4% against the greenback as markets reacted to a Wall Street Journal article expressing concern about economic recovery as the government is forced to raise taxes and trim spending to cut down the massive fiscal deficit. We remain short EURUSD at 1.4881 and short GBPUSD at 1.6648.

Asia Session Highlights



Japan’s Current Account surplus registered at 1397.6 billion yen in October, nearly doubling the outcome from a year earlier as the annual drop in imports (-37.7%) outstripped the decline in exports (-24.6%). The pace of decline in overseas sales has steadily moderated since hitting a record -50.5% in February as the world’s governments spent a combined total of close to $2 trillion on fiscal stimulus measures, helping to boost demand for Japanese cars and electronics. Meanwhile, continued weakness in the labor market has trimmed disposable incomes and discouraged spending, weighing on Japanese consumers’ purchases of foreign-made goods. However, the Yen’s recent gains may bring a change to this dynamic, discouraging demand from abroad while boosting domestic purchasing power of imported products.

Separately, the Eco Watchers survey showed that merchant sentiment unexpectedly tumbled in November, with a gauge of current conditions slipping to the lowest since March while the forward-looking Outlook component that forecasts developments in the coming two to three months declined to the lowest since February. In fact, expectations dropped 8.3 points, the biggest monthly loss on record.

Against this dire backdrop, Japan’s government moved ahead with a new stimulus package as competing interests in the ruling coalition reached agreement after haggling over the plan’s size delayed the announcement last week. Policymakers are planning to allocate a total of 7.2 trillion yen; 3.5 trillion will go to helping Japan’s regional economies, 600 billion will go towards boosting employment, and 800 billion will be targeted to various environmental initiatives. Government officials have previously said that the money for the plan will largely come from funds frozen and diverted from the previous government’s infrastructure initiatives, assuring markets that it will not boost Japan’s budget deficit (the largest as a percentage of GDP in the developed world) or boost borrowing costs through new bond issuance. Rumors of planned selling of some of Japan’s US Treasury holdings were also dismissed.

In Australia, the Current Account deficit widened to –A$16.2 billion in the third quarter from –A$13.1 billion in the three months to June to shave 1.8% off overall economic growth. Exports declined 6%, led by a 12% drop in overseas gold sales. Notable declines were also seen in rural goods (primarily grains), which fell 22%, as well as coal and metal ores, which declined 11% and 4% respectively. Imports rose 2%, led by purchases of foreign-made personal and industrial vehicles, machinery and food. The data suggests that consumption and investment continue to be boosted by stimulus spending (including A$20 billion in cash handouts to households and A$22 billion in various infrastructure projects) while foreign demand is drying up, invariably raising concerns about the ability of the seemingly resilient antipodean economy to remain supported after the flow of government cash dries up.

The National Australia Bank (NAB) offered a counter-balance to negative cues from the trade figures, reporting that Business Confidence rose to the highest level in over 7 years in November. NAB chief economist Alan Oster said the result was “remarkable”, adding that it puts “upside risks to [the bank’s] near-term interest rate outlook”. NAB expects the Reserve Bank of Australia will raise rates to 4.25% by March before pausing for about six months and then pushing them to 5.5% by late 2011. The bank also upgraded its 2010 economic growth forecast to 2.75% from 2.5%.

Euro Session: What to Expect



October’s Industrial Production figures headline the economic calendar in European hours, with the annual pace of decline in UK output expected to slow to -7.6% while that of Germany moderates to -10.2%. The story behind the figures is a familiar one, with manufacturing continuing to see a boost from worldwide stimulus efforts. To that effect, the data should not prove to be especially market-moving barring a wild deviation from expectations, especially on the downside. Indeed, the fiscally driven rebound from the worst of the global economic downturn has been amply priced into exchange rates at this point, so markets seem inherently more sensitive to disappointing rather than optimistic data outcomes.

On balance, risk trends are likely to remain in focus. Stocks slipped in Asian trading after US Fed Chairman Ben Bernanke said the world’s largest economy still faces “formidable headwinds”, opening the door for a similar outcome in Europe considering much of the region’s major economies owe a good deal of their rebound to exports. This could see a return to risk aversion, feeding near-term gains in the US Dollar and the Japanese Yen.

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