FOREX TRADING

FOMC Indicate A Sooner Than Expected Asset Sale In A Move To Drain Liquidity From The System!

• Yesterday’s trading saw a stronger USD across the board following the FOMC release of its January meeting. To summarize, the report communicated to the market that the Fed should start selling its assets soon so as to drain liquidity from the market. Philly Fed President Plosser said that he prefers the Feds balance sheet to return to pre crisis levels which is aligned with the views of Kansas City Fed President Hoeing’s position. On the data front we saw a rise in US industrial production by 0.9% indicating good strength in the manufacturing sector and housing starts also climbed by 2.8% showing a strong recovery in the housing sector as well. US 2 year yields rose to 0.88% following the FOMC minutes and USDJPY price action was between 90.15 – 91.38.
• In Europe we had a weaker than expected trade balance report coming in at EUR4.4bln. On the topic of Greece a spokesman in Brussels commented that Greece has not made any requests for financial help and also said that the monetary bloc was able to maintain financial stability. However it must be noted that Goldman Sachs took part in helping Greece issue certain off balance sheet derivatives so as to hide the magnitude of Greece’s deficit. EURUSD price action yesterday saw a rally up to 1.3787 and subsequently got hammered all the way back to 1.3556.
• In Japan we had the BoJ 2 day policy meeting take place; the result was to keep rates unchanged at 0.1%. BoJ Governor Shirakawa said in an earlier statement that the BoJ will maintain its easy monetary conditions so as to help the recovery.
• In the UK the BoE minutes showed the unanimous agreement to pause QE however the minutes showed that a few members are cautious about the nation’s economic outlook. The minutes also showed that the MPC ”would provide further monetary stimulus should the inflation outlook warrant such measures.
• Today the financial calendar will show CBI trends for the UK expected to come in at -36 and the public sector net borrowing figures (PSNB) expected to have dropped by GBP2.8bln. In the US we will have jobless claims initial and continuous. Producer prices and Phily Fed business index are also expected out of the US calendar today.

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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…)

USD Higher, Jobless Claims Post a Sharp Drop

• USD: Higher, jobless claims post an unexpected sharp decline, few details on Greek bailout
• JPY: Higher, Japanese markets closed for holiday
• EUR: Lower, pressured by lack of details of EU Greek support plan
• GBP: Higher, supported by gains in cross trade to the EUR
• CAD and AUD: AUD & CAD higher, stronger Australian employment growth, Chinese inflation slows

Overview

USD traded mixed Thursday with the EUR pressured by report of a vague promise from the EU to help Greece and the AUD surging in reaction to report of much stronger than expected Australian employment data. According to EU officials the EU is working on a plan to help Greece avoid debt default but the details of the plan have not been released. Australia’s unemployment rate declined and jobs growth was three times stronger than expected in January. The combination of the Greek support plan and the Australian employment report contributed to improving risk appetite along with a report that China’s January consumer prices rose at a slower than expected pace. China’s January CPI rose by 1.5% the trade had expected a 2% rise. Slower inflation growth in China reduces fear of the need for aggressive tightening from China. China’s central bank signaled that it plans to maintain accommodative monetary policy. The improvement in risk sentiment was somewhat dampened by the fact that China also reported that lending was the third highest on record in January and the US Congressional oversight panel warned that 3k US banks may have to curtail retail lending because of exposure to commercial real estate loan risk. Growing risk of commercial real estate loan default may be the next looming crisis for the financial markets. US economic data was positive with jobless claims posting a sharp drop. A Bloomberg survey of economists finds that the majority of economists surveyed believe that US employment rate has peaked at 10.1% will fall to 9.5% per year end. The White House forecasts that nonfarm payrolls growth will be 95k a month in 2010 with unemployment averaging 10%. The White House expects payroll growth to accelerate by 190k per month in 2011, 251k in 2012 and 274k in 2013 with unemployment falling back to 5.5% by 2016. The USD continued to gain versus the EUR after the release of the US jobless claims report and in reaction to the statement that the German Free Democratic Party has yet to consent to the Greek bailout. EUR traded to the day’s lows in reaction to a statement from an EU official that they will deal with Greece in March. (more…)

USD Higher, Trade Deficit and Bernanke Pressure Stocks

• USD: Higher, risk aversion re-emerges, uncertainty about EU Greek bailout plans, trade deficit widens
• JPY: Mixed, machinery orders and corporate good prices turn higher, CAPEX spending improves
• EUR: Lower, concern Greek rescue plans may slow the EU recovery
• GBP: Lower, BOE cuts UK inflation and growth forecast, King says the bank may consider expanding QE
• CAD and AUD: AUD & CAD lower, China’s trade surplus narrows, risk aversion re-emerges

