FOREX TRADING

U.S. Review

Economic Recovery Continues, but is it Enough?

• Economic indicators this week suggested continued economic growth. Factory orders, the Institute for Supply Management manufacturing index and employment all suggest continued progress.
• Yet the pace of the recovery still presents several fundamental challenges. First, construction spending is disappointing and for a society that has put so much emphasis on housing, there is a disconnect between aspirations and reality. Second, the pace of growth will not likely solve the budget shortfalls in many states or at the national level.

Economic Recovery Continues, but is it Enough?

Three important economic indicators this week suggested continued economic growth. Factory orders, the Institute for Supply Management Index and employment all suggested continued progress on the economic front. Factory orders increased 0.6 percent in February and the gain reported for January was revised higher. Factory orders have gained in 10 of the past 11 months and are now more than a third of the way back to where they were at their peak in July 2008. Specifically, new orders for non-defense capital goods ex-aircraft are up nine percent (annualized) over the last three months, consistent with our expectations for 8 percent or more gains in real equipment & software spending for this year.

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Weekly Economic and Financial Commentary

U.S. Review

Public Policy Grabs Center Stage

• Public policy dominated this week, with the passage of healthcare reform and confirmation the social security system would run into deficit this year contributing to disappointing Treasury auctions and higher bond yields.
• Advance orders for durable goods rose in line with expectations, but a large downward revision to January’s nondefense capital goods orders raises a red flag as to how strong capital spending will be in the first quarter.
• Sales of new and existing homes both declined in February, raising fears the incipient recovery in housing has faltered.

Strange Days in the Credit Markets

The bond market is the ultimate truth detector and its verdict on healthcare reform is the new law will be more costly than the Congressional Budget Office (CBO) estimated and budget deficits will be larger. The bond market was already on edge from the ongoing Greek debt saga and reports that Berkshire Hathaway and a handful of other businesses can now borrow more cheaply than the U.S. Treasury. The CBO confirmed the Social Security system would pay out more in benefits this year than it receives in taxes, something that was not supposed to occur until 2016. The Social Security shortfall means the Treasury will need to redeem the “special issue notes” issued to the Social Security trust fund, which will require the Treasury to sell real bonds, which has become more challenging in recent weeks.

The last few years have seen Treasury yields rise during the spring, triggering a whole new set of challenges. History looks like it will repeat itself this year, with the end of the Fed’s mortgage-backed securities purchases next week adding to the upward drift in yields. The supply of bonds coming to market will remain a challenge, with additional money needed to pay Social Security benefits and recapitalize Fannie Mae and Freddie Mac. Sovereign credit risk and worries about growing supply also extend to municipalities, which saw yields climb sharply recently.

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The Week Ahead

Highlights

• Greek denouement looms
• RBI hikes, more coming from others
• SNB pulls the rug out from under EUR/CHF
• March 24 UK budget will be critical in pre-election positioning
• CAD–To parity and beyond
• Key data and events to watch next week

Greek denouement looms

FX markets continue to fluctuate broadly in recent ranges, turning with every twist in the ongoing Greek drama. Risk saw higher in the beginning of the past week as EU leaders appeared to be in agreement on a plan to provide an aid package to Greece. Then the German government indicated it could not legally support such a plan and that Greece should seek aid from the IMF, sending EUR/USD and most other risk assets lower into the end of the week. Then on Friday, EU Commission President Barroso confused matters further by advocating a standby financial aid mechanism of coordinated bilateral loans from Euro-area countries. The immediate Greek drama may be entering the final act, though, as next week’s EU summit is likely to see a definitive resolution one way or the other. If European leaders fail to reach an agreement, it will look very bad for Euro-area cohesion, exposing the fiscal vulnerabilities of other members now seen to be on their own, and likely see the Euro suffer as a result.

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Overbought Test Of Resolve

Gbp/Usd moved 100 pips higher during the European session after reports from the U.K. labor market hit the newswires that were better than expected. The minutes from the recent Bank of England rate meeting revealed that nothing much had changed from the previous month, and that CPI and inflation reads were as much to do with a weaker pound than instigated by internal growth.

