Forecasts of a dollar rebound in 2008 are becoming more frequent as the US current account and budget deficits continue shrinking further. The dollar is unlikely to pursue single directional moves against the major currency pairs in 2008 as was the case in 2007. The extent of the dollar rebound will largely depend on the scope of interest rate cuts in Europe, Canada and Australia , serving as an offset to further rate cuts by the Fed. The main reason we expect any dollar rebound to be relatively limited is the nature of the interest rate cuts. The Fedâ€™s 2008 rate cuts will be aimed at treating increasingly structural problems in nature (falling bank credit, deepening housing recession spilling onto price, sales and construction, an increasingly weak commercial property market and faulty consumer demand). Meanwhile, any rate cuts from the ECB, BoC and BoE are expected to address temporary/cyclical issues such as slowing business activity and reduced aggregate demand.
Gold seen reaching $700 before year-end
The gold correction is expected to continue towards the $700 per ounce target before year end on a combination of FX market repositioning and broadening retreat in risk appetite. A much anticipated December 11 Fed cut may trigger fresh equity losses in the event that a 25-bp rate cut is seen too little too late in an environment of plunging bond yields. FX repositioning means further unwinding of dollar shorts as we approach the end of the year. Although gold prices have fallen 8% from their highs 4 weeks ago, we expect further selling to ensue into the rest of the year. The anticipated declines are in line with our expectation for $1.42 and $2.01 in EURUSD and GBPUSD respectively before year-end.
Due at 10 am EST is US manufacturing ISM, expected to have eased to 50.6 from 50.9. But with the November Chicago PMI making a stronger than expected rebound to 57.4 from 46.9, we may see the ISM rising to as high as 51. Markets will also watch the new orders and employment sub-indices. The former slipped to 52.5 from 53.4, while the latter rose to 52 from 51.7.
Euro seen testing $1.45 this week
Rising inflationary pressures have been the main obstacle standing in the way of ECB rate cuts. A 3.0% inflation rate in November is well above the bankâ€™s preferred target of 2.0%. Even barring high inflation, Eurozone activity continues to show signs of strength, such as all time lows in Eurozone unemployment rate and improved business sentiment in Germany â€™s IFO survey. Indeed, Eurozone manufacturing PMI rose to 52.8 in November from a 26-month low in October.
Nonetheless, shaky consumer confidence figures from Europe coupled with the overall decline in commodity prices will likely trigger further unwinding gold, oil and net dollar shorts. Looking at the EURUSD weekly chart, we expect the $1.46 figure to be tested early this week. With our forecast for gold reaching $750 this week, we could well see the $660 in the second half of December. The possibility of a $1.45 reading hinges primarily on further signs of a European cooling, while specsâ€™ continued retreat of net longs is likely to accelerate momentum. Upside seen capped at 1.4750, followed by 1.4820. Support stands at 1.4620, followed by 1.4580.
No BoC rate cut seen on Tuesday
We expect the Bank of Canada to leave rates unchanged tomorrow as not only the loonie has already weakened 11% from its highs over the past 4 weeks, but also the Canadian economy continues to show signs of strength that do not yet warrant an easing. Last weekâ€™s release of Q3 GDP showed an expectedly strong 2.9% increase mainly due to robust personal expenditure. The looniesâ€™ decline has been mainly a result of the 13% decline in oil prices and weaker than expected CPI. But the decision to leave rates unchanged at 4.50% may not necessarily be CAD positive as the BoC will likely maintain its cautious stance in the policy statement, raising its concerns for negative spillover from the US and the strong loonie. We expect support to crop up at 0.9960, backed by 0.9920. Upside seen extending towards 1.0020, followed by 1.0050.
USDJPY capped at 110.80
Last weekâ€™s USDJPY rebound from 108 to 111.20 coincided with a run-up in US equities that was largely result of the Abu Dhabi Investment Authorityâ€™s $7.5 bln purchase of 5% in Citigroup and increased indications by the Federal Reserve officials that a rate cut may be needed at the December 11 meeting. Despite the sharp rebound, 110 yen remains the new anchor level in the pair even if further gains are seen testing 111.75. On the short-term, we expect USDJY capped at 110.70, followed by trend line resistance at 111. Support seen at 110.30, followed by 110.
Aussie remains pressured by medium term appetite outlook
As in the case of the ECB, the Reserve Bank of Australia faces rising inflationary concerns, which explains the rate hikes of September and November, months characterized by broadening damage in global equities. Yet the recent retreat in the Aussie from its 94-cent high has been mainly a result of the deterioration in global risk appetite weighing on high yielding currencies. Our expectation for further losses in equities and gold leave us to expect further retreat in the Aussie at 85.80 cents. A rate cut by the Fed is seen producing considerable boosting to the Aussie, associated with rising risk appetite. In the event that the incoming price action in equities shows further gainsâ€”based on optimism of a Dec 11 rate cut, we may see the Aussie strength extending ground towards 90 cents.
Sterling eyes $2.0450
UK purchasing managers index rose to 54.4 in November from Octoberâ€™s 52.8, defying expectations of a decline to 52.9. But we continue to deem sterling advances are largely short-term in nature. In light of our expectations for prolonged dollar selling in Euro FX and gold pull down, we expect GBP to test the interim support of $2.06, followed by 2.0570. Last weekâ€™s soft figures from UK (housing prices, mortgage lending and CBI) provide the fundamental reason for sterlingâ€™s decline. Upside seen capped at 2.0670, followed by $2.07.