Overview

USD traded firmer Wednesday supported by uncertainty about a potential Greek rescue plan, weaker than expected trade data from China and Bernanke’s testimony on withdrawing liquidity. The EU is expected to release the details of a plan to support Greece but there is concern that whatever plans emerge that EU sovereign debt risk and the need for austerity measures present a threat to the EU and the global recovery. According to a Bloomberg survey, optimism about the USD is at a 15 month high with the USD supported by concern that sovereign debt risk in Europe will hurt the EU and global recovery. China’s trade balance for January unexpectedly narrowed to 14.2bln, a reading 19.5bln was expected. Narrowing of China’s trade surplus generates concern about the strength of the global recovery. Bernanke laid out the Feds plans for withdrawing liquidity as the economy recovers in testimony before Congress today. He said that the timing of exit will be data dependent and the Fed may soon consider raising the discount rate. He went on to say the Fed can use the interest-rate paid on reserves, selling of Fed security holdings, reverse repos or offering of term deposits to depository institutions as ways to guide monetary policy. Bernanke said the Fed will eventually have to raise rates. The US trade balance widened by a much more than expected 10%. Widening of the trade balance was due to a 4.8% increase and imports in the impact of recent USD strength. The widening of the trade deficit and Bernanke’s rate hike talk pressured US equities and supported the USD. The trade awaits the outcome of Thursday’s EU summit for details of what the EU plans for Greece. According to a German official Greek aid is not on Thursday’s agenda. FX price movement has been volatile with risk appetite supported by optimism about Greek rescue plan and risk aversion re-emerging on uncertainty about the implications of the rescue plan for the EU recovery. Some analysts warn of a moral hazard if EU bails Greece out, but the EU may have little choice. (more…)

Potential Eurozone Assistance for Greece Gives Risk a Boost

Forex News and Events:

Markets were very busy yesterday pricing in speculation and conjecture. The day started with rumors that ECB’s Trichet had left a meeting of central bankers prematurely to head to Brussels to address the Greek situation. Then, later in the day, a German official was cited in say that the Eurozone governments have decided to ‘take significant steps’ to support Greece. This buzz sent traders scrambling out of their safe haven hiding spots. The EURUSD traded up from 1.3700 to nearly 1.3840, while AUDJPY climbed to 0.8800. The rapid move also caught the markets that were considerably short EUR off guard, and the ensuing short squeeze gave the move a frantic feel. Later and through today, German officials are continuing to adamantly deny that any decision on aid for Greece has been made. The Maastricht treaty is vague in this unexplored area, but it seemingly forbids guaranteed loans from the ECB or member states (assuming “liabilities of other member states”) and discrediting today’s WSJ article. However, support could come directly from unguaranteed loans from member states. Hence, the constant mention of Germany. It’s really just a gut feeling the current rhetoric was aimed to relieve pressure and buy time (halting “contagion” speculation). We do believe some sort of stability or bailout program is imminent, but in this rushed, manic fashion. Overshadowed by the gossiping (potential teleconference between EZ ministers this afternoon) UK released Industrial production data and Inflation reports. The Industrial production climbed to m/m 0.5% vs. 0.2% exp, while the inflation forecast on the two year time horizon was revised slightly down. For tomorrow, markets are expecting the Riksbank to leave interest rates on hold at 0.25% this month and also look for the central bank to upgrade its forecasts for employment, growth and inflation. For now, policymakers continue to affirm that they will raise rates in the Autumn of 2010, citing uncertainties to the Swedish economic recovery as the basis for their cautious approach. Nevertheless, if the fundamental rebound in Nordic economy is faster than expected, markets could start bringing forward their timeline for the first hike to July. (more…)

Sterling Falls To A Nine Month Low As The Euro Zone’s Debt Worries Investors

The British pound fell to nine month low against the dollar as concerns over euro zone sovereign debt problems boosted the appeal of the greenback as a safe haven currency. Worries about debt problems in the euro zone have extended beyond Greece to Spain and Portugal, hitting riskier assets, with sterling falling in tandem with the euro against the greenback. Last week producer prices data showed further upward pressure on UK inflation, with British manufacturers raw material costs up more than expected last month and continuing to rise at their sharpest annual rate since October 2008. Traders said position adjustment ahead of the weekend accelerated selling of the pound, which has lost close to 2 percent against the dollar this week. The GBP/USD is currently trading at $1.5570 as of 7:14am, GMT, with a bullish trend.

