| Daily Forex Fundamentals | Written by GFT | Oct 04 08 06:40 GMT | | |
TODAY'S BIGGEST PERCENTAGE MOVERS
THE STORIES IN THE CURRENCY MARKET
EXPECTATIONS FOR UPCOMING FED MEETINGS
** PERCENTAGES MAY NOT ADD UP TO 100% BECAUSE OF THE PROBABILITY OF LARGER OR SMALLER MOVES BEYOND THOSE SHOWN ON THIS TABLE DOLLAR SELLS OFF AS TRADERS QUESTION IF BAILOUT PLAN IS THE RIGHT PRESCRIPTIONThe wait is over - the House of Representatives have finally passed the $700B bailout plan but the markets remain unconvinced that this is the right prescription for the credit crunch. The goal of Congress was to find a way to bolster confidence and unfortunately the fact that the stock market went from being up more than 300 points to down more than 150 points by the end of day indicates that the crisis of confidence has not been resolved. Although USD/JPY has trailed the stock market lower, the greenback's weakness against the Euro and British pound illustrates the market's belief that the Federal Reserve is gearing up for an interest rate cut. We have previously said that if the bailout plan fails to do the trick of materially unfreezing the credit markets and so far it hasn't, investors will be looking to Bernanke for help. With the big disappointment in non-farm payrolls and the lack of celebratory fireworks in reaction to the bailout plan, there is little doubt that the Federal Reserve will cut interest rates by the end of this month. $10 Trillion in Debt and Counting However for the time being, the problem of a weak economy still exists and it may be a while before the average American reaps any benefits from the bailout package. The national debt has exceeded $10 Trillion this week and this does even not include the costs of the bailout. The more liquidity initiatives that the Federal Reserve takes, the more destruction is done to the US balance sheet. The US government is bailing out Wall Street, but will foreign investors continue to bailout out the US government? Herein lies the critical question that will determine the fate of the US dollar. The weakness in the US economy and the global slowdown may cause foreign central banks and sovereign wealth funds to fold their arms when it comes to recapitalizing the US financial system. This is one of the main reasons why we believe that the US dollar will continue to weaken against the Japanese Yen. The second reason is the prospect of US interest rates falling to 1.50 percent by the end of the year. Ninth Consecutive Month of Job Losses, Largest Decline in Payrolls Since March 2003 Non-farm payrolls dropped 159k in September, 50 percent more than the market expected. This marks the ninth consecutive month of job losses in the US economy and the largest decline in payrolls since March 2003. It is difficult to argue that the labor market is in anything but bad shape and we expect conditions to worsen. Unfortunately, there was no silver lining in the details of the employment report. The unemployment rate remained at a 5 year high of 6.1 percent while average hourly earnings and weekly hours slipped. This indicates that not only are Americans having difficulty finding jobs but they are making less as well. Although the job report was not bad enough to warrant a 50bp rate cut, it is still worrisome enough for the Fed to cut interest rates by 25bp at the end of this month. Bailout Plan Has Less than 4 Weeks to Prove Itself With the Federal Reserve's interest rate decision is scheduled for October 29, the bailout plan has less than 4 weeks to prove itself. Outside of the minutes from the most recent FOMC meeting, pending home sales and the trade balance, there are no significant numbers on the US economic calendar next week. This means that traders will be focusing on digesting the implications of the drop in non-farm payrolls and the impact of the bailout plan on Wall Street and Main Street. These 2 factors should be the primary drivers of the dollar's price action in the coming week. HOW MUCH FURTHER CAN THE EURO FALL?The Euro came under further selling pressure at the beginning of the US trading session as it hit a fresh 1 year low of 1.3704 against the US dollar. Since then, it has recovered but overall, the currency still remains weak. There was a fundamental shift in the outlook for the EUR/USD this week after ECB President Trichet signaled to the markets that he is ready to cut interest rates. At this point, it is realistic to expect that the ECB to ease monetary policy in November for the first in 5 years if not sooner. As we have seen, interest rate expectations have been the primary driver of the EUR/USD. Therefore the fate of the currency pair is contingent upon who cuts interest rates first - Bernanke or Trichet. Now that the EUR/USD is more than 14 percent off its July highs, traders