In the upcoming week the US calendar is nearly barren with only Existing Homes on the docket. Monday is a holiday and Friday’s slate is empty so event risk will not be primary driver of trade next week. Instead, the familiar forces of risk aversion and central bank speak will likely dominate the flow. If equities continue to decline, expect the greenback to strengthen further unless policy makers hint at an unsually large 75bp rate cut.
Dollar Done Dropping?
What a whipsaw week. On a closing basis the greenback only gained 100 points on the euro, but the placid end results hid a tremendous amount of turbulence in between as markets did not know which way to go. As we noted in our daily, “With little clarity on the economic front as traders wait to see if the predictions of US recession come true, the currency markets have become particularly volatile turning on a single word from monetary officials.” Ben Bernanke testimony in front of Congress proved less than impressive and President Bush’s stimulus package was received with little enthusiasm by the markets as the Dow continued to drop like a rock losing nearly 500 points for the week.
Ironically enough the fall in the equity indices was one of the key drivers of dollar strength. As stocks faltered, carry was unwound pushing EURJPY well below the critical 160.00 level and taking EURUSD down with it in the process. On the economic front, US data was mostly horrid with Retail Sales, Building Permits and Philly Fed all falling off the cliff. On the bright side, TICS came in much better than forecast suggesting that at least for the time being capital flows will not be a problem. Finally the U of M survey surprised to the upside climbing back from its depths in the 70’ s back to the 80 level. Overall the news suggests that while 50bp cut is a strong possibility, any talk of a “panic” 75bp cut must be put to rest as the Fed tries to reserve its ammunition.
In the upcoming week the US calendar is nearly barren with only Existing Homes on the docket. Monday is a holiday and Friday’s slate is empty so event risk will not be primary driver of trade next week. Instead the familiar forces of risk aversion and central bank speak will likely dominate the flow. If equities continue to decline, expect the greenback to strengthen further unless policy makers hint at an unsually large 75bp rate cut.
Visit our recently updated EUR/USD Currency Room for more resources dedicated to the US Dollar. – BS
Euro – Who Says What?
Yves Mersch is hardly the most powerful man on the ECB council, but last week the Luxemburg finance minister triggered an avalanche of sell orders when he suggested that worries about price pressures in the Euro-zone may have been overblown. In sharp contrast to ECB chief Jean Claude Trichet Mr. Mersch stated that “We have certainly downside risks to economic activity and are not unaware of mitigation to price developments.” This seemingly offhand comment dropped the euro for 200 points as traders feared that the ECB changed posture and was now on the verge of entertaining a rate cut. Mr. Mersch then quickly reversed himself the next day sending the EURUSD promptly higher. When the dust settled, the unit was marginally lower on the week after generating some of the biggest volatility in months.
On Friday we concluded that, “Traders are still trying to come to grips with contradictory signals from ECB member Yves Mersch who appeared to be dovish one day and hawkish the next. Neutrality remains the most likely policy path for the ECB and that fact has taken quite a lot of momentum out of the euro rally. The pair has also suffered from fresh bouts of risk aversion as EURJPY rests well below the 160 level. Nevertheless, if US rates continue to decline euro’s long term trend remains to be up.”
Next week the Eurozone calendar will be quiet as well, but two key reports may have some impact. On Thursday, the IFO survey is due and while analysts expect a slightly lower read, if the drop is more severe than forecast, talk of easing may resume especially if the consumer sentiment survey on Friday shows further deterioration. At this point it is abundantly clear that the ECB will not tighten and any further gains in the euro will come only from additional US easing.
Visit our recently updated EUR/USD Currency Room for more resources dedicated to the Euro. – BS
Japanese Yen Remains Supported by Risk Aversion
The Japanese Yen gained across the majors last week as the markets were in agreement about one thing: risky assets were not the place to be. Indeed, global equities tumbled as the S&P 500 plunged 5.4 percent - marking its worst weekly loss since July 2002 – while the MSCI Asia Pacific Index dropped for the third consecutive week by 3.2 percent. US recession fears are high on the list of concerns for traders in not only global equities, but in the forex markets as well. With the instability in the financial sector and tight credit conditions remaining a major issue, it appears that there remains major downside potential for all things risk and “carry” related, meaning that the Japanese Yen could be in for additional gains. Looking at last week’s economic data, the national currency hardly acknowledged any of the releases, as consumer confidence hit a four-year low in December, according to the Cabinet Office’s most recent survey, amidst soaring inflation expectations and tepid wage growth. While the Bank of Japan has long been saying that prices are not in deflation and would rise as a result of building consumer demand, mild increases in various inflation indexes have purely been the result of energy and food costs, much to the disappointment of the central bank.