The euro continued to fall this week against the dollar on speculation widening budget deficits in European nations such as Greece and Portugal will deter investors from buying the region’s assets. ‘As sovereign risks spread in the euro-zone, risk aversion will continue in the market,’ said Susumu Kato, chief economist in Tokyo at Credit Agricole Securities, a unit of France’s Credit Agricole SA. ‘Implications of the financial issues remain unclear, which has weighed heavily on the euro.’ (more…)

Fed Upgrades Economic Outlook, A Dissent on “Extended”

Today’s FOMC statement was more optimistic on the economy with emphasis on improvement in business and investment spending. “Subdued” inflation remains. Dissent brings into question the length of easy policy.

Economic Outlook: Upgraded

Economic activity “continued to strengthen” according to the FOMC statement. We would agree. Household spending continues to expand but with the drag of income, wealth and credit constraints. The story here though is the upgraded outlook for business spending in equipment & software. Again we agree, orders and shipments reports have improved in recent months and that is consistent with increased capital spending.

Our outlook for 2010 is for 2.7 percent growth compared to the recession of last year with equipment & software spending up 4-5 percent compared to a drop of more than 15 percent last year. Two interesting aspects appear in this recovery from these trends. First, gains in the economy are associated with no additional labor so far. As a result, we are seeing very strong productivity gains. Second, adding capital equipment without labor suggests a rise in the capital/labor ratio. These two trends suggest increased returns to a smaller workforce but more limited job opportunities to those without the right skills. (more…)

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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USD Pares Gains as Consumer Confidence Rises

• USD: Higher, spike in risk aversion as China’s tightens monetary policy, consumer confidence rises
• JPY: Higher, China to hike reserve ratios on two major banks, BOJ policy unchanged, cuts deflation forecast
• EUR: Lower, above forecast German IFO fails to boost demand
• GBP: Lower, UK GDP disappoints, UK crawls out of recession, Pimco’s Gross says avoid UK debt
• CAD and AUD: AUD & CAD lower, China’s reserve ratio hike discourages demand for high yield currencies

Overview

USD traded higher Tuesday supported by a spike in risk aversion as equity markets decline in reaction to report that China hiked reserve ratios on some of its banks. Tightening of monetary policy in China generates concern about the global recovery. GBP was pressured by a report of weaker than expected UK Q4 GDP.EUR traded lower despite report that German IFO came in above forecast. GBP and EUR were pressured by selling in cross trade to the JPY with JPY supported by safe haven flows as equity markets decline. JPY traded higher despite S&P lowering of Japans bond outlook to negative from stable. S&P placed Japan on negative watch due to concern about Japan’s rising debt load and lack of flexibility to deal with reducing the debt. Commodity currencies traded lower tracking the spike in risk aversion and weaker commodities with crude oil prices falling below $74 a barrel. There was limited reaction to report that Fed officials are considering adopting a new benchmark interest rate to replace the one used for the last two decades (Fed funds). According to a Bloomberg report Fed officials are considering interest on reserves as the new benchmark rate. Today’s US economic data was mixed with case Shiller home price index down and consumer confidence rising. USD came off its high after the consumer confidence report. Focus turns to Wednesday’s FOMC meeting and President Obama’s State of the Union address. (more…)

U.S. Review

Disappointing Economic Data Continue in January

• The economic data this week largely disappointed equity investors and missed analyst expectations.
• Homebuilder confidence has ebbed as new home sales remain sluggish and buyer traffic has dropped since September.
• A pull-back in the January Philly Fed index has raised concerns about the strength of the economic recovery in the first quarter.
• Expect slower economic activity in January following robust improvement in the fourth quarter.

Reality Bites

Political upheaval in Washington with the election of Republican Scott Brown to the Senate turned conventional wisdom on healthcare reform and financial sector reform on its head this week. Regulatory risk has risen against the banking industry as the Obama Administration tries to score political points off of popular anger over bank bailouts and executive compensation and bonuses. At the same time, the economic data released this week pointed to weaker expansion as the first quarter gets underway.

The NAHB/Wells Fargo builders’ sentiment index dropped another point in January to 15 from a post-bubble peak of 19 last September. The index is still seven points above where it was a year ago. Prospective buyer traffic has dropped five points since September’s first time homebuyer credit surge. Regionally, the biggest declines in the housing market index since September have come from the Midwest followed by the Northeast and South. The regional index in the West has been comparatively steady.

