FOREX TRADING

Today’s US session was one for those who enjoy watching paint dry. But tomorrow is NFP day and may be yet another day for a USD inflection point.

Today’s session was hardly one for the history books, though we did see fairly strong moves in NOK (in support of the interest rate spreads favoring the currency as we have noted in recent days) and in SEK off the back of the Riksbank interest rate hike and guidance. EURUSD and the other major USD pairs failed to follow up on yesterday’s exuberant move higher in respect of the upcoming US employment report and ISM non-manufacturing report tomorrow.

Nonfarm payroll expectations and reactions

Some have lowered expectations for US nonfarm payrolls due to the weak ADP release (soon we’ll be dropping the "private payrolls" figure, which remains the focus, once the rest of these pesky census workers are fired). The Saxo call (see a great report on the release here: is for a virtually unchanged figure versus a slightly more positive consensus. The market is already very short the USD, but risk is made a sharp comeback yesterday, which pushed the dollar lower. It feels like we’re in need of direction here after so many days of aimless trading in EURUSD and whippy trading in the more risk-correlated AUDUSD, but will we get any kind of resolution in tomorrow’s trading? It’s tough to build any conviction in this environment. For now, risk appetite measures are generally very complacent.

It is perhaps worth noting the reactions to the last three US employment reports.

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Highlights

• Making lemonade out of lemons
• Important levels to watch
• Emergency BOJ meeting may hit the JPY
• Key data and events to watch next week

Making lemonade out of lemons

The past week saw a continuation of the stream of disappointing data out of the US and elsewhere, but around mid-week markets decided it was no longer a reason to sell risk. New lows were made in USD/JPY and the JPY-crosses early in the week after eye-popping declines in US housing data and a drop in durable goods orders. In Europe, comments from ECB and BOE officials warned of the real risk of a return to recession in the months ahead. European debt spreads continued to widen, with peripheral Eurozone (Ireland (credit rating cut), Greece, and Portugal) debt being sold and core Eurozone (Germany and France) bonds being bought on continuing fears of a sovereign default amid the worsening outlook. US Treasury yields dropped to new lows, with 10-year note yields touching 2.42% at mid-week.

But by the end of the week, it was all good. US weekly jobless claims declined, though they remain at highly elevated levels, and the revision to 2Q GDP was not as bad as feared, though it confirms the meager pace of the US recovery. In a much anticipated speech, Fed Chair Bernanke repeated earlier comments that the Fed stood ready to undertake further unconventional easing measures if the outlook deteriorates more significantly, but was short on specifics about what might actually trigger Fed action. Perhaps most significantly, he did not make a concrete commitment to another round of quantitative easing (buying US Treasury or other debt), which effectively pulled the rug out from under bond prices. Bond markets have been on a moon-shot in recent weeks and the lack of assurances from Bernanke that fresh buying from the Fed would soon materialize sent the longs dashing for the exits, sending 10-year yields up over 16 bps on Friday alone and more than 20bps from their lows. That move inspired further gains in USD/JPY and the JPY-crosses, sending them out with actual gains on the week. (more…)

Highlights

• The USD bounces back on global weakness, positioning
• Eurozone debt concerns resurface
• JPY-strength may prompt official action
• Key data and events to watch next week

The USD bounces back on global weakness, positioning

Just a week after making new lows for the current decline, the USD has rebounded sharply against all other major currencies, though less so against the JPY. For the last several weeks, we had been suggesting that an eventual turn for the worse in economic data outside of the US would see the USD come back into demand. But where we were looking for a gradual turnaround in the data and most likely later in September, the shift came sooner and over a matter of days. (more…)

HIGHLIGHTS OF THE WEEK

• The FOMC reflects recent economic weakness with a dovish statement. “To help support the economic recovery,” the Fed also announces a plan to rollover asset purchases and maintain the size of its balance sheet.
• U.S. international trade data show a surprising jump in the trade deficit in July as exports fall 1.3% and imports jump 3.0%.
• Consumer prices beat expectations with a 0.3% M/M gain. Consumer price inflation (Y/Y) moves up to 1.3% from 1.1% previously. Core consumer prices edge up 0.1% M/M leaving the core inflation rate steady at 0.9%
• Retail sales rise by 0.4% on strong auto and gasoline sales. Core retail sales (excluding autos and gas) fall slightly by 0.1%.
• The dreaded ‘D’ word (deflation) is once again making the rounds. We join the discussion in our U.S. commentary this week.
• Canadian housing starts in July subsided to 189,200 units, ahead of market expectations but a decline of 1.6% from June. With starts having declined for three months, homebuilding appears to be easing in sync with cooling resale housing markets.
• Canada’s trade deficit widened to $1.1 billion in June from $0.7 billion in May, owing to a contraction in export volumes and a fall in export prices that outstripped the pull-back in import values. (more…)

HIGHLIGHTS OF THE WEEK

• A slew of positive macroeconomic data across Europe lifted market sentiment, underpinning the euro
• European financial stocks were up sharply and sovereign debt spreads narrowed significantly
• U.S. second quarter real GDP came in to the downside of expectations at 2.4% (annualized). Downward revisions to past growth show a deeper recession than previously thought with a peak-to-trough decline of -4.1%.
• Real consumer spending comes in weak at 1.6% (annualized) in Q2. Consumer spending growth is also up a meager 1.6% from its trough a year ago.
• St. Louis Federal Reserve President James Bullard says the U.S. is as close to a deflationary threat that it has even been and recommends the Fed do more to anchor inflation expectations.
• Canadian economic activity improves marginally in May, with real GDP growing by 0.1%.
• Goods-producing sectors, as in the past, are driving the recovery; however, these were also the sectors responsible for much of the decline in economic output.
• In particular, manufacturing, mining, oil, and gas extraction, transportation & warehousing, wholesale trade and retail trade have accounted for most of the peak-to-trough decline in overall real GDP, and the subsequent growth thereafter.
• If the 1980′s recession and recovery was a capital ‘V’, then undoubtedly the 2008-2009 recession would be a lower-case ‘v’.
• Overall, the current recovery will continue to be driven by goods-producing sectors such as manufacturing, construction, and mining, oil, & gas extraction due mainly to capacity underutilization.