may be wondering how much further the currency pair can fall. Based upon Economist Magazine's Big Mac Index, which is a rough calculation of purchasing power parity, the Euro does not hit fair value until parity which is one to one with the US dollar. The OECD has a much more realistic valuation for the Euro. According to their latest report and the estimates of many economists, the EUR/USD is fairly value at 1.10 to 1.20. Purchasing parity has its flaws because it only compares the price of a specific good or basket of goods and it does not take into consideration the quality of the goods. Nonetheless, understanding what the PPP value of the EUR/USD is allows us to understand possible value points for the Euro. Looking ahead, the big releases for the Eurozone next week are the German trade and manufacturing sector reports - unfortunately none of these releases will stop the Euro from falling. EU SUMMIT AND UK INTEREST RATE DECISIONThere are 2 big events for Europe next week that can have a material impact on the British pound and the Euro - the EU Summit and the Bank of England interest rate decision. The EU Summit is the event at which a possible TARP style plan may be discussed. Given that France, Ireland and Greece have already taken individual actions, we do not expect the group to agree on any financial rescue plan. Politicians in Europe have an even more difficult time agreeing than politicians in the US. The most likely outcome of the EU Summit is some sort of agreement on regulations to prevent a repeat of the banking crisis. Unfortunately this does not solve any immediate problems and since we know that the BoE realizes this as well, we expect them to cut interest rates on Thursday from 5.00 to 4.75 percent. In addition to the rate cut, the UK has industrial and trade numbers due for release. The British pound could have a tough time rallying next week. AUSTRALIA EXPECTED TO CUT 50BP, USDCAD HITS 1 YEAR HIGHThe Australian and New Zealand dollars ended the US trading session slightly firmer against the US dollar while the Canadian dollar fell to a 1 year low. Oil and gold prices continued to fall but their sell off has tempered. The rally in the AUD and NZD is tied to the sell-off in the greenback and stronger Australian economic data. Service sector PMI and inflation beat expectations in the month of September, however it is important to point out that activity in the sector is below the boom / bust level which means that it is still contracting. The weakness of the Australian economy and the drop in commodity prices will allow the Reserve Bank of Australia to cut interest rates next week. Economists are calling for a 50bp drop which would bring interest rates down to 6.50. In addition to the rate decision, Australia will be releasing employment numbers. There are no significant economic numbers from New Zealand but from Canada, we are expecting IVEY PMI, the employment report and the trade balance. USD/JPY SELLS OFF AS US EQUITIES TURN LOWERThe Dow Jones Industrial Average is now 157 points closer to the 10,000 level. The index fell to a new 2 year low today, dragging USD/JPY and other carry trades down with it. The lack of meaningful US economic data next week will leave the fate of USD/JPY in the hands of market sentiment. We don't see any compelling reason for stocks to reverse unless the Federal Reserve steps into the market. If there were bargain hunters left, they would have come in following the House's approval of the bailout plan. This week's Japanese economic data reinforces the notion that Japan's economy has not escaped the global slowdown. The Bank of Japan also has a monetary policy decision next week but with interest rates already at an ultralow level, the central bank does not have any room to ease monetary policy. CAD/JPY: CURRENCY PAIR IN PLAY ON MONDAYWith the release of the Canadian Ivey Purchasing Managers Index scheduled for 10:00 am ET or 14:00 GMT, CAD/JPY will be the currency in play in Monday's markets. A negative number will precipitate further CAD/JPY declines. Technically, CAD/JPY is in the "sell zone," which we determine using Bollinger Bands. Resistance will take place at the 99.00 level as the one standard deviation Bollinger band is followed by a 23.6% retracement of the July to September sell-off. However, a strong support level exists at 96.50 which will match the lows of September 16 and the lows made in late March. In order for the down-trend to be invalidated, CAD/JPY has to break both the one standard deviation Bollinger band and the Fibonacci retracement. Such an event can propel CAD/JPY to 100.00.
Kathy Lien | |
Saturday, October 4, 2008
Dollar Sells Off as Traders Question if Bailout Plan is the Right Prescription
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