** PERCENTAGES MAY NOT ADD UP TO 100% BECAUSE OF THE PROBABILITY OF LARGER OR SMALLER MOVES BEYOND THOSE SHOWN ON THIS TABLE
US DOLLAR: FINALLY SOME GOODS NEWS?
Better than expected US economic data was like a breath of fresh air for the currency markets today. Producer prices fell less than expected last month while manufacturing conditions in the Empire State and Philadelphia regions improved. The dollar rebounded against the Japanese Yen indicating that risk aversion is abating, albeit modestly. The overwhelmingly pessimistic investors will not be easily swayed by a few pieces of secondary economic data, especially since all of the numbers are still in negative territory. Looking ahead, we will have another busy day in the currency market with US consumer prices, the Treasury International Capital flow report, industrial production and consumer confidence due for release.
Good News Fails to Impress
With the US economy in recession, any good news is still shrouded in weakness. Despite the rebound, a sharp decline was seen in the employment component of the Empire State and Philly Fed surveys. Much of the improvement can be attributed to lower oil prices and softer inflationary pressures. We see the same story in the producer price report. Oil prices fell more than 35 percent in the month of December, driving producer prices lower for the fifth consecutive month. Excluding the more volatile food and energy components, producer prices actually rose 0.2 percent last month. However the big story was the jump in jobless claims which rose to 524k from 470k. Since the beginning of November, weekly jobless claims have averaged above 500k. The dip in the last week of December and the first week of January was most likely due to seasonal factors. It is earnings season and unfortunately the earnings reports are being accompanied by layoff announcements. Pfizer recently announced a round of layoffs while Microsoft is expected to cut staff next week. With job security still a major problem for many Americans, consumer confidence should remain weak.
Impact of Lower Oil Prices
Oil prices dropped below $35 barrel today for the first time in close a month after OPEC warned that demand will fall this year as fuel use decreases. China is no longer growing at the double digit rates that they have been known for and along with that, their demand for oil is falling. Lower oil prices will help to support the global economy but for countries in the Middle East or Canada, the double blow of slowing global demand and falling commodity prices could force these big spenders to cut back significantly. For central banks around the world, lower inflationary pressures will allow them to continue to ease monetary policy or at least maintain ultra low interest rates for an extended period of time.
Will the Obama Administration Change Its Approach on China?
Tomorrow's Treasury International Capital flow report will shed more light on whether the low yield in the US has driven sovereign wealth funds out of the US dollar. According to a recent report by China, they have continued to buy US dollars despite doubt that they would be unwilling to fund the growing US deficit. With the Bush Administration leaving office on Tuesday, it is interesting to consider if the Obama Administration will change its approach on China. As Treasury Secretary, Paulson has favored the buddy versus bully approach to China. Although the Chinese Yuan has appreciated 15 percent over the past 2 years, it is still considered undervalued. If Obama labels China as a currency manipulator or takes more active measures to get the Asian giant to strengthen the Yuan, it could lead to further USD/JPY weakness as it would give the Bank of Japan less reason to intervene and sell the Yen.
EUR/USD: ECB CUTS 50BP, SIGNALS POTENTIAL PAUSE IN FEB
After having cut interest rates by 50bp this morning to 2 percent, ECB President Trichet is finally buckling down and signaling that he is ready to cut interest rates again BUT NOT UNTIL March. Despite the weakness in the economy and softer inflation pressures, the hawk in Trichet refuses to die. By saying that the Feb meeting will not be important suggests that pausing is still an option. The next meeting that matters is in March at which the ECB will release new projections. The Feb meeting is only 3 weeks away but by March, they will have a lot more economic data to base their decisions. The possibility that the ECB could leave interest rates unchanged next month is driving the Euro higher. We will probably see the Euro recover for the rest of the week but it is important for FX traders to realize that Eurozone interest are still coming down. Zero interest rates are not an option but the terminal rate for the ECB is likely to be as low as 1.25 percent.