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U.S. Review

Consumer Spending Still Contributing to the Recovery

• Following a solid first-quarter contribution, consumer spending remained expansionary as retail sales continued to gain ground in April. Despite a slip in core retail sales, consumer spending should continue to propel the recovery forward.
• The manufacturing sector’s V-shaped recovery remains intact. Led by improving global demand and domestic inventory restocking following an unusually long drawdown, total industrial production expanded further in April.

Despite Euro-zone Uncertainty, the U.S Economic Recovery Is Still on Pace

Economic indicators released during the week were mixed, but continue to suggest the recovery is under way. The nominal U.S. trade deficit for goods and services widened slightly in March to $40.4 billion with broad-based increases in both exports and imports. Both increases reflect the economic recovery that is occurring in both the U.S. and the global economy.

While trade data released this week continued to support an upward trend in exports, some market participants suggest turmoil in Europe and dollar strength will likely be deleterious for U.S. exports in the long run. Indeed, slow growth in Europe will result in somewhat slower growth in U.S. exports, but at around 20 percent of the total market share, it is simply not large enough to change the upward trajectory in U.S. exports if the rest of the world continues to grow.

Retail sales grew 0.4 percent in April due largely to the third consecutive increase in building materials, which grew 6.9 percent on the month. Core retail sales, which excludes autos, gasoline and building material sales, is now up 9 percent on a three-month annualized basis. While the Easter holiday helped boost first-quarter consumer spending, we still expect the second quarter to grow at around a 3.1 percent annual rate. With spending currently outpacing income growth, however, the rebound in consumer spending will likely lose some momentum in the second half of the year.

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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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This Week’s Market Outlook

Highlights

• Currency markets to remain beholden to the risk trade
• Bullion’s bull-run still intact
• Sterling takes a hammering, focus on 3Q GDP and public finances
• Key data and events to watch next week

Currency markets to remain beholden to the risk trade

The moves this week should convince anyone that had any doubt, that the correlation between equity markets and currencies remains alive and well. It was a rollercoaster, with EUR/USD oscillating between 1.4800 support and 1.5000 resistance for the better part of the week. The S&P 500 meanwhile continued to find interest on either side of the pivotal 1100 level. It seems that EUR/USD 1.50 and the S&P 1100 go hand in hand as both remain extremely challenging technical and psychological levels. Indeed, both have only closed above those crucial levels three times this year – euro in October and stocks just this week. It should not surprise anyone that the correlation between these two since the beginning of the second half of 2009 has been a stellar 92%. Don’t look for much to change on this front anytime soon.

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USD Sharply Lower, IMF Says USD Still Overvalued

FX Highlights

• The USD is trading lower to start the week pressured by stronger equity markets, in reaction to the G-20 meeting and by a statement from the IMF about the USD, the G-20 was silent on USD weakness and pledged to continue to support the global economy, the IMF says that USD is still being used as a funding currency and may be overvalued, EUR supported by strong industrial output data and widening of German trade surplus, commodity currencies supported by another record rise in the price of gold and higher price of crude, the Fed is expected to maintain low yields as worse than expected US unemployment threatens the US recovery
• Focus turns to today’s release of Canada’s housing starts
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Preview of Thursday’s BOE & ECB meetings

The Bank of England (BOE) will hold a policy meeting on Thursday November 5th. At the October policy meeting the BOE elected to maintain the current level of interest rates at a record low 0.5% and asset purchases at £175bln. The BOE indicated that they would keep the scale of the asset purchase plan under review. Two recent UK economic reports generated concern about the outlook for the UK economy and may encourage the BOE to expand its asset purchase plan at the November policy meeting. UK Q3 GDP posted an unexpected 0.4% decline.

The trade had expected a rise of 0.2% for Q3 GDP. The decline in GDP suggests that the BOE asset purchase plan has yet to boost the UK economy out of recession. UK manufacturing output fell by 1.8% in August. The decline in manufacturing output adds additional doubt about the UK economic recovery. The BOE must also take in consideration today’s report of continued UK bank troubles. The UK government announced Tuesday that it will take a bigger stake in RBS and Lloyds Bank. It is not clear if he BOE will hold its asset purchase plan unchanged or elect to expand the purchase plan by £25bln or £50bln at Thursday’s policy meeting. Today’s Wall Street Journal reports that a majority of economists expect the BOE to hold policy steady and expand its asset purchase plan by £25bln. Based on the UK Q3 GDP report it may be difficult for the BOE to refrain from adding additional stimulus. Recent GBP price action has found that the GBP benefits from BOE decision to hold the level of asset purchases and weakens when the BOE elects to expand quantitative ease. Monday, the BOE’s Blanchflower said that the BOE may expand its asset purchase program by another £50bln. The Sunday Times however carried a piece warning the BOE not to panic over the Q3 GDP report. GDP is seen as a lagging indicator.

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