The MPC minutes suggest that interest rate increases are just as far away in the U.K. as any other major region, with the exception of Australia. This news had a positive effect on the major currencies, but the pound is the only pair to make a substantial breakout. (more…)

U.S. Review

Upbeat, Downbeat or Simply No Rhythm

• Economic news continues to come in mixed, with positive reports on retail sales and the trade deficit being offset by disappointing reports on small business optimism and unemployment claims.
• Revised employment data for states show larger job losses during the recession and cast some doubt on January’s drop in the national unemployment rate.
• Stronger retail sales and declines in imports led to surprising drops in inventories at retailer and wholesalers in January. Inventories rose slightly at manufacturers, however.

Still on Pace for a Modest Economic Recovery

February’s retail sales report was easily the best economic news released this week. Overall sales rose 0.3 percent during February, with strong gains reported across nearly every major category. Sales excluding gasoline, building material and automotive dealers, which is a category that tends to track the personal consumption data, rose 0.9 percent in February, following a 0.6 percent gain in January. The strong back-to-back gains suggest consumer spending will rise at a 2.2 percent pace or better during the first quarter, which is in line with our forecast, published earlier this week.

One complicating factor in the retail sales figures is that retailers have done a really good job at bringing inventories in line with sales and are discounting much less than they did in prior years. As a result, the better numbers reported for January and February may not reflect as much volume as they first appear. The lack of discounting is also apparent in the Consumer Price Index, which has shown larger price gains for core good prices. Prices for core goods are currently up 2.9 percent over the past year, which is their largest gain since the early 1990s.

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Weekly Economic and Financial Commentary

U.S. Review

Making Progress on the Road to Recovery

• December’s employment report was generally disappointing, with a larger than expected 85,000-job decline in nonfarm payrolls and huge declines in household employment and the civilian labor force.
• Most major chain stores reported better-than-expected results for December.
• Manufacturing activity improved toward the end of 2009, with factory orders rising solidly and the ISM manufacturing survey ending the year at 55.9.

Employment Gains Are Not There Yet

December’s employment report was somewhat of a disappointment. Many were expecting a small increase in employment to be reported for December, even though the consensus was calling for a small decline. Our own forecast called for a larger than consensus drop and we had repeatedly noted that the optimism so many were showing was premature. The actual data proved to be weaker than our forecast, with nonfarm payrolls declining by 85,000 in December and the household survey showing substantial drops in both employment and the labor force.

Revisions to the previously published data produced a slight increase in employment during November. The 4,000 job increase was the first since the recession began back in December 2007. Any celebration about November’s increase was tempered by downward revisions to the October data. On net, the employment data were revised down for the two previous months by 1,000 jobs. Moreover, benchmark revisions will be made to the employment data next month dating back March 2008. The BLS has reported the revision would be around 0.6 percent, which would result in an additional 830,000 job losses over the past two years.

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Weekly Market Wrap

Trading volumes and data were light this week as markets wound down ahead of the holidays. In the US, the November housing starts and building permits data bounced back from the softness seen in October. The FOMC kept interest rates on hold and slightly sweetened its economic outlook, although this positive note was somewhat offset by the second consecutive increase in weekly jobless claims. The dollar gained steadily for a second week against the euro and the yen as sovereign debt issues continued to roil the Euro Zone, while gold hit a one month low below $1,100 on Thursday. The Senate Banking Committee voted to move the nomination of Fed Chairman Bernanke to a full Senate vote, but not without another round of Bernanke bashing from the usual quarters (even after Time named Bernanke the Man of the Year). In the background, there were dark rumblings: PIMCO’s Bill Gross raised his cash holdings to the highest level since the failure of Lehman in Sept 2008, while BoA/Merrill Lynch analysts discussed the possibility of a “Valentine’s day massacre” market correction in Q1 that could stem from the end of the Treasury’s MBS buying program or other factors, and Meredith Whitney took another swipe at banks, cutting her 2009-2011 EPS targets on JP Morgan, Goldman and Morgan Stanley. US equity markets closed the week out on high volume due to quadruple witching and the quarterly Q&P rebalancing. Equity indices ended mixed for the week, with the DJIA down 1.3%, the Nasdaq rising 1%, and the S&P 500 slipping 0.4%.

Little was expected from the FOMC this week, although ahead of the decision an FT article prompted speculation that, in a nod to the ECB, the Fed might choose to distinguish between liquidity and monetary policy, specifically by raising the discount rate from the existing 0.50% level and simultaneously keeping the Fed Funds target rate steady at 0-0.25%. The discount rate hike never came to fruition, but the FOMC did alter its policy statement to remind markets that most of its special liquidity facilities are scheduled to wind down in Q1 2010. As expected, the Fed funds rate was kept unchanged and the commitment to keeping rates on hold for an “extended period” was reaffirmed, with the economic outlook paragraph slightly more optimistic.

