FOREX TRADING

Market Outlook

Tactical view:

• Risk of snap back in GBP/USD and USD/JPY
• Long AUD positions outpace CAD

Dollar weakness continues to characterise G10 fx markets as doubts over the US economy multiply and all-time lows for US yields boost the attractiveness of carry. With the Fed running out of policy options and evidence of macro economic decoupling in the G10 prevailing, we look for the AUD to remain a desirable G10 destination. A test of 85.0 in USD/JPY now looks probable. Though next week will be dominated by the FOMC, all eyes in the UK will be on the latest BoE Inflation Report (QIR) on Wednesday. The QIR has proved a hurdle for GBP in the past and could again prove the proverbial ‘bridge too far’ that forces GBP/USD bulls to rein in their exuberance. Special notes on GBP/USD and AUD/ ZAR are included in this week’s publication.

Recap

GBP/USD closed up 1.7% at 1.5962 and just fell short of 1.60. GBP lost 0.04% vs the EUR as EUR/USD (+1.7%) kept track of GBP/USD. GBP/CAD burst through the 1.64 level (1.65 target) after a shock 139,000 drop in Canadian employment in July. The MPC left Bank Rate on hold at 0.50% and the APF at £200bln, but suspense is set to stay elevated over the next two weeks and leaves GBP vulnerable to possible profit taking after a stellar run. Elsewhere, we note the gains for the JPY and the fall in USD/JPY blow 0.8550. A test of the Nov-09 low now looms, prompting possible intervention to weaken the yen. (more…)

U.S. Review

The Second Quarter Ended on a Soft Note

• Real GDP grew at a 2.4 percent annual rate during the second quarter, but recent data suggest the period ended on a weak note and point to a slower second half of 2010.
• New home sales rose in June, but downward revisions to April and May data show an even larger pullback following the end of homebuyer tax incentives.
• Advance orders for durable goods fell in June, and regional surveys show industrial activity losing steam.
• Consumer confidence fell in July, despite generally good news on corporate earnings and rising share prices.

More Evidence Of A Second Half Slowdown

Real GDP grew at a 2.4 percent annual rate during the second quarter. While the gain was slightly higher than the reduced market expectations, most of the strength occurred earlier in the quarter and the revisions to previously published data show the recession was deeper than first reported and the recovery in private final demand has been much weaker.

There is a growing debate about whether the economy will need more fiscal and monetary stimulus during the second half of the year. The argument for stimulus got a boost from a paper released by Mark Zandi and Alan Blinder that shows the extraordinary efforts taken by the Treasury, Federal Reserve and the Congress that helped to stave off a much more dire economic outcome than what actually transpired. Altogether, around $4 trillion in fiscal and monetary stimulus was thrown at the economy. While this spending may have averted a deeper recession, or even depression, it has not done much to promote economic growth over the past year. With most of the spending now behind us, the debate is shifting to whether policymakers should do more of what has already been tried, do less or do something different.

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In testimony before the House Budget Committee Bernanke said that the economy will continue to grow at a moderate pace, with expectations of GDP growth of 3.5% over the course of 2010. However that growth rate will mean a slow reduction in the unemployment rate which would keep inflation subdued. Those factors will likely keep the Fed on the sidelines in terms or raising interest rates. A strong May non-farm payroll report may have pushed up the timetable for a rate increase, but that was not the case.

While stimulus spending is due to wind down, Bernanke cites increases in consumer spending and increases in spending by businesses on equipment and software.

“Real consumer spending has risen at an annual rate of nearly 3-1/2 percent so far this year, with particular strength in the highly cyclical category of durable goods. Consumer spending is likely to increase at a moderate pace going forward, supported by a gradual pickup in employment and income, greater consumer confidence, and some improvement in credit conditions. In the business sector, real outlays for equipment and software posted another solid gain in the first quarter, and the increases were more broadly based than in late 2009; the available indicators point to continued strength in the second quarter. Looking forward, investment in new equipment and software is expected to be supported by healthy corporate balance sheets, relatively low costs of financing of new projects, increased confidence in the durability of the recovery, and the need of many businesses to replace aging equipment and expand capacity as sales prospects brighten.”

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Daily Technical Analysis

EURUSD Outlook

The EURUSD continued its bearish momentum earlier today in Asian session, hit 1.8882 level and seems comfortable moving below 1.2000 indicating potential bearish continuation targeting 1.1800 before testing 1.1600 this week. Upside risks/correction indicated by a falling wedge formation as you can see on my h4 chart below and the fact that price is in oversold area. This upside pullback scenario is valid only when price breakout above the formation, so until that happen, I am still in bearish mode for this pair. Immediate resistance at 1.2000. Break above that area could trigger further upside pullback testing 1.2150 but the main scenario remains bearish at this phase.

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A Roadmap for the Fed’s Exit

• The Fed is moving towards an exit of its very easy monetary policy, and the first steps to reduce liquidity have already been taken There are several more steps on the road to the first fed funds rate hike, but the Fed will prepare markets well in advance.
• The unwinding of alternative easing measures has so far been smooth and we see the biggest risk for a destructive market reaction from the termination of the MBS/Agency purchase programme by end March. A surge in mortgage yields could potentially delay the first rate hike.
• Fundamentals would call for an unchanged fed funds rate through 2011, but given its extremely low level, the first hike is expected to arrive late this year. That said, the Fed will be cautious not to tighten too aggressively and is likely to pause hiking close to the 1% level in 2011.