While the Japanese financial markets have not been roiled to the degree the US, UK, and European markets have in the midst of a credit crunch, they are not entirely in the clear either. Indeed, given the noted economic conditions, Japan has become ever more reliant on capital spending and exports. However, both of these areas have proven to be soft spots as of late, and with global growth expected to slow in 2008, there is little evidence to suggest they will improve significantly. This week's Bank of Japan policy meeting and monthly report may highlight this, as the bank is expected to leave rates steady at an ultra-low 0.50 percent and will have little to be optimistic about in subsequent commentary. Nevertheless, risk aversion trends and the status of the US Dollar will be the main driver of USDJPY, and as Technical Strategist Jamie Saettele pointed out in Friday's Daily Technical Report, the pair may return to 106 once again.
Do you follow the USD/JPY daily? Visit the Japanese Yen Currency Room for resources dedicated specifically to the Yen. – TB
Has Cable Found Support? BOE Minutes and Q4 GDP May Decide.
The British Pound struggled to hold above support at 1.9500/50 last week amidst mixed economic data out of the UK. First, the bullish news: UK labor markets tightened further in December, as jobless claims dropped a greater-than-expected 6,400, helping to keep the jobless rate at the 1975 low of 2.5 percent. Meanwhile, CPI was slightly stronger than expected, as the index rose 0.6 percent during the month of December, which left the annual rate above the Bank of England's 2.0 percent target at 2.1 percent. Unsurprisingly, food and transport (which includes gasoline) buoyed the headline figure, as commodity prices have rocketed in recent months. Commentary from BOE Deputy Governor John Gieve suggested that these inflation pressures would leave monetary policy more neutral, as CPI will likely remain “well above target in the coming months at a time when short-term inflation expectations remain uncomfortably high.” However, Gieve also noted that “growth is slowing quite sharply now, in part because of the rises in interest rates last year,” and the December consumer spending figures highlighted this insight. In fact, UK retail sales unexpectedly fell 0.4 percent during the month of November, pulling the annual rate down to a more than one year low of 2.7 percent, as the BOE’s December rate cut did little to stimulate spending during the holiday shopping season. With economic conditions only anticipated to deteriorate further in 2008, consumption is not likely to recover much in the near-term. However, such slowdowns are expected by the BOE, and with upside inflation risks uncomfortably high for many central bankers, the monetary policy committee will likely leave rates unchanged in February.
While the Cable trend is clearly to the downside, there are signs that GBP/USD may have bottomed for the near-term, though a drop below 1.95 would target the March 2007 lows of 1.9186. Such a move may depend more upon whether the markets ramp up their bets that the BOE will opt to cut rates in February, and Wednesday’s economic data will provide ample opportunities to judge these probabilities, as the minutes from the January BOE MPC meeting and Q4 GDP figures will hit the wires. Economic expansion is anticipated to have slowed to 2.8 percent, but if the minutes of the January policy meeting indicate that the central bank has no desire to cut rates again in the near-term, Cable will likely surge higher. On the other hand, the combination of dovish minutes along with tepid GDP figures could weigh Cable down below 1.95.
Has the British Pound found a bottom or are more declines in store? Discuss the topic in the DailyFX GBP/USD Forum. – TB
Risk Premium Boosts The Swiss Franc’s Appeal
Like the Japanese yen, the Swiss Franc was meeting resistance in its advance against the US dollar. A sharp drop in USDCHF at the beginning of the trading week pushed the pair below to a new generational low – overtaking the 1.0883 intraday low printed back on November 23rd. However, though the Swiss would mark a new record low, a less granular look at the USDCHF chart shows a chart formation that looks more like a double bottom around 1.09 rather than a developing break. So, why was the Swissie unable to confirm a breakout against its US counterpart? Scheduled event risk may have a little to do with it. The only economic indicator on the docket last week was the ZEW investor confidence survey for the month of January. And, like its Euro-Zone counterpart, the sentiment gauge marked yet a deeper advance into pessimism. The reading reported a net 32.7 percent of respondents that were pessimistic on the investment environment as prime export markets the US economy threatens recession and the EZ starts to follow its lead.