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USD Mixed, JPY Lower, BOJ Won’t Tolerate Deflation

• USD: Mixed, overseas loses pared by news of Iran/Iraq tension
• JPY: Lower, BOJ won’t tolerate deflation, five-year bond yields hit a four-year low
• EUR: Mixed, German IFO hits 17 month high, trade balance swung to surplus, EUR/CHF declines
• GBP: Higher, mortgage approvals rise, BOE says banking system more stable, PSNCR at record high
• CAD and AUD: AUD & CAD higher, Australia’s business sales rise, Carney says low rate pledge conditional

Overview

USD drifted lower Friday pressured by a slight uptick in risk appetite as US equity markets edged higher. The EUR was supported by report that the German IFO business sentiment hit its highest level in 17 months and the EU trade deficit swung to surplus in October. GBP edged higher in reaction to report that UK mortgage approvals rose for the third month in a row and the BOE says that the UK banking system is more stable. Commodity currencies traded higher supported by improving risk sentiment and rising crude prices. AUD was supported by report of improvement in Australian business sales. CAD traded higher in reaction to a statement from the BOE’s Carney that the BOC has the flexibility to shorten the time frame for its commitment to keep rates low until mid 2010. Carney appeared to be reacting to Wednesday’s report of higher than expected Canadian CPI. JPY traded lower in reaction to a pledge from the BOJ that the central bank would not tolerate deflation. This pledge encourages speculation that the BOJ may ease monetary policy early next year. USD downside was limited by report of tensions between Iran and Iraq as Iraqi troops were reported to have crossed over the border into Iran and temporarily occupied one of Iraq’s oil fields. The Iraqi deputy minister denied the report. EUR/CHF dropped below 1.50 with CHF supported by rumors of a coup in Pakistan. The drop in EUR/CHF may encourage the SNB to intervene as the SNB has defended the 1.5100 level in the past. The Pakistan government denied the coup rumor.

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Long Equity Momentum – Mixed Global Markets

Forex Trader Note: Global momentum reads are indicating long equity direction, mixed oil and gold trade, and very mixed currency reads. That intimates that Usd weakness may hit, on the strength of risk tolerance in the global market. Over the last few days of trading the dollar index has been in a clear uptrend, helped by positive macroeconomic data coming from the U.S. economy.

This has forced the market to revalue the strength of the dollar index, and is something that will continue until fair value is found off the economic calendar this week. Look for the mixed momentum in these pairs to continue.

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European Market Update

Risk aversion sentiment subsides as European central bankers express confidence that Greek authorities will address its debt problems

ECONOMIC DATA

(SZ) SNB left its 3-Month Libor Target Rate unchanged at 0.25%; as expected. To end corp bind purchases and reiterates to counter any CHF currency strength

Iceland cuts its interest rates by 100bps to 10.00%

(TU) Turkey Oct Current Account: -0.9Be v -0.9B prior

(FI) Finland Oct Preliminary Trade Balance: €1.4B v €1.1Be
(FI) Finland Oct Industrial Production M/M: 2.2% v 2.0%e; Y/Y: -18.9% v -20.8%e

(GE) German Nov Wholesale Prices M/M: 0.7% v -0.4% prior, Y/Y: -3.2% v -7.0% prior

(FR) French Q3 Final Non-farm Payrolls Q/Q: -.06% v 0.0% prior
(FR) French Q3 Manufacturing Production M/M: -0.8% v 1.0%e; Y/Y: -8.8% v -6.5%e
(FR) French Oct Industrial Production M/M: -0.8% v 0.7%e; Y/Y: -8.4% v -6.6%e

(TU) Turkish Oct GDP Y/Y: -3.3% v -3.7%e
(TU) Turkey Nov Capacity Utilization: 70.7% v 71.2%e

(SW) Swedish Nov CPI-Headline Rate M/M: 0.0% v-0.1%e; Y/Y: -0.7% v -0.7%e

(SW) Swedish Nov CPI- Underlying Inflation M/M: 0.0% v0.0%e; Y/Y: 2.3% v 2.3%e; CPI Level 301.03 v 301.22e