Exit already in progress

This week a testimony by Chairman Bernanke to the House revealed the Fed has progressed further in its move towards the exit. During the crisis the Federal Reserve System implemented several alternative policy measures to cope with the seizure of money market liquidity and to ease financial conditions for the real economy beyond what could be obtained by a zero interest rate policy. With signs of an economic recovery becoming increasingly convincing, the debate about how and when the Fed will tighten monetary conditions has intensified.

While the Fed will not fully complete its purchase programme for mortgage assets before 31 March, the unwinding has already begun. By 1 February, most short-term liquidity and some lending facilities were terminated. Further, the Fed has laid out a plan for the unwinding of the remaining liquidity and short-term lending programmes. According to this plan, all these measures will be terminated by end H1, as illustrated by the timeline below. (more…)

The dollar rose on Friday for a third consecutive day, pressuring stocks and commodity prices for a third day. US nonfarm payrolls declined a modest 20K in January with the unemployment rate falling to 9.7%. The S&P 500 gained 3.08 to 1,066.19 and erased earlier large losses as US consumer credit declined less than forecast and support at 1050 held. The yen fell versus the dollar but rose against most other key currencies on carry trade unwinding. The euro declined amid ongoing concerns about the fiscal stability in the PIGS countries and concern that efforts by Greece, Portugal and Spain to reduce their deficits will hurt the fragile economic recovery. Sterling fell despite higher-than-expected producer-price inflation. The oversold Australian and Canadian dollars rose. The Canadian dollar was supported by an unexpected drop in Canada’s unemployment rate and stronger-than-expected employment growth. The Swiss National Bank reportedly intervened in the FX market to prevent the Swiss franc from further appreciation against the euro after the EUR/CHF fell to the lowest level since October 2008.

The dollar index rose for a third straight day and touched the highest level since July 9. The appreciating dollar is increasing deflationary pressures, depreciating risky assets and may end the US/global fragile economic recovery. The dollar index rose about 9% since the beginning of December. There are support in the 79-area and important resistance at the 81 area. We expect a consolidation between the support and resistance.

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January NFP Likely Turned Positive

January unemployment and nonfarm payrolls will be released on Friday February 5th at 8:30 am (EST). December nonfarm payrolls (nfp) declined by 85k and the unemployment rate was unchanged at 10%. The trade had expected the December nonfarm payrolls to come in at around -35k with a number of analysts looking for a possible positive reading for the December nfp report. The November nonfarm payrolls was revised to plus 4k. This marks the first monthly increase in nonfarm payrolls since the US recession began in December 2007. The headline unemployment rate was expected to have up ticked by 0.1% to 10.1%. The reason the headline unemployment rate did not rise is 600k unemployed persons declared they were no longer looking for employment. As the labor market improves more discouraged workers are likely to seek employment and this could send headline employment higher for many months to come. A number of analysts expect the headline unemployment rate to reach 10.5% sometime in 2010.

The December unemployment report was disappointing and dampened optimism about improvement in the US labor market. The US shed 4.2mln jobs since the start of 2009 and the total number of unemployed remained unchanged at 15.3mln. The number of long-term unemployed, those unemployed for 27 weeks or more continued to trend up reaching 6.1mln in December. The number of part-time workers was unchanged at 9.2mln. The number of unemployed and underemployed is above 16%. The Labor Department reported Wednesday that unemployment rose in 306 of 372 metro areas in December. This report suggests employers remain reluctant to hire and that the US may face a jobless recovery. According to President Obama one in ten Americans can’t find a job. The continued elevated level of US unemployment has the Obama administration shifting focus to jobs creation. The Obama administration proposed a new $100bln job stimulus bill. It’s unclear what the impact of a new jobs stimulus plan will be or if Congress will pass the plan.

Despite the disappointing December unemployment report the trend of improvement in the US labor market appears to have continued with the December report showing jobs creation in professional and business services along with education and health services. In addition, temporary employment rose by 47k. Hiring of temporary workers is seen as a prelude to increased full time hiring. The manufacturing and construction sector continued to shed jobs in December. The average workweek was unchanged at 33.2 hours and wages rose by three cents.

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FOMC Meeting Wednesday, No Change Expected

The FOMC will conclude a two-day policy meeting on Wednesday the 27th of January and announce its policy decision at 14:15 PM ET. The FOMC is widely expected to maintain steady rate policy and 0.0 to .25%. At the December FOMC meeting the FOMC concluded that economic conditions warrant maintaining yields a low level for an ‘extended period’ and the economy is strengthening. The FOMC is expected to reaffirm commitment to maintaining low yields for an extended period at Wednesday’s policy meeting. If the Fed were to surprise and drop the extended period language from statement it would be a sign that the Fed is shifting monetary policy and preparing its tightening cycle. This is unlikely at Wednesday’s policy meeting because there has not been a significant change in the US economic outlook since the last policy meeting. In December Fed officials said that the economy is improving and that inflation pressures were likely to remain subdued. Recent US economic data has been mixed with Christmas retail sales weak, improvement in the housing market slowing and December unemployment disappointing.

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