** PERCENTAGES MAY NOT ADD UP TO 100% BECAUSE OF THE PROBABILITY OF LARGER OR SMALLER MOVES BEYOND THOSE SHOWN ON THIS TABLE
USD: WHY THE RALLY MAY CONTINUE
The price action in the currency markets over the past 2 trading days indicates that investors may be growing less pessimistic. Although US economic data continues to disappoint, investors are starting to become immune to the weak economic data. So much of the bad news has already been priced into the markets and therefore investors have latched onto any good news. Currencies and equities rallied strongly today following reports that Bank of America and Chrysler have both received government aid. With US markets closed for Martin Luther King Day on Monday and little meaningful economic data on the calendar next week, the currency pairs that rallied today could extend their gains in the new trading week.
Chrysler Gets $1.5B, Bank of America Gets $20B
After a month or so of little developments from a fiscal perspective, government bailouts are returning. The timing of these bailouts is a bit surprising since they come days before the new Administration takes office. The US recession has hit Chrysler hard with sales plunging 30 percent last year. The new loan has allowed the automaker to offer zero interest financing which they hope will drive more sales of cars and trucks. Bank of America on the other hand received another $20B to ease their absorption of Merrill Lynch. These loans will make survival easier for both companies, but it remains to be seen whether it is enough to turn them around. Nonetheless investors are happy to see more initiatives by the US government. Stocks have rallied and since currencies have been taking their cue from equities, USD/JPY, EUR/USD and GBP/USD appreciated as well.
Foreigners Sell US Dollars, Sharp Decline in Industrial Production
As for economic data, consumer prices continued to fall, foreign demand of dollar denominated investments was the weakest since September 2007 and industrial production declined for the fourth time in five months. The overwhelmingly dollar bearish news only had a limited impact on the dollar as most investors are already expecting a weak set of economic data this month. The bigger surprises will come from earnings which is why we are keeping a close eye on equities. Taking a look at the data in more detail, headline consumer prices dropped 0.7 percent last month while core prices held steady. The annualized pace of CPI growth slowed to 0.1 percent. This is smallest increase in consumer prices in 54 years. Discounts on clothing and lower gasoline prices have driven inflation lower. For the Federal Reserve, this will support their plans to keep interest rates at ultra low levels for at least the next 6 months. In terms of the Treasury International Capital flow report, net long term flows declined by $21.7B. The numbers show that China is still buying US assets, but at an increasingly slower pace. Japan was a net seller but in general, we saw a large exodus out of all debt instruments including treasuries, corporate and agency bonds. Clearly the dollar's low yield is turning foreign investors away. The manufacturing sector still has many problems as indicated by the 2 percent decline in industrial production.
EUR: THE TRADING RANGE
Next week, the market's focus should shift to Europe. The US economic calendar is very light, but there are a number of potentially market moving reports on the Eurozone calendar. This includes the ZEW survey of analyst sentiment, producer prices, the ECB's monthly report, service and manufacturing PMI. The economic data should reflect a continual deterioration in the Eurozone economy. When the central bank cut interest rates by 50bp earlier this week, ECB President Trichet warned that growth could slow further. We have already seen a sharp deterioration in trade. For the ninth consecutive month, the Eurozone trade balance was negative. Exports plunged 10 percent on an annualized basis while import fell 4 percent. The Euro began strengthening against the British pound in November, but the bulk of the appreciation did not happen until December. Trade next month will probably be even worse with the deficit possibly hitting the high that we saw in January. However with that in mind, weak economic data may not the hurt the Euro since ECB President Trichet has indicated that he may refrain from cutting interest rates next month. These counteracting forces could keep the EUR/USD confined within a 1.30 to 1.37 trading range next week.
