US Dollar: Further Weakness Ahead?

Daily Forex Fundamentals | Written by GFT | Dec 13 08 05:31 GMT |

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 US DOLLAR: FURTHER WEAKNESS AHEAD? The automaker bailout drama has exerted its toll on the financial markets. Last night, news that the bailout deal fell apart in the Senate drove the US dollar to a 13 year low against the Japanese Yen. Almost immediately, the dollar rebounded and its recovery accelerated after reports that the White House may provide assistance to the automakers by tapping the TARP funds. Stocks have rebounded from negative territory, but the unconvincing rally in both the currency and equity markets suggest that traders do not know what to make of the automaker bailout saga, which is sure to drag out into the New Year. With the Federal Reserve expected to cut interest rates on Tuesday, the US dollar could remain weak going into the rate decision. Retail Sales and Producer Prices = Recession and Deflation Even though US retail sales and producer prices were basically in line with expectations, the data was very weak and confirms that the Federal Reserve will need to cut interest rates again on Tuesday. Consumer spending fell for the fifth month in a row while producer prices dropped for the second straight month pointing to recessionary and deflationary conditions in US. The two biggest inputs into GDP are retail sales and trade. Consumers cut back spending more aggressively in October and November which suggests that GDP growth could take a big dive in the fourth quarter, especially with the widening trade deficit. The biggest drop in consumer spending came from gasoline station receipts. Prices at the pump have fallen more than 50 percent since the summer and gas stations have suffered as a result. The only silver lining in the retail sales report is the fact that not every sector saw slower sales. Electronics and sporting goods were in demand but the rebound after 4 consecutive months of softer spending is likely related to Black Friday sales. Consumer confidence for the month of December improved, which was a bit surprising but it is important to remember that the index remains near 1980 levels. Federal Reserve: 50bp vs. 75bp Although we are putting our confidence in the Federal Reserve and hope that they will be proactive in cutting rates by 75bp on Tuesday, a smaller 50bp rate cut is still on the table. The majority of economists are still calling only a half point rate cut, but as of Friday afternoon, Fed fund futures are pricing in a 70 percent chance of a 75bp rate cut. Taking interest rates to zero is all but inevitable but it is not clear how quickly the Federal Reserve wants to make that move. If the Fed cuts by 75bp on Tuesday, then zero interest rates will probably be reached at the March meeting but if they cut by 50bp instead, then we may not see rates at zero until late April. The Federal Reserve has extended their meeting to 2 days to explore all options but the bottom line is that they have to decide whether to deliver more stimulus now or postpone it for later. Both economists and Fed fund futures have incorrectly forecasted the Fed's move in the past and this time around one of them will be wrong. Implications of the Fed's Rate Decision on Currencies The weakness of the US dollar against the Japanese Yen reflects the market's expectation that after Tuesday, the US dollar will yield less than the Japanese Yen. If that comes to reality, we could see further weakness in the US dollar against all of the major currency pairs but if it doesn't and the Fed only cuts by 50bp, there could be a violent recovery in the US dollar. Either way, currency traders need to know that there could be a lot of volatility following the interest rate decision. The FOMC statement will also be heavily scrutinized for any indication of what the Federal Reserve will do next and because of that, traders need to be particularly careful with their positions going into the rate decision. The outcome could set the tone for trading until the end of the year. In addition to the FOMC meeting, consumer prices, the current account balance, housing and manufacturing data are due for release in the coming week. EUR/USD: JANUARY RATE CUT NOT A DONE DEAL Of all the high yielding currencies, the Euro was the only one to appreciate against the US dollar today. The move was certainly not spurred by economic data, which continued to disappoint, but instead by the market's realization that the Euro will remain the third highest yielding currency for some time. Industrial production dropped 1.2 percent in October while French business confidence plunged. Labor costs rose 4 percent, which may be a bit worrisome for the ECB, who is obsessed with inflation pressures. Higher labor markets could be yet another reason why they may want to refrain from cutting interest rates as aggressively as their peers. Yesterday, ECB member Weber said that a January rate cut is not a done deal. Comments today from Mersch and Constancio confirm that the central bank have not made up their minds yet. Both ECB members said there is still room for maneuver but everything is data dependent and they may not have much new information before February or March. Although there are a lot of important economic data due for release next week, the ECB