Up until now, Trichet's biggest concern is price stability and for the first time in this easing cycle, he believes that the risks to price stability are broadly balanced. This is a big shift for the central bank and one that should not be ignored. The 50bp rate cut today reflects weaker growth and lower inflation risks. A lot has changed since the last meeting as the problems in the Eurozone economy worsen. Not only is the region in recession but many countries are at risk of getting their sovereign debt rating downgraded. Greece's credit rating was cut by S&P yesterday. There are no silver linings for the Eurozone. Unemployment is rising and consumer spending is contracting. According to the Trichet, the risks to growth are certainly to the downside. Eurozone governments will have to dig deeper into their pocketbooks to deliver enough fiscal stimulus to turn their own economies around. Over the next few months, we expect weaker economic data that provides more of evidence of the continual slowdown in the Eurozone economy.
GBP/USD EXTENDS GAINS FOR SECOND DAY
For the second day in a row, the British pound has strengthened against the US dollar and Euro. No economic data was released from the UK and nothing is expected for the next 24 hours. In their continuing efforts to stimulate the economy, the UK has unveiled a new plan to help the auto industry. They are considering providing a special liquidity program that would allow auto loan providers to give favorable terms to customers looking to buy new cars. They are also talking about setting up a bank that would absorb toxic debt. We continue to believe that the innovative efforts by the Bank of England will pay off in the long run and the price action of the British pound indicate that the market may be waking up to this notion as well. This could lead to further gains in the British pound, particularly against the Euro.
USD/CAD BREAKS 1.25
The Canadian and New Zealand dollars continued to slip against the greenback. As oil prices drop, so does the Canadian dollar. Economic data was also weak with new motor vehicle sales in Canada falling 7 percent in the month of November, the largest decline in 3 years. The US is the largest importer of automobiles manufactured in Canada and unfortunately demand has waned significantly. New Zealand house prices also saw a larger decline in the month of December but the currency's weakness is most likely tied to concerns about a potential downgrade of their sovereign debt rating. Meanwhile the Australian dollar was the only commodity currency to rally against the US dollar. Labor market numbers were much stronger than the consensus forecast with employment falling by only 1.2k in the month of December. The unemployment rate ticked higher, but the important thing is that less people lost their jobs.
USD/JPY: STOCKS STABILIZE, YEN CROSSES RECOVER
Japanese Yen crosses recovered thanks to the mild rebound in US equities. Having been down as much as 2.5 percent, the Dow Jones Industrial Average experienced a dramatic reversal that left it up 0.15 percent on the day. The economic outlook for Japan continues to be grim, as the Machinery Order fell by a record 16.2% from the previous month. The current outlook for the intermediate timeframe continues to be negative as economic figures on business sentiment and spending continues to get worse. A testament to the following is cuts in the production of vehicles from Nissan, which joined its rivals, Honda and Toyota in the reductions of output. BoJ announced earlier, starting this month that it is planning on buying as much as ¥22 trillion yen ($22.2 Billion) of commercial paper in order to supply liquidity and unfreeze credit. Later in the day, Bank of Japan will have its Quarterly Branch Managers' Meeting which will primarily focus on alternative option in order to unfreeze credit for struggling businesses.
USD/CHF: Currency in Play for Next 24 Hours
The currency in play for the upcoming 24 hours will be USD/CHF. Switzerland is expected to release its figures for Producer and Import Prices at 8:15GMT or 3:15AM EST. United States will be announcing its figures for CPI around 13:30GMT or 8:30AM EST, along with U. of Michigan Confidence which will be released at 15:00GMT or 10:00AM EST.
After a vast depreciation in last 2 month of the past year, USD/CHF rallied drastically and is currently trading within the Buy Zone which is established using Bollinger Bands. Currently, the trend seems slightly overbought as the pair appreciated roughly 800 pips from the beginning of the year. The current level of resistance is placed at 1.1330, which is a 50% retracement of November high and December low, in addition to it being a 2nd Standard Deviation. Support is originating around the 38.2% retracement of November high and December low, which coincides with the 20-day EMA. The uptrend is negated on the break of support which is currently placed around 1.1100-1.1105.