On the other hand, while this event risk likely had an impact on currency traders’ longer-term outlook on Swiss growth, the dour sentiment didn’t really match up with price action – meaning there were greater influences at work. Looking for the true fundamental guide to price action for the weak, we once again come to the carry trade appeal of the Swissie. General risk trends were in flux over the period as a number of major bank’s earnings announcements threatened the health of the global equities market and worsened credit market losses. Fears started off with a bang on Tuesday when Citigroup – the world’s largest bank – reported its worst loss in its long history and an $18.1 write down. The pressure on the carry held up for the following two days when JP Morgan announced a 34% drop in profit and $1.8 billion write down while Merrill Lynch reported a $9.8 billion quarterly loss and $11.5 billion write off.
In the week ahead, the garden-variety economic event risk may have a greater influence on price action. Clearing the ticker on Monday morning, the upstream producer and import inflation index data for December will measure how confident Swiss firms are in passing on rising raw material costs onto consumers – and in turning boosting front-line inflation pressures. On the following day, the retail sales report will make a real go at the franc. An expected 4.0 percent increase in spending in the year through December would mark an improvement for the holiday, but is hardly a standout performance considering the indicator’s volatility. More than likely, the currency will once again find its direction from risk trends. Though many of the biggest bank earnings reports have been released, any additional sign that the largest international corporations in other sectors are faltering will raise a red flag for the health of the global economy. - JK
Canadian Dollar Loses Further on Dour Economic Outlook
The Canadian dollar fell against the US dollar for the third consecutive week of currency trading, as a broader Greenback recovery combined with disappointing Canadian economic data to send the USDCAD to fresh four-month highs. The previously high-flying Loonie seems incapable of catching a break, as more recent developments have placed serious doubt on the future of the currency’s performance against its US namesake. Following last week’s disappointing Employment report, markets have now priced in a near-certainty of further Bank of Canada interest rate cuts through the months ahead. Indeed, a Bloomberg News survey shows that 18 of 18 analysts polled believe that the BoC will cut interest rates by 25 basis points at their January 22 announcement date. Such a bearish outlook for domestic yields places the Loonie in the same boat as the seemingly hopeless US dollar, and markets have allowed the downtrodden Greenback to outperform the relatively overbought Canadian dollar. Judging by concrete interest rate expectations, a Bank of Canada 25bp rate cut would still leave the Loonie at a yield advantage to the USD following a near-certain 50bp move by the US federal Reserve. Yet traders seem unwilling to buy the Canadian dollar on expectations that a US economic slowdown may cause a similar pullback in Canadian expansion. Given that the US accounts for 75 percent for all Canadian exports, it is certainly reasonable to believe that the Loonie stands to lose further ground on economic difficulties in the world’s largest economy. Such bearish factors may continue to place upward pressure on the USDCAD through the medium term, but the short-term outlook will very much depend on the upcoming week of critical Canadian economic event risk.
The pending Bank of Canada Rate Decision, Retail Sales report, and Consumer Price Index data are all virtually guaranteed to force noteworthy Canadian dollar volatility. Traders will likely focus attention on the rate decision on Tuesday morning, as markets want to hear exactly what to expect for domestic interest rates through the new year. Current consensus forecasts clearly call for the central bank to lower interest rates to 4.00 percent, and any surprises would almost certainly elicit strong reactions from currency trading markets. Yet the likely highlight will be the attached statement. A key question will be whether or not outgoing BoC Governor David Dodge will signal further rate cuts in the year ahead, and perhaps more importantly, whether incoming Governor Mark Carney will follow in Dodge’s footsteps. Given that he currently serves as an advisor to David Dodge, however, it stands to reason that the two men will have much the same stance on monetary policy. Thus markets will likely react to any surprising rhetoric from Dodge and the Canadian Dollar will trade accordingly. Otherwise, markets will watch for any noteworthy results in earlier-morning Retail Sales data as well as the Consumer Price Index report due the 25th. – DR
RBA Hints at Further Rate Hikes and Australian Dollar Rallies
A sharp selloff in the Dow Jones Industrial Average and other major risky assets forced the largest Australian dollar weekly decline in over a month, but the currency nonetheless showed signs of promise on bullish outlook for domestic interest rates. Strong economic data continued to make a case for more Reserve Bank of Australia interest rate hikes through 2008; a midweek unemployment report showed that the national jobless rate dropped to 4.3 percent. Unemployment now rests near 30-year lows and further labor market constriction would only embolden the RBA to continue monetary policy tightening despite financial market duress. In an address to Australian Business, RBA Governor Glenn Stevens made it clear that the domestic economy has thus far stood firm in the face of credit market tightness and the threat of slowing growth in major global economies. As such, Stevens feels that it is key to watch the potential risk that persistently high commodity prices will derail inflation expectations despite a slowdown in economic growth. His prepared speech highlighted the potential for a global economic slowdown and detrimental effects for the Aussie economy, but it is key to note that the nascent pullback in global growth has yet to have an impact on Aussie expansion due to robust demand from major emerging market economies. Given his hawkish rhetoric, it seems almost certain that we will see higher Australian interest rates in the year ahead—leaving the AUD with an important source of support against major forex counterparts.