Housing starts took a step backward in December dropping 4.0 percent as rough weather seems to have hampered single-family starts, which dropped 6.9 percent. On a more encouraging note, multi-family starts jumped another 12.2 percent in December after a steep 70 percent increase in November. The permits data continue to point toward a sustainable recovery in housing activity. Housing permits have risen for two consecutive months, gaining another 10.9 percent in December. Total housing permits are now running 15.8 percent above year ago rates with single-family permits running a whopping 37.3 percent above last year’s rates.

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BoC Monetary Policy Report – Raises 2010 Inflation Profile Though Does Not Signal Change to Policy Outlook

In the final analysis, the details of the Bank’s forecast show a mild nudge up in its expectation for growth in Canada’s economy over the next couple of years. The 2010 real GDP forecast was trimmed back to 2.9% from 3.0%, while 2011′s forecasted growth rate rose to 3.5% from 3.3%. Not significant changes on either year’s growth rate, but they balance out to a 0.1% overall increase compared to the October projection. The Bank was more aggressive in terms of upgrading its forecast for the global economy with world GDP growth forecasted to increase by 3.7% in 2010 (from 3.1% in October) and 4.1% in 2011 (from 4.0%). In terms of its outlook for inflation, the Bank boosted the 2010 headline and core forecasts. The updated forecast looks for the core rate to average 1.6% in the first-quarter 2010 (from 1.4% in October) and 1.7% for the entire year (from 1.5% in the previous forecast). The headline rate was also bumped up in 2010 and forecasted to average 1.8% (from 1.4%). Forecasts for core rate were unchanged in 2011 while the headline rate is expected to be one-tenth higher in the first quarter of 2011 and then settle back into the prior forecast.

The other notable change in the forecast was oil prices, which are assumed to be higher over the forecast horizon, averaging $83.50 in 2010 (from $76.5) and $88.00 in 2011 from ($80.00). The assumed level of the Canadian dollar was unrevised at 96 U.S. cents, and the Bank still expects non-energy commodity prices to increase “progressively” and credit conditions to “gradually improve.”

The report presented changes to the quarterly profile for growth in Canada’s economy throughout 2010 and the first quarter of 2011. Growth is expected to be slightly milder in the first quarter of 2010 but to accelerate at a faster pace in the following four quarters. The combination of a strong Canadian dollar and weak U.S. demand will weigh on net exports, which are forecasted to trim 1.2% from the 2010 growth rate. Imports are expected to increase at a faster pace than exports this year likely helped along by the stronger currency making purchases from abroad less expensive. In 2011, however, higher commodity prices and a stronger U.S. economy will see net exports contribute to growth in this update, a switch from the October outlook, which forecasted that the sector would restrain overall growth in 2011.

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News and Events:

This morning’s UK CPI was sharply higher than forecasts; coming in at a monstrous 0.6% MoM, 2.9% YoY in December, up from last month’s 0.3% MoM, 1.9% YoY rise. Today’s reading comes within a fraction of hitting the 3% threshold where BoE Governor King would be obliged to write a letter to the UK Chancellor of the Exchequer to explain the massive overshoot above the 2% target. GBPUSD has responded with a knee-jerk spike higher to 1.6456 levels, but the momentum of the move has lacked much follow through, as there are a couple of mitigating factors to consider. Firstly, it was clearly outlined in the BoE’s Quarterly Inflation Report last November that the MPC expected a sharp rise in CPI around the turn of the year, and, according to their forecast, this would drop back towards target in the subsequent months. Secondly, despite optimism for UK growth prospects going forward (stimulated by an article in the UK Telegraph newspaper today), the UK remains the only economy in the G10 that has yet to emerge from recession; leaving the slightly uncomfortable possibility that analysts begin to consider a stagflationary scenario (high inflation, negative growth). (more…)

U.S. Review

The Fourth Quarter Ended on a Weak Note

• We raised our estimate of fourth quarter real GDP growth to a 5.6 percent pace based on recent data on business inventories and international trade.
• December economic data continue to come in below expectations. Retail sales declined 0.2 percent and sales excluding motor vehicles fell 0.3 percent.
• The Fed’s Beige Book and the National Federation of Independent Business survey showed conditions continuing to deteriorate across much of the country.
• Consumer prices rose 0.1 percent in December.

Caution Remains the Buzz Word

Businesses and consumers remain exceptionally cautious and will not likely be phased by a blowout real GDP number for the fourth quarter. We have recently raised our estimate for fourth quarter real GDP growth to a 5.6 percent annual rate. A substantial slowdown in the rate of inventory liquidations will account for the overwhelming majority of that gain. Final demand remains exceptionally weak and, while the worst of the layoffs appear to have passed, there is little sign hiring is set to pick up. Three major reports, the National Federation of Independent Businesses (NFIB) Small Business Optimism Index, the BLS Job Openings and Labor Turnover (JOLTS) report, and the Fed’s Beige Book reiterated this point this past week.

