Saturday, 08 November 2008 03:04:51 GMT
Throughout last week, grim economic data was met by seeming indifference by the US dollar. After five years of steady depreciation, the greenback has been well prepared for data to confirm what international investors have long expected. However, speculation doesn’t happen in a vacuum; and the deterioration of US fundamentals – and, more importantly, speculation of the eventual rebound – has to be measured against the economy’s counterparts.
Dollar Congestion Belies High Volatility, Bigger Fundamental Problems
Fundamental Outlook for US Dollar: Bullish
- Non-farm payrolls contracts for the 10th consecutive month, sending the jobless rate to a 14 year high
- Fourth quarter GDP numbers may be months away, but data suggests a recession is already underway
- Factory activity hits its lowest level since 1982, while the service sector is in a record-breaking contraction
Throughout last week, grim economic data was met by seeming indifference by the US dollar. After five years of steady depreciation, the greenback has been well prepared for data to confirm what international investors have long expected. However, speculation doesn’t happen in a vacuum; and the deterioration of US fundamentals – and, more importantly, speculation of the eventual rebound – has to be measured against the economy’s counterparts. It is the knowledge that the US economy is already well ahead of the global recession curve, policy officials have shored up the domestic markets with liquidity and guarantees, and the US dollar was hovering at record lows just months ago that will keep the US dollar fundamentally buoyant in the weeks ahead. We have seen conditions just like these many times before – when a bullish market will ignore all bad news but rally when a positive reading crosses the wires and visa versa.
Another source of strength for the US dollar is the constant presence of risk and the currency’s status as a safe haven. While it may seem that the tumble in capital markets has tapered over the past two weeks, volatility (a good measure of fear) has barely budged from historical highs. This is clearly seen in day-to-day dollar price action. The average true range for the dollar index over the past ten trading days has surged to 290 points from 77 at the beginning of September and 106 through the middle of October. This level of volatility isn’t unique to the dollar either. All risk-sensitive pairs have traced exaggerated price swings; and the threat that another momentous trend could develop from these wild market moves is therefore very high.
Knowing that the dollar is fighting the fundamental current, it will be important to measure the probable turning point for the US economy and measure its progress against the Euro Zone, the UK, Japan and other developed nations. This will keep some level of focus on this week’s economic docket. There are a number of notable indicators scheduled for release later in the week; but once again their influence will be distorted somewhat by the perception of risk in the market. The trade balance is no longer a source of optimism after the US dollar appreciated so dramatically and just when the realization that a global recession was dawning on market participants. Far more influential will be the consumer data. Representing the single largest component of GDP and the best hope for the eventual economic rebound, the outlook for American consumption trends will be shaped by October retail sales and the preliminary sentiment gauge for the current month. Forecasts are discouraging on both accounts; but therein lies the chance for an amplified response to a better-than-expected reading. - JK
Euro Falls Despite Relatively Hawkish ECB and US Data – What Gives?
Fundamental Outlook for Euro: Bearish
- Euro Dives on European Central Bank Interest Rate Cut, but What’s Next from the ECB?
- Yet Euro may be Bottoming Against US Dollar on Overextended Forex Futures Positioning
- View our monthly Euro-US Dollar Exchange Rate Forecast
Aggressive European Central Bank interest rate cuts and astounding job losses out of the US economy had surprisingly little effect on the Euro – US Dollar exchange rate, and indeed the Euro remained effectively unchanged against the dollar through the week’s close. Dealers reported low participation rates and trading volume across the majority of forex pairs—a clear sign that many traders have grown weary following explosive forex market volatility. One has to subsequently wonder what could actually force the Euro/US Dollar out of its 1.2500-1.3000 trading range, and clearly stressed market conditions make it difficult to predict how markets may actually react to important economic data.
Forex market reaction to recent European Central Bank interest rate cuts and dismal US Non Farm Payrolls data was anything but intuitive, and it is difficult to imagine that upcoming German ZEW, Euro Zone GDP, and Euro Zone CPI numbers will elicit straightforward reactions out of the EUR/USD. Markets initially sent the Euro higher following the European Central Bank’s 50 basis point interest rate cut, as many traders had priced in a far-more aggressive 75 basis point or even 100 basis point decrease from the monetary policy authority. Yet traders subsequently punished the Euro on what was perceived to be relatively hawkish commentary from ECB President Jean Claude Trichet. Many expressed concern that the ECB could fall behind the monetary policy accommodation curve and keep rates exceedingly high despite falling inflation—hurting the euro’s prospects against the US Dollar and other major currencies. That previously yield-hungry speculators were disappointed to hear that the ECB may not continue to slash interest rates like their US and British counterparts only emphasizes that market conditions remain far from normal. As such, it is admittedly difficult to predict what may happen through the upcoming week full of economic event risk.