Whether or not the Aussie can recover from recent losses will largely depend on the performance of risky asset classes in the week ahead. The S&P Australian Stock Exchange index fell for the 10th consecutive trading day through Friday—its worst losing streak in history. US stock market routs have spread to other major financial markets, and few risky assets have remain unscathed in the recent sell-off. Such market price action typically forces strong decline in high-yielding currencies—leaving the Australian and New Zealand dollars particularly susceptible to major losses. It remains of utmost importance to watch the relative performance of the US Dow Jones Industrial Average and the Japanese Nikkei 225. Indeed, stock market price action may potentially overshadow key economic event risk in the week ahead.
Markets will likewise watch the results of Producer Price Index and consumer Price index reports on the 20th and 21st, respectively, as any surprises could easily derail expectations for RBA interest rate hikes through 2008. Current forecasts of a robust 3.4 percent core CPI inflation rate would certainly bolster the case for higher Aussie yields, but any disappointments could just as easily remove a key pillar of support for the domestic currency. - DR
New Zealand Dollar’s Channel May Be Challenged By The RBNZ
The New Zealand dollar had a very active week. Seizing control of the kiwi’s wheel, a wave of risk aversion infected the high-yield currency and virtually crowded out the fundamental influence of a slew of top market moving economic indicators. The flight from risk over the period clearly visible through corrections in many of the assets traditionally associated with volatility. Global equities sold off, credit spreads widened, default swap premiums rose, government bond yields sank, gold prices corrected from their all time highs and the carry trade was broadly sold. However, the top shelve indicators hitting the wires over the same period did not go unnoticed; and they will almost certainly have a big impact on RBNZ Governor Alan Bollard’s monetary policy decision next week – especially considering the figures covered the full gamut of the central bank’s list of economic concerns.
After the policy authority announced his fourth consecutive rate hike to a record 8.25 percent last July, he made it blatantly clear that he would not change his hawkish stance on policy until inflation, consumer spending and housing market activity cooled. The housing market clearly responded to the high interest rates as one price gauge fell to a 10-month low, another a seven year low and building permits dropped for a third consecutive month. Consumer spending was a mixed bag. Though retail sales rose 2.0 percent – the most in nine-months – the increase was predominately the reflection of higher gasoline prices and not discretionary purchases. And, even the fourth quarter consumer inflation report came with a few caveats. Though the annual pace of price pressures accelerated to an 18-month high, Bollard himself forecasted as much and this indicator was too a reflection of higher gasoline prices and food costs.
Looking out at the event risk ahead of the kiwi, only Wednesday will hold any fundamental sway over currency traders. A business PMI report for December will give a modest push with a significant surprise, but after the NZIER’s fourth quarter sentiment report form last week, this data will seem redundant and deflated. Without doubt, though, the RBNZ rate decision holds considerable potential. Governor Bollard has seen a cooling in housing; but consumer spending has not proven definitely that it has eased, and inflation is still above his mandated target zone. There is no forecast for any change to the benchmark lending rate; but if there is risk, it is for a tightening. We will watch this scheduled event risk and monitor risk sentiment through the week to see if there is any sudden fundamental push in NZDUSD that can force a break of the pairs mature, rising trend channel. To see this formation, and learn how to trade it under calmer market conditions, check out the Pairs To Range Trade report on DailyFX. – JK