Friday October 30, 2009

News on Friday included a decline in September's reading of consumer spending, coinciding with the closing of the stimulus spigot. While this news should not be confused with a fresh downturn for the U.S. economy it is a little disappointing, while inviting further consumer stimulus in the first quarter of next year. It does show that the U.S. consumer can indeed be led to the well. And the report is pouring a little luke-warm water on Thursday's strong GDP report and as it does so the dollar is gaining weight today.

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The dollar has pushed back against the euro to $1.4763 as investors take back almost half of yesterday's hearty equity market gains. At the same time data from the Chicago purchasing managers and from the University of Michigan in its consumer confidence index were both stronger than expected. One would usually expect these reports to depress the dollar but today there may be some month-end position squaring taking precedence of the usual knee-jerk responses to data.

Another less than typical item has also taken some of the gloss off risk appetite today. The Bank of Japan announced that it would end its purchase of domestic corporate bonds at the end of 2009. This fact was largely anticipated by investors and is not a major surprise. The Bank's intent all along was to make credit markets turn over manually at a time of engine failure. The resumption of normal credit market activity has once again presented corporate Japan access to credit and so removes the need for the central bank to continue.

The success of the measure today led to a rally in the yen because it essentially reduces the Bank's liquidity addition to the financial system. The supply of yen will therefore be reduced. A down day for equities and a rise in the typically risk-averse Japanese yen are conspiring to boost the dollar's value today. The yen rose against the dollar to ¥91.17 and against the euro to ¥134.50.

The downbeat mood flowed over into the commodity currencies where the Aussie dollar dropped by almost a cent to 90.77 U.S. cents. The mood was further darkened by news of a monthly contraction in Canadian growth. Investors had expected a 0.1% expansion for August but were depressed to learn of a contraction of the same magnitude at a time when Canadian auto plants were feeding U.S. led car sales. The number is a little confusing and we wonder how much (if at all) this vilifies the local authorities' argument that unwarranted currency strength hinders growth. The Canadian dollar eased to buy 92.50 cents as a result on Friday and is close to a one-month low.

With Norway's interest rate increase this week, the first European central bank to start taking back its monetary easing, investors are increasingly aware of the so-called removal of the punchbowl. Next week brings a whole host of central bank meetings and currency experts will be scrutinizing various accompanying statements to see if there are any subtle changes in the message they convey. We expect nothing out of the FOMC when they convey Fed policy on Wednesday.

This week the Bank of England completed its £175 billion asset purchase program and next week investors will look for an extension. The pound is not yet discounting that potential as negative, something investors balked at only two weeks ago. Instead sterling is holding up well to the dollar at $1.6514 on Friday after data showed strengthening consumer confidence and the first annual gain for home prices in 19 months. Against the euro the pound rose with one euro buying 89.35 pence.

Andrew Wilkinson

Senior Market Analyst