Expectations remain aggressively bearish for all four key pieces of Euro Zone economic data due next week. Economists predict that the German ZEW Economic Sentiment survey will continue to reflect recessionary conditions in the German economy—the previous engine of broader Euro Zone economic growth. Subsequent EZ Industrial Production data will likewise reflect poor conditions for regional producers, and end-of-week GDP and CPI numbers are unlikely to boost confidence in fundamentals for the domestic economies. Absent a truly material positive surprise out of any of these reports, we do not expect a noteworthy improvement in outlook for regional growth and fundamental bias for the Euro. Of course, much the same can be said for the US economy, and the Euro/US Dollar pair could remain in its wide trading range until a bigger shift in fundamental outlook for these global economic titans. – DR
British Pound Could Tumble If BOE Confirms Deflation Is A Concern
Fundamental Outlook for British Pound: Bearish
- UK Manufacturing PMI improved very slightly, but held below 50 – signaling contraction – for the 6th straight month
- UK HBOS home prices fell by the most on record in October, indicating the housing collapse is far from over
- The Bank of England slashed interest rates by 150bps to 3.00% - the lowest since 1955
The British pound ended the week nearly 3 percent lower versus the greenback last week, which isn’t half bad when you take into consideration the Bank of England’s massive 150bp rate cut that brought the Bank Rate down to a 53-year low of 3.00 percent. However, with US economic arguably just as negative for the greenback given the surge in the unemployment to a 14-year of 6.5 percent and the loss of over a million jobs since the start of 2008, it’s a little easier to see why GBP/USD hasn’t collapsed. However, this week’s economic releases could be crucial to the status of the currency.
UK releases such as PPI, BRC retail sales, and the trade balance don’t tend to be very market-moving for the British pound. However, Wednesday’s indicators could really shake things up as jobless claims in the UK are anticipated to rise for the ninth consecutive month in October, adding to evidence that the combination of a slowing global economy, sharp declines in domestic consumption, and the continuous collapse of the UK housing sector are bound to make the UK economic contraction extend for a lengthy amount of time. Indeed, the jobless claims change is anticipated to rise by 40K, the largest single-month gain since 1992, and while this could impact the British pound upon release at 4:30 ET, the announcement of the Bank of England’s Quarterly Inflation Report may be more important. Given the BOE’s latest policy statement following their aggressive 150 basis point rate cut, it appears that the Monetary Policy Committee is now more concerned about the potential for deflation, and if the Inflation Report confirms this outlook, the news could trigger a large British pound sell-off.
Japanese Yen Unlikely to Break Highs Against Dollar Through Coming Week
Fundamental Outlook for Japanese Yen: Bullish
- Japanese Yen Slips on Improved Risk Sentiment
- Australian Dollar Rallies Against Japanese Yen Despite Bearish Rate Outlook
- View Our US Dollar – Japanese Yen Exchange Rate Forecast
The Japanese Yen remained effectively unchanged through end-of-week trade, as whippy price action in the US Dow Jones and other global equity indices made for similarly indecisive movements in the USD/JPY. It seemed as though the Yen was almost certainly going to finish the week significantly higher as the S&P 500 posted its worst two-day decline since 1987, but a counterintuitive S&P rally following truly dismal US Non Farm Payrolls data left the Yen almost exactly even with its weekly open. We subsequently forecast that the Japanese Yen is likely to remain within its recent trading range against the US dollar and other currencies for the foreseeable future. Absent a material shift in global risk sentiment, forex traders are unlikely to push the USD/JPY above weekly peaks near 100.50 or below 97.00.
If four major central bank interest rate cuts and a truly dismal US employment report were unable to break the Yen out of its recent channel, it is unclear that anything on the coming week’s economic calendar will be enough to elicit strong reactions from weary forex speculators. Instead, reports of low volume from major trading desks suggest that speculators are unlikely to force major moves in the Yen or other currency pairs. Limited liquidity may make for choppy intraday price action—much as we saw this past week—but few seem willing to test significant support and resistance levels following the amazing volatility seen through previous trade. Our longer-term bias for the Japanese Yen calls for further rallies against the US dollar and other counterparts, but it seems reasonable to believe that markets will consolidate following truly breathtaking Yen gains.
In terms of Japanese economic data, traders may keep an eye out for upcoming Current Account and Eco Watchers survey results. The Japanese economy’s impressive balance of payments surplus will likely be put to the test through the ongoing global economic slowdown; as global demand slows, Japanese exports may suffer. Current forecasts for an impressive 1.4 trillion yen Current Account surplus for the month of September are bullish for the Yen, but noteworthy disappointments could dim outlook for the recently resurgent currency. Otherwise, it may be important to watch results out of subsequent Eco Watchers survey results. Though markets have proven largely indifferent to Japanese economic data through the past several months of trading, incredible Yen strength may once again turn the focus on the relative health of the domestic economy. As such, we will keep an eye out for truly material surprises in these key economic reports. - DR
Source : DailyFX
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