(DE) Danish NOV M/M: 0.0% v 0.1%e; Y/Y: 1.3% v 1.5%e

(DE) Danish NOV CPI EU Harmonized M/M: 0.0% v 0.2%e; Y/Y: 0.9% v 1.1%e

(SP) Spain Q3 Housing sales Y/Y: -13.6%

(IT) Italian Oct Production M/M: 0.5% v 1.3%e; Y/Y: -11.8% v -12.7%e; Ind Prod WDA Y/Y: -14.0% v -12.9%e

(EU) ECB Monthly Report: Mirrors ECB press conference from Dec 3rd

(NO) Norwegian Nov CPI M/M: 0.3% v 0.2%e; Y/Y: 1.5% v 1.4%e
(NO) Norwegian Nov CPI Underlying M/M: 0.1% v 0.1%e; Y/Y: 2.4% v 2.4%e
(NO) Norwegian Nov Producer Prices (incl oil) M/M: 3.6% v 1.5% prior, Y/Y: 4.8% v -4.1% prior

(SW) Swedish AMV unemployment Rate: 5.3% v 5.4%e

(SA) South African Q3 Current Account Balance (ZAR): -77.4B v -72.5Be; Ratio to GDP): -3.2% v -3.1%e

(UK) Oct Mortgage approvals M/M: 55.3K v 50.6K prior -Council of Morgtage Lenders: Mortgage

(IT) Italian Q3 Final GDP Q/Q: 0.6% v 0.6%e; Y/Y: -4.6 v -4.6%e v -5.9% prior

(GR) Greek Sept Unemployment Rate: 9.1% v 9.3%e

(IC) Iceland Nov Unemployment rate: 8.0% v 7.6% prior

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USD Higher, Fed Outlook Reduces USD Funding Activity

• USD: Higher, supported by speculation the Fed may begin to withdraw stimulus sooner than expected
• JPY: Higher, technical bounce, new stimulus measures expected to be announced Tuesday
• EUR: Lower, Sentix index rose to an 18 month high, Trichet sees less need for nonconventional policies
• CHF: Lower, retail sales rise 3.1%, SNB policy meeting Thursday, no change is expected
• GBP: Lower, concern about UK budget outlook and exposure to Dubai debt
• CAD and AUD: AUD lower & CAD higher, gold and crude prices fall, Canada’s building permits surge

Overview

The USD traded higher Monday supported by speculation that Friday’s report of better than expected US November unemployment will encourage the Fed to begin to remove stimulus. Fed rate hike talk sparked selling of commodities and equity markets. Despite fresh Fed rate hike speculation, a Reuter’s poll shows that dealer expectations for the timing of Fed rate hike ranged from second quarter 2010 to 2012 with the majority expecting the Fed to hike rates by the end of first quarter 2011.

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This Week’s Market Outlook

Highlights

• The US Dollar turns a corner; gold melts
• JPY to reprise as the FX punching bag
• Four central bank meetings next week
• NFP beats, but buyer beware
• Key data and events to watch next week

The US Dollar turns a corner; gold melts

The greenback looks to have made a significant reversal as we head into the year-end. The proximate catalyst was a better than expected November jobs report (see below), which saw Fed interest rate expectations move up, but the move was unfolding from earlier in the week as USD/JPY staged a sharp rebound. In a twist to the normal ‘risk on’ reaction, stock markets failed to sustain initial gains and continued to show signs of stalling below recent highs. The failure in shares may stem from multiple causes: the USD rebound may have driven risk positioning out; accelerated rate hike expectations may have damped investor sentiment; year-end profit-taking/position reductions; technical exhaustion as new highs fail, take your pick. But for the USD it was a one-way ticket higher.

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ECB Meeting: Heading for the Exit

