US Dollar Teetering on the Edge of the Abyss after a Better GDP Release?
It was an extremely dangerous way to end the week. The US dollar has held very close to general support for some time now; but the ante was upped when steady selling pressure pushed the single currency to its lowest close on a trade-weighted basis since September 30th. We can see the same level of intensity among the individual majors. EURUSD is just below its June highs of 1.4340 while GBPUSD managed to close at a nine-month high well above range resistance at 1.6600. Despite this tremendous pressure and the relative records, this is not a definitive bearish break for the greenback. When liquidity returns early Monday morning in the Asian session, speculators will immediately go back to work on trying to jump start the next major trend. For those that have dollar exposure or are waiting for the dollar to make its move, it will be an open not to be missed.
How did we come to this point? When did the dollar’s feeble attempts to rebound from its lows give way? The currency fell 1.2 percent through Friday’s session - the largest decline and absolute move since June 23rd - following the release of what at first glance seemed to be a better-than-expected outcome for the advance reading of second quarter growth. The Bloomberg consensus was projecting a tempered 1.5 percent pace of annualized contraction following what was initially a multi-decade, 5.5 percent plunge. Given this benchmark, the 1.0 percent decline that crossed the wires seemed to be a big step closer to realizing expectations for the inevitable return of positive growth. However, just below the surface, the cracks were clearly visible. The peak of the recession marked by the previous quarter was distended to a 6.4 percent malaise that matched the worst the world’s largest economy had seen since 1980. What is far more disconcerting (but not yet fully appreciated) is that the foundation for this recovery is unstable. Of all the major categories of economic activity, only government spending was rising. Personal consumption dropped 1.2 percent, exports 7 percent and private investment 20.4 percent. Fiscal stimulus is already reaching its limits and the cries to reign in aid and work down the deficit are growing louder. Without consumer spending (which accounts for approximately 70 percent of activity), the economy will not easily be able to recover on its own power. Expect to see the terms ‘L’ and ‘W’-shaped recession used more often.
The long-term outlook is highly uncertain and certainly bearish; but come next week, market participants may not immediately be concerned with underlying trends. With the dollar backed up to a technical wall, speculators will look to either force a break or offer a modest relief rebound first thing. The longer the currency holds to its technical floor, the more violent the eventual market shift could ultimately be. There is plenty of event risk on the docket; but its influence on the critical decision of breakout or reversal is likely low. ISM manufacturing and service sector surveys, consumer credit, personal spending and income are all notable indicators; but the NFPs once again holds the greatest clout. There are many indicators that hint at stabilization and eventual recovery; but none are as truly influential and accurate as the monthly payrolls report.
Euro Could be the Primary Benefactor of Dollar Selling, but Take Account of the ECB
If the dollar is destined to plunge next week; many of its counterparts will no doubt rally. But, in the event of a genuine trend change, where will the capital flow? The British pound is suffering its suffering economic and financial troubles that rival the United States and Australia is heavily dependent on exports. Positive growth projections, rates that have stabilized at a level that is at a significant premium to many of its counterparts and policy officials attempting to work down deficits (not to mention liquidity) make the euro the primary alternative to the world’s reserve currency. However, outside of the dollar’s influence, the currency will have its own fundamental drivers to worry about. Setting aside retail sales, industrial production and other secondary releases; the top event risk is Thursday’s ECB rate decision. President Trichet and his fellow policy makers aren’t expected to change the benchmark from its 1.00 percent perch; but their statement and his commentary in the Q&A session to follow can get the speculative wheels turning. Any dovish or hawkish leanings or changes to the covered bond purchase plan would be notable.
British Pound’s Risk Correlations May Not Weather the BoE’s Rate Decision
There was little contribution from the UK docket today; yet the British pound would end the week at the most critical level against its US counterpart. Looking ahead to next week though, the situation will be reversed. The domestic calendar will be overflowing and its piece de resistance will be a central bank announcement that holds the greatest potential for making a significant impact on price action. Like the ECB and RBA announcements, the MPC is not expected to change its benchmark rate. On the other hand, there is a very good chance that the group could alter its stance on policy and/or its outlook for the economy. The chief concern from the statement that follows the holding of the overnight lending rate at 0.50 percent is any possible changes to the bond purchasing program. The BoE is already working to purchase 125 billion pounds worth of debt; but the government has allowed for 150 billion. If they in fact increased it to this limit, it may be construed as prudent after the extended recession in last week’s GDP numbers. Holding back, on the other hand, may be seen as reckless and hurt its correlation to risk.
Commodity Bloc Hold Offers Its Own Employment Reports and Rate Decisions
There may very well be a lot of volatility for the larger majors considering all the data on deck; but the commodity bloc may keep pace or even outperform. Mirroring the US, Canada is scheduled to release its own July employment change figures on Friday morning. Making it one of the general themes for the week, both Australia and New Zealand will also take stock of labor; but earlier in the week. The other theme that will be filled in for is policy activity. The RBA is expected to hold its benchmark at its high 3.00 percent Tuesday; but their outlook is unknown.
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Written by: John Kicklighter, Currency Strategist for DailyFX.com