** PERCENTAGES MAY NOT ADD UP TO 100% BECAUSE OF THE PROBABILITY OF LARGER OR SMALLER MOVES BEYOND THOSE SHOWN ON THIS TABLE
US DOLLAR RALLIES ON BERNANKE'S ACTION PLAN AND TRADE NUMBERS
The US dollar strengthened across the board today following better than expected economic data and more clarity from the Federal Reserve on their plans to stimulate the economy going forward. However the strength of the greenback could be fleeting particularly against the Japanese Yen as the upside surprises in US data masks underlying weakness. The December retail sales report is due for release tomorrow. Even though there is a chance that we may see an upside surprise, consumer spending is still expected to be negative for the sixth consecutive month.
Bernanke: Credit Easing Not Quantitative Easing
For the first time since cutting interest rates to 0.25 percent, Federal Reserve Chairman Ben Bernanke outlined his plan of action. In a speech at the London School of Economics, Bernanke talked about the additional tools available to the Fed, an orderly exit strategy, concerns about inflation and suggestions about how the Obama Administration should use the remainder of the TARP funds. Most importantly, Bernanke created a new name for his regime – credit easing. In contrast to Quantitative Easing, which Bernanke explains focuses on the liabilities portion of the central bank's balance sheet, Credit Easing focuses on expanding the asset side of the balance sheet. However since the balance sheet is suppose to balance, this may just be a difference of semantics since both efforts ultimately add liquidity into the financial system. The Federal Reserve wants to draw a distinction between their current policies and the Bank of Japan's policies between 2001 and 2006.
The Fed's Toolbox and Exit Strategy
As for the tools that they have at their disposal, there was nothing groundbreaking. Their number one tool is policy communication, followed by liquidity facilities for banks, facilities for other markets and purchases of long term securities. Like Federal Reserve President Lockhart, Bernanke expects interest rates to remain low for an extended period of time. As we expected, inflation is not a concern because the Fed believes that weaker growth will keep inflation low. In terms of an exit strategy, he expects demand for the emergency facilities to wane as the US economy improves. Like many members of the Bush Administration, Bernanke supports using the rest of the TARP funds on the credit markets. Without stabilization in the financial system, he does not believe that any fiscal stimulus will have a lasting impact on the economy.
Trade Deficit Hits 5 Year Low, Retail Sales Outlook
Meanwhile the US trade deficit narrowed materially in the month of November to the smallest level since June 2003. The better than expected report helped to fuel the dollar's rally. Although a narrower trade deficit is normally something to cheer about, the details of the report indicate that the only reasons why trade improved are because of falling oil prices and slower domestic demand. The big story is in imports, which plunged 12 percent in November. Unfortunately the strength of the dollar did not drive stronger US demand for foreign goods but it did cut exports by 5.8 percent. The IBD/TIPP economic optimism index also improved marginally. However dollar bulls need to cautious ahead of tomorrow's retail sales report. There is no question that consumer spending will be negative but the pace of contraction could slow given the smaller decline in the ICSC and SpendingPulse reports. If retail sales drops less than the market expected, the US dollar could extend its gains. The Fed's Beige Book report is also due for release and we expect the report to cast more doubt on the health of the US economy.
EUR/USD CONTINUES TO WEAKEN AHEAD OF ECB MEETING
If inflation is only thing keeping the European Central Bank from cutting interest rates, then the latest wholesale price report from Germany should eradicate their concerns. Wholesale prices plunged 3 percent on a monthly and annualized basis. This sharp decline can be almost entirely attributed to lower commodity prices. Other than a much weaker than expected US retail sales report, there is nothing stopping the EUR/USD from falling further ahead of the monetary policy decision. With US equities falling for the fifth consecutive trading session, risk aversion is also weighing on the EUR/USD. The market is already pricing in a 50bp rate cut for Thursday and the price action of the EUR/USD indicates a similar belief amongst currency traders. As a result, the risk is for a more Euro bullish outcome. ECB officials have been moaning and groaning about having to cut interest rates, which means that 25bp rate could be the middle ground.
