The Week Ahead updated January 9, 2009
• Data continues to soften across the globe
• EUR looks set to weaken further
• ECB looks poised to cut rates aggressively next week
• Key data and events to watch next week
Data continues to soften across the globe
In case anyone doubted that we're facing a global recession, data reports this week pointed to an accelerating deterioration in key economic indicators from all the major economies. In the US, the Dec. NFP report released Friday, while not as disastrous as worst-case scenarios, revealed the loss of 1.1 mio jobs and a 0.5% increase in the unemployment rate to 7.2% over the last two months. The precarious labor market in the US, alongside still-falling home prices, keeps US consumers under a cloud and will keep US consumer spending on a downward trajectory for the foreseeable future. The incoming Obama administration's efforts to establish a fiscal stimulus package, the source of much optimism at the start of the year, appear to face numerous obstacles. Beyond potential Congressional opposition, the size of the package being discussed is likely too small to make a significant difference. Congressional wrangling threatens to delay the package beyond mid-February, but even if a package is passed sooner rather than later, it will still take several months before any effects are felt. The best case scenario is that declines in job losses and personal consumption can begin to stabilize sometime in the 2Q, which feels like an eternity.
Outside the US, recent data point to similarly deteriorating outlooks. Keep in mind many of the data points are from Nov. and that December will be even worse. In Europe, German and French Nov. industrial production fell sharply (German IP -3.1% MoM/-6.4% YoY; French IP -2.4% MoM/-9.0% YoY) alongside further declines in consumer and business sentiment, according to Dec. EU confidence surveys. In the UK, home prices continue to fall (Dec. Nationwide house prices -2.5% MoM/-15.9% YoY and prior -13.9% YoY) as unemployment rises (Nov. jobless rate rose from 3.1% to 3.3%), depressing already weak consumer confidence (Dec. Nationwide consumer confidence 47 from prior 51). In Canada, the Dec. unemployment rate jumped from 6.3% to 6.6% and the Dec. Ivey PMI fell to a new all-time low at 39.1, down from 52.2 as recently as Oct. In Japan, the trade surplus-turned-deficit continues to deteriorate, while the preliminary Nov. leading indicator fell to 81.5 from 85.2 in October. I won't go into developing markets except to note that China's 4Q Business Climate Index plunged from 128.6 to 107.0.
What does this mean for FX? For starters, further interest rate cuts from the ECB (Jan. 15--see below), the Bank of Canada (Jan. 20), New Zealand (Jan. 28), Australia (Feb. 3) and further cuts from the Bank of England also likely on Feb. 5. Lower interest rate expectations are likely to limit the upside for these currencies, especially as they are cutting in the face of deteriorating data. Stock markets broadly are also likely to remain weak as fresh worries over corporate earnings permeate market sentiment, potentially supporting the JPY, as repatriation flows continue, and the USD, on safe haven buying of US Treasuries. Lastly, commodities should continue to decline on ever-weakening global demand, and this will weigh mostly on CAD and AUD going forward.
EUR looks set to weaken further
Of the major currencies, EUR appears to be the most vulnerable in the weeks ahead. The current economic data and the interest rate outlook are reviewed below, so here I'll focus on the technical picture in EUR/USD. Keep in mind that EUR weakness may be most pronounced on the crosses (e.g. EUR/GBP, EUR/CAD and EUR/JPY) as the USD outlook is far from rosy, but the technical case for EUR/USD is also compelling. EUR/USD started last week by breaking below the key 1.3820/50 support zone. Subsequent attempts to rally came up short and took the form of a bear flag consolidation, best viewed on an hourly chart. The break below the base of the bear flag targets a minimum measured move objective of 1.3175. The attempt to rally also came up short of surpassing any recent highs, keeping the prospect of a parabolic (i.e. accelerating) decline from the 1.4720 highs intact.
On the Ichimoku charts, EUR/USD was holding above its cloud, but Friday's weakness sent it back into the cloud (cloud top is at 1.3504 to start next week and it falls sharply during the course of the week to end at 1.3181 next Friday). Perhaps more ominously, the Tenkan line (which contained EUR/USD rebounds on a daily closing basis since late December) is about to cross down over the Kijun line, triggering a moderate strength sell signal if the price remains inside the cloud. The recent low at 1.3310/20 is the first support of significance, but I would note sovereign interest to buy EUR/USD was in evidence between 1.3350/80 on the way back up, so we'll need to see if that interest re-emerges. If not, a break below 1.3300 would open up potential declines to the bear flag objective at 1.3175 and then to the bottom of the Ichimoku cloud, which moves from 1.2780 at the beginning of the week to about 1.2940 by the end of next week.
ECB looks poised to cut rates aggressively next week
The European Central Bank is due to announce their interest rate decision on Thursday at 0745ET. The market expectation is that the bank will cut rates by -50 basis points to 2.0%, but the forecast is quite contentious. Several economists/strategists are looking for a more modest -25 bps cut while a few are even betting on no move in rates. We believe that the ECB will decide to take the more aggressive path of the three. In this scenario, we would expect EUR to fall as more aggressive cuts would be an admission that the economic outlook has worsened discernibly.
This past week alone we saw evidence of more cracks in the foundation of Eurozone fundamentals. The December PMI composite was revised down to a paltry 38.2 and is down from 38.9 in November and 43.6 in October. Indeed, the deterioration in this index is commensurate with the slowdown in the US ISM manufacturing and services indices – and we all know how dire the prospects for US growth have become. It wasn't merely business that was downbeat either, as consumer confidence plunged to its lowest level on record in December, dropping to -30 from -25 the prior month. This took out the previous low set back in 1993 when