may be alluding to the fact they want to see how the 75bp rate cut impacts the financial markets and the economy. Eurozone purchasing manager indices are due for release on Tuesday, consumer prices on Wednesday, German IFO index on Thursday and German producer prices on Friday. EUR/GBP: NEAR TERM TOP? It has been a tough week for the British pound, which fell to a record low against the Euro. In the past, the big action in the pound was against the US dollar and the Japanese Yen, while EUR/GBP would range trade away. However over the past few months, there has been a huge divergence between growth and monetary policy in the UK and growth in the Eurozone. The Eurozone economy has held up better than the UK but more importantly, the BoE has cut interest rates aggressively while the ECB has not. This has led to a dramatic run in EUR/GBP. Not only has the currency pair appreciated more than 16 percent in the past 2 months, but it rallied every single day this week. The strength of the Euro and the weakness of the British pound should be the factors that engineer a reversal in the currency pair next year. The weakness of the British pound and the aggressive interest rate cuts by the BoE will help to turn economy around in the second half of the year. The comparably restrictive monetary policy in the Eurozone and the strength of the Euro could crimp growth and delay a recovery. The price action in the EUR/GBP today suggests that some investors may already be realizing this notion. It will be a very busy week in the UK with consumer prices, the BoE minutes, employment data and retail sales due for release. AUD/USD: RISK AVERSION HITS THE COMMODITY CURRENCIES Commodity currencies are largely under pressure as new apprehensions have erupted in the face of the failure of the US auto bailout. Once again, risk aversion takes hold of the market. Concerns about the recession-prone Canadian economy have reignited today as Capacity Utilization falls to a record low. The figure, established in 1987, will prove to be a certain hindrance on growth as any level of corporate investment spending has been relinquished. New Motor Vehicle Sales fell -0.9%, after posting a gain of 2.4% last month. The signs that consumer and business spending will face renewed pressure should present an intensifying headache for the Bank of Canada. Thursday's Retail Sales and Friday's Consumer Price report will give more color on the state of the Canadian economy. The Reserve Bank of New Zealand has boosted its efforts in restoring liquidity for lending institutions by broadening its acceptance of investment vehicles to corporate bonds. The bank will now purchase investment grade dollar denominated corporate bonds in their open market operations. Next week's most important Australian economic figures will be the RBA minutes and Westpac Leading Index on Tuesday, New Home Sales on Wednesday, and Quarterly Wage Agreements on Friday. For New Zealand, we expect Business Confidence on Thursday. USD/JPY: WILL THE BOJ INTERVENE? The Japanese Yen surged to a 13 year high against the US dollar after news that the bailout plan for automakers has failed to pass the Senate. Although USD/JPY rebounded almost instantly after hitting a low of 88.22, the weakness of the currency leads many traders to wonder if and when the Bank of Japan will intervene. In our opinion, BoJ intervention will not happen anytime soon. As an export dependent nation, a strong currency is not in Japan's best interest. However unlike the past where the BoJ has intervened when USD/JPY fell below 105 and 100, we may not see any action by the Japanese government this time around. Since the problems are inherent in the US and the Eurozone, intervening at this time may be counterproductive for the Japanese. The only type of intervention that has ever worked is coordinated intervention. The BoJ will have a very tough time convincing Americans to take any steps that would lead to further strength in the US dollar. The Japanese government needs to stand aside and allow the US and Eurozone governments to take their own steps to spur growth. The Bank of Japan has an interest rate decision scheduled next week - no moves are expected from the central bank. USD/JPY: Currency in Play for Next 24 Hours The currency in play on Monday will be USD/JPY. Japan is set to release Tankan Surveys on Sunday at 6:50PM EST or 23:50GMT. The U.S. is set to release its Empire Manufacturing survey along with TIC flow at 8:30AM EST or 13:30GMT and 9:00AM EST or 14:00GMT on Monday, respectively. After hitting a 13 year low, USD/JPY retraced on the day forming a textbook example of candlestick hammer. The pair remains in the Sell-Zone that was derived using the Bollinger Bands. Although today's drastic recovery may signal a reversal for the currency pair, a close above 92.50 would be needed for the downtrend to be negated. Nevertheless, it is important to be cautious as volatility expanded drastically. Short term support is at the 2nd Standard Deviation of the Bollinger Bands at 90.60. Below that is today's 13-year low of 88.30. Resistance is placed at 92.50 which is the 1st Standard Deviation of the Bollinger Bands as well as 10-day SMA. The Tankan survey will contribute to the increase in volatility, for which, support and resistance may be tested. Kathy Lien http://www.gftforex.com