GBP/USD BREAKS 1.45 AS TRADE DEFICIT HITS RECORD LEVELS
The UK trade deficit for the month of November hit the highest level since the country began keeping records in 1697, more than 300 years ago. The last time there was a surplus in the visible trade balance was in May 1985. Exports dropped 6 percent while imports fell 2 percent. Unfortunately the weakness of the British pound has failed to increase foreign demand. In the month of November, EUR/GBP rose from 79 cents to 85 cents while the GBP/USD fell from 1.6050 to 1.49. The latest trade data indicates that weakening global demand has completely dwarfed the stimulative effects of a weak currency. Based upon this data alone, the Bank of England will have no choice but to continue to cut interest rates because demand is not improving. According to the British Retail Consortium, retailers have suffered the weakest Christmas on record. The only silver lining is the hope that the impact of currency fluctuations on trade will hit the economy with a lag which means that the December figures could be better. Now that the GBP/USD has broken below the 1.45 level on an intraday basis, there is no major support until the 6 year low of 1.4350.
NZD/USD: S&P DOWNGRADES NEW ZEALAND'S CREDIT OUTLOOK
The Canadian, Australian and New Zealand dollars continued to weaken against the greenback as risk aversion sent investors flocking into the safety of the US dollar. Both the New Zealand and Australian dollars weakened significantly, breaking important support levels in the process. There was no Australian or New Zealand economic data released last night, but Standard and Poor's reduced their credit rating for New Zealand from stable to negative, which puts the country at risk of losing its AAA sovereign debt rating. Meanwhile Canada reported a much weaker than expected trade balance. The country's trade surplus shrank from 3.3B to 1.3B, an 11 year low. The toxic combination of falling oil prices and weaker US demand for vehicles has caused exports to drop 6.8 percent. Exports have fallen for the fourth consecutive month and will probably continue to fall in the months ahead. The disappointing report has sent the Canadian dollar lower against the US dollar and Japanese Yen. Over the next 24 hours, the market's focus will shift away from the Canadian dollar and onto the Australian and New Zealand dollars. Australian business confidence, home loans and investment lending reports are due for release tomorrow while New Zealand will be releasing its building permits data.
GBP/JPY HITS 30 YEAR LOW DESPITE WEAK ECONOMIC DATA
The Japanese yen appreciated against all of the major currencies today but the most significant gain was against the British pound. On an intraday basis, GBP/JPY fell to the lowest in more than 30 years. Weak economic data has not stopped the Japanese Yen from rising, but it will stop the Japanese economy from improving. The country's trade surplus turned into a deficit in the month of November. The current account surplus also dropped 65 percent due to a 26 percent decline in exports. The current account now stands at JPY581 billion, down from JPY960.5 billion. The amount of the negative news associated with trade and current account balance reports might support the claim that BOJ needs to intervene in the foreign exchange markets and stop the JPY from rising. This is a very tough decision for the BoJ and if verbal intervention continues to fail, they may have to resort to physical intervention for the first time since 2004. In reaction to the trade numbers, Finance Minister Nakagawa told the markets that he is watching the foreign exchange markets carefully and that rapid moves in currencies is undesirable. Other economic data also provides cause for concern. Bankruptcies surged 24 percent in December, the highest in close to 8 years. Bank lending accelerated at the fastest pace in 16 years, climbing to 4.1% in the month of December as companies are scrambling to receive monetary support to stay in business. Consumers are also feeling the pressure of the slowdown, as the Economy Watchers index plunged to the lowest levels since its initiation. Tomorrow, Japan is set to release its numbers for Machine Tools orders and Domestic Corporate Goods Prices which should confirm that manufacturing sector is continuing to contract.
EUR/USD: Currency in Play for Next 24 Hours
The currency in play over the next 24 hours is the EUR/USD. Eurozone industrial production numbers are due for release at 10:00 GMT or 5:00 EST while US retail sales numbers are due for release at 13:30 GMT or 8:30 EST.
The EUR/USD is trading well within the Sell Zone, which we determine using Bollinger Bands. It has also broken below the 50-day SMA, which was the closest level of support for the currency pair. It is now flirting with the 1.32 level, which is the 23.6 percent Fibonacci retracement of the 1.6037 to 1.2330 sell-off that lasted from July to October of 2008. The next level of support is not until the psychological level of 1.30. If the EUR/USD manages to rally back above today's high of1.3375, we could see a stronger rally that takes the currency pair above 1.35. However if it rallies, a close above 1.3600 will be needed to negate the downtrend.