• The ECB is now heading for the exit. For one thing they are cutting down on the longer term auctions. The 12-month auction in December will be the last of its kind and so will the 6-month auction at end-March. This is slightly more hawkish than expected.
• Markets were particularly surprised by the ECB moving away from 1% at the 12-month auction and instead applying a rate calculated as the average minimum bid rate of the weekly main refinancing operations over 12 months. Consensus expectation was a flat 1%.
• Trichet was eager to say that this was not intended as a signal of future rate hikes, but it is nevertheless likely to be interpreted as an indication that the ECB considers hikes in 2010 likely. The procedure might help to curb banks’ demand at the auction without affecting interest rate expectations as much as a fixed spread would have.
• The weekly main refinancing operations and the 1-month and 3-month auctions will be with full allotment at least until early April. We find it likely that the ECB moves away from full allotment at the 1-month and 3-month auctions in April.
• The ECB’s assessment of the economic situation is becoming more positive. Nevertheless we still consider that the ECB is too downbeat. We think that they could double their growth forecast for 2010 and still turn out to be too dovish.
• The ECB expects inflationary pressures to be low. But in their inflation projection, the upper end of their band for 2011 is nevertheless 2.0%. They will not have to revise their inflation expectations much upward before they can defend moving away from record low interest rates.
• Today’s press conference has been slightly more hawkish than we expected. It has clearly surprised some observers how determined the ECB is to move towards the exit. Nevertheless market reactions were muted – with interest rates rising ahead of the meeting on rumours that the ECB would be hawkish.

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China Commerce Minister Deals Another Blow To Prospect Of Yuan Appreciation

News and Events:

Yet another day of Asian equity market gains have ensured the European session has started with a positive tone; and gold has once again made new all-time highs above $1226 as the USD has been put under renewed pressure from virtually all currencies except the JPY. The morning rally has pushed EURUSD to test 1.5130 resistance, and after negligible effect from the Eurozone Services and Composite PMI data, the mantle will likely fall to this afternoon’s ECB policy meeting to provide the catalyst for a further climb to test 1.5150 levels. Really there is only one factor that hangs in the balance at this meeting, and that will be the possible discontinuation of the ECB’s 12-month fixed rate-tenders. There is not expected to be any alteration in the refinancing rate, and indeed the recent rhetoric from US officials that they are not concerned by USD depreciation will likely negate the effect of any repetition of the ‘strong USD policy’ from European officials. For now, the issue of JPY strength is taking a back seat after USDJPY has recovered back above 87.15 pivot levels to touch highs of 87.92. However the tension surrounding the recent appreciation of the currency is still simmering amongst Japanese policymakers, with the leader of the Japanese government’s opposition accusing the Prime Minister of exacerbating the currency surge with confusing comments that ‘prompted misconceptions’ in the market. With the powerful downtrend in USDJPY still intact, it is unlikely this matter is going to stay on the sidelines for long, and recent meetings between Japanese and US officials has certainly ignited speculation that Japan is trying to lay the foundations for coordinated currency intervention. In other headlines from Asia, it seems that China is more resolute than ever to deflect pressure for the CNY to appreciate. Commerce Minister Chen Deming was on the wires overnight to say that the world’s attentions would be better focused on the damaging lack of stability in the USD, rather than the value of the CNY. He claimed that an unstable CNY would have a very bad effect on the global economy; echoing previous Chinese rhetoric that by keeping the CNY stable they have helped stimulate the recovery. As we have frequently observed whenever CNY appreciation has been debated in the press, it is almost never supported by China itself, and this is yet another setback for US officials after the much-hyped Obama visit last month. (more…)

ECB To Hold Rates Steady, Outline An Exit Strategy

The European Central Bank (ECB) will hold a policy meeting on Thursday December 3rd. The ECB is expected to maintain steady interest rate policy and outline an exit strategy from extraordinary liquidity measures. Last week, ECB President Trichet said that the ECB would cautiously begin to exit strategies that helped provide liquidity during the global financial crisis that could pose inflation threats in the future. Trichet warned EU banks not to get addicted to cheap credit provided by the ECB and he indicated that liquidity measures will be phased out in a timely and gradual fashion to counter any threat to price stability over the medium and long-term. Trichet indicated that the ECB will tighten collateral criteria for the March auction. The tightening of collateral criteria is seen as the first step in an exit strategy by the ECB.

Note in Trichet’s statement above his focus on the impact of extraordinary liquidity measures on price stability. Monday, the EU reported that CPI rose for the first time in seven months. The rise in EU inflation may influence Thursday’s ECB policy decision. The rise in the EU CPI could encourage ECB officials to move the timeframe of an exit strategy forward as inflation pressures may be starting to build. The trade will be closely monitoring what Trichet say about the ECB’s 12 month auctions in the press conference following the ECB policy announcement. The ECB will likely confirm that the 12 month auctions will be allowed to lapse and that liquidity operations may be for shorter term loans. This would signal the start of the ECB’s exit strategy.

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