It is a new trading week and growing doubt about the global economy has seeped through the financial markets once again. For the foreign exchange market, we are seeing broad based liquidation or weakness in all of the major currency pairs. The concerns are not unique to the US economy which is why we have not seen any consistent behavior in the US dollar. The greenback weakened against the Japanese Yen but it rallied against the Euro, British pound and the commodity currencies. For currency traders who simply have a view on the US economy and nothing else, the price action of USD/JPY has been best aligned with the trend of the US economy. All of the other currency pairs are diluted by speculation about upcoming interest rate decisions and commodity prices.

Desperate Times, Desperate Measures

So far, the month of January has been particularly tough for the US equities market. The Dow Jones Industrial Average has ended lower for the fourth consecutive trading session. Earnings season has begun and the reports that we have seen so far give more reasons for concern than relief. Alcoa is set to report this afternoon and if earnings were healthy, they would not have to make plans to lay off 13,500 employees. The strength in the US dollar in the fourth quarter will contribute to weaker earnings. There is also talk that Citigroup is considering selling a controlling stake in their brokerage operations to Morgan Stanley. This division is one Citigroup's most prized possession and the fact that they are even entertaining this notion suggests that they are in desperate need of capital. Desperate times call for desperate measures and this may only be the beginning of more weddings in the banking sector.

We are also keeping a close eye on the retail sector. Now that the holiday shopping season is over, retailers are reviewing their books and are faced with the difficult decision of whether or not to file for bankruptcy protection. According to this morning's WSJ, Loehmann's, Duane Reade, Bon-Ton Stores and Claire's Stores are all at risk. However, there is a chance that we could see a smaller decline in consumer spending since the pace of contraction in December is slowing according to the ICSC and SpendingPulse report. Before Wednesday's retail sales report, we have Tuesday's trade balance numbers. The export component of ISM remained in contractionary territory which suggests that exports in general have been weak. This is hardly a stretch considering the state of the global economy.

Monetary and Fiscal Stimulus: What to Expect

With US interest rates effectively at zero, many people are wondering what to expect from the US government. On Tuesday January 20th, the US will usher in a new President that has pledged to hit the ground running when he takes office. This morning, Barack Obama said that he has already asked President Bush to tap the rest of the TARP funds to get the ball rolling. The Bush Administration has already used $350 billion, leaving another $350 billion for the Obama Administration. Obama plans on using the money to help ease housing foreclosures and small businesses. This is a dramatic departure from the Bush Administration who spent the first half of the TARP funds providing support for the banking sector. As for monetary policy, Federal Reserve President Lockhart, who is a voting member in the FOMC said that the central bank could keep interest rates at zero for the entire year. If the US economy continues to weaken, expect the Fed to inject more liquidity into the financial system by buying up more US debt. With oil prices falling, inflation is not a problem. Looking ahead, we continue to expect more dollar weakness against the Japanese Yen but the EUR/USD may be nearing support.


There were 3 forces driving the Euro lower today – risk aversion, speculation about interest rate cut from the European Central Bank and the potential downgrade of Spain's AAA sovereign debt rating. Fears about consumer debt and the nation's finances have compelled Standard and Poor's to put the country on a negative ratings watch. They did the same for Greece on Friday and have recently cut the outlook for Ireland's rating from stable to negative. The risk of a deeper recession in the Eurozone is growing and that is why the market has priced in a 50bp rate cut by the European Central Bank on Thursday. However given the recent comments from the ECB, the risk is for a more Euro bullish outcome. The ECB could cut interest rates by 25bp instead of 50 and even if they do acquiesce by cutting interest rates 50bp, don't expect particularly dovish comments from ECB President Trichet. Like in past meetings, he will most likely moan and groan about having to cut interest rates and risk boosting price pressures. He will also give little signal as to where interest rates are headed next. Being behind the curve will hurt the Eurozone economy in the long run, but the ECB's reluctance to cut interest rates again could help the EUR/USD in the short term. Individual nations in the Eurozone have resorted to their own fiscal measures to stimulate their economies. Germany is planning to adopt a 2 year EUR50 billion fiscal package that would include EUR100billion worth of credit guarantees to help businesses raise debt.


Despite more innovative measures by the UK government to stimulate the economy, the British pound continued to weaken against the Euro and US dollar. The latest announcement from the UK government includes an emergency GBP500 million plan for employers to recruit and train new staff and cash for unemployed people looking to set up businesses. The UK has done everything from cutting interest rates, reducing the VAT tax, pumping money into the financial sector and taking stakes in banks. Now they are taking steps to directly reverse the weakness in the labor market. It will just be a matter of time before the UK government's aggressive efforts pay off. The deeper the sell-off in the British pound, the more optimistic we are about an end of the year recovery in the UK. However pound traders are not looking at the potential turnaround in the UK economy 3 months now. Instead, their focus is shorter term. The UK trade balance is due for release tomorrow and despite the improvement in manufacturing PMI, new and export orders declined.


The Canadian, Australian and New Zealand dollars sold off aggressively as weak economic data and lower commodity prices dragged the currencies lower. Oil and gold prices fell dramatically with crude trading at $37.70 a barrel and gold trading at $821 an ounce. The sell-off in commodities reflects the market's expectation for weak global growth. Back in December, oil prices fell to $33.87 a barrel, a 4 year low. Canadian economic data remains weak with house prices falling for the second consecutive month and business sentiment slipping to a 10 year low. The Canadian trade balance is due for release tomorrow and the drop in the IVEY PMI index signals a smaller trade surplus. Meanwhile job advertisements in Australia fell by the largest amount in 26 years, reflecting overall weakness in the Australian labor market. Business sentiment has also deteriorated materially in New Zealand according to the NZIER business opinion survey.


The sell-off in US equities dragged all of the Japanese Yen crosses lower. Japanese markets were closed yesterday for Coming of Age day but they are set to reopen this evening in force. There are ton of economic data from Japan this week starting with the trade and current account balance reports this evening. The strength of the Yen should turn Japan's trade surplus into a deficit in the month of November. In the British pound commentary we said that the deeper the decline in the pound, the more optimistic we are about a UK recovery. For Japan, it is the complete opposite. The stronger the rally in the Japanese Yen, the more pessimistic we are about the outlook for the Japanese economy. Toyota, the world's largest car maker has already suffered greatly from weaker global demand and a strong currency. It also doesn't help that Chinese imports have slowed materially - in December, imports fell 21 percent. As the primary engine of global growth over the past 10 years, slowing Chinese demand will have severe consequences for countries like Japan