GBP: MAJOR INTRADAY REVERSAL AHEAD OF BUSY WEEK
It has been an unusually volatile trading day for the British pound - having come within a whisker of the 1.50 price level at the open of the US trading session, the currency pair fell significantly following the release of US economic data and ended the day at 1.4734. This past week, the British pound has been at the whim of the market's risk appetite and announcements from the UK government. Next week however, there will be a number of economic data for UK traders to key off of. There is a much awaited speech by Alistar Darling, Chancellor of the Exchequer. The Chancellor could discuss additional guarantees for assets that are eating away at bank's balance sheets. Theoretically, if the banks were to be freed from these securities and assets they should be more confident in their lending efforts. However, the UK government has already poured nearly £100B into similar efforts, only to see financial institutions continue to resist any possible risks in potential defaults. In addition to the speech, the minutes from the most recent Bank of England meeting are also due for release. Traders will be looking at this report for clues on how much the central bank could ease interest rates. Consumer prices, employment numbers, retail sales and GDP are also due for releasing, promising an exciting week for the GBP/USD.
CAD: ANOTHER RATE CUT FROM THE BANK OF CANADA?
An initial bout of revitalized risk appetite fails to sustain itself through the entire day as all commodity currencies have lost much of their earlier gains. In particular, price action in USD/CAD has seen a 250 pip range. After losing 200 pips the pair retraced and turned into positive territory, only to see gains quickly evaporate. On a weekly basis, the Canadian dollar lost an amazing 600 pips against the dollar, its worst weekly performance since the height of the financial crisis. This is a good indication of how fear and uncertainty in the market has not relinquished. The most important catalyst for USD/CAD next week is the BoC Rate Decision on Tuesday. The market is pricing in a 50bp cut, bringing rates down to 1.00%. The Australian and New Zealand faced a similarly difficult week only to experience small gains in today's trading. Commodity Prices manage to pull ahead during the brief envelope of renewed risk appetite. Gold rallied up 3.10% on the day, while oil managed to post a gain of 1.4%. The economic calendar for next week shows New Zealand CPI for Monday, NZD AON 1-Year Inflation Expectations, NZD Retail Sales, and the BoC Rate Decision for Tuesday, CAD Retail Sales on Thursday, and CAD CPI on Friday.
JPY: RISK APPETITE RETURNS, DRIVING YEN CROSSES HIGHER
The yen crosses continued to recover for a second consecutive day as risk aversion declines. Earlier in the day, the Bank of Japan announced that the economy has weakened across all of the country's nine regions over the past quarter as slumping exports and a rise in the yen prompted businesses to reduce production and lay-off workers. As a result of sluggish economic data and a global recession, the BoJ has decreased its regional assessments for all areas in the second quarter. The cut in assessments were guided by the lack of demand for goods, weakness in employment, and decrease in private consumption. Further, Japan announced that they will miss the projections to balance the budget by 2011 due to the severity of the recession. Calculations by the Cabinet Office predicted that the balance will be between 2.3% and 2.9% of the GDP starting April of 2011. The budget was revised to reach its goal by 2018. On Monday of next week, Japan is set to release Dept. Store Sales along with Tertiary Industry Index. If the weakness in the economy persists, additional speculation will arise on a possibility of BoJ buying corporate bonds in order to relieve the credit freeze.
GBP/JPY: Currency in Play for Next 24 Hours
GBP/JPY will be the currency pair in play for Monday. The UK is scheduled to release Rightmove House Prices at 7:00 pm ET Sunday or 1:00 GMT. Japanese Industrial Production is also expected to come in at 11:30 pm ET Sunday or 4:30 GMT. GBP/JPY has retained its range bound trading for more than a month, as it firmly supplants itself in the Bollinger band range trading zone. The development of this month long range zone is based on the significance of the 140.00 and 130.00 levels. The pair has lacked needed conviction to exceed movement beyond these levels. As resistance, we are using the 140.00 level. Even though it is not the precise high of January 1st it does a good job of equalizing highs and lows placed during prior months. Combined with the psychological nature of the level, it proves to be fairly significant. As support, the 130.00 has the psychological factor firmly in place as it supported two lows and represents a record low in the pair. A break to the downside should see substantial declines. The sheer longevity of the consolidation makes a break much more significant.