The NFIB Small Business Optimism Index fell 0.3 points to 88.0 in December. Plans to hire increased modestly but remain in negative territory, rising to -2 percent from -3 percent. In addition, fewer businesses said they were able to raise prices and fewer planned to boost inventories. The one positive aspect of the report is the number of firms stating they planned to boost capital spending rose slightly, climbing 2 points to 18 percent.

The lack of any clear sign that hiring is picking up is particularly discouraging following last Friday’s weak employment report. Job openings in the November JOLTS report fell back to their series low of 1.8 percent. The number of hires and number of total separations both increased in November but total separations still outnumber hires, indicating employment declined on a net basis. There has been a slight improvement in hiring over the past five months. The number of people hired each month peaked in July 2006 and fell by 1.7 million by June of 2009. Hiring has since increased by 257,000 per month.

Total separations, which include quits, layoffs and retirements, rose in November but have generally been trending lower. The combination of fewer hires and fewer separations means that businesses are reducing their workforces more through quits and retirements today than by layoffs. The data also provided the missing link as to why the drop in weekly first-time unemployment claims has not translated into a net increase in nonfarm payrolls.
The Fed’s Beige Book also noted weaker economic conditions and relatively few districts had anything positive to say about the employment outlook. Most districts said layoffs continued but most also noted there has been some reduction in the number and size of cutbacks and that more firms are opting for hiring freezes or reducing hours instead of making large-scale cuts.

The other major disappointment this week was November’s retail sales report, which showed a 0.3 percent drop for December. Earlier reports had indicated that chain store sales were up for the month, so expectations for the Commerce Department’s retail sales figures were high. The Commerce Department sales figures are adjusted for both seasonal and holiday day changes and this year’s earlier Thanksgiving means that more holiday shopping took place in November and sales were thus pulled forward. On a net basis, holiday sales still show modest gains from last year.

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Dow -102 S&P -11.7 NASDAQ -22.2

ECONOMIC DATA

(RU) Russia Dec Official Reserve Assets: $439.0B v $441.8Be

(CL) Chile Dec Copper Exports: $3.2B v $2.9B prior

(IS) Israel Dec Consumer Prices M/M: 0.0% v 0.3%e; Y/Y: 3.9% v 4.2%e

(PD) Poland Nov Trade Balance: -€292M v -€750Me; Current Account: -€1.2B v -€975Me

(CA) Canada Nov New Motor Vehicle Sales M/M: -7.0%e v 3.5% prior

(US) Dec Consumer Price Index M/M: 01% v .2%e; CPI Ex Food&Energy M/M: 0.1% v 0.1%e; CPI NSA: 215.949 v 216.000e

(US Jan Empire manufacturing: 15.92 v 12.00e

(BE) Belgium Nov Trade Balance: €1.9B v €0.9B prior

(US) Dec Industrial Production: 0.6% v 0.6%e; Capacity Utilization: 72.0% v 71.8%e

(US) University of Michigan Confidence: 72.8 v 74.0e

(MX) Mexico Central Bank Interest rate leaves Overnight rate unchanged at 4.50%; as expected

JP Morgan’s disappointing earnings report is hammering US indices this morning. Investors have all but forgotten Intel’s hot quarterly report from yesterday. The final CPI reading of 2009 showed that consumer inflation was tame last year, with prices rising 2.7%, following at 0.1% increase in 2008. The January Empire Manufacturing was better than expected, with very strong growth in the prices paid (hit a one-year high) and new orders components. (more…)

Inflationary Levels Subdued Over the Short Term, Rising on the Long Term

The cost of living in the U.S continues to rise on the long term whereas the yearly Consumer Price Index reported today about the month of December showed rising inflationary levels on the long term while on the short term it is still below the Fed’s target rate.

The Commerce Department report, Consumer Price index inclined in the month of December by 0.1% compared with the previous rise of 0.4% while markets were expecting 0.2%, while on the yearly scale the index rose by 2.7% compared with the previous 1.8% and the expected 2.8%.

As for the Core CPI; which excludes food and energy prices, the index rose during the same month by 0.1% compared with the previous flat reading and the expected 0.1%, while on the yearly scale the Core CPI dipped slightly to 1.7% which came in below the previous and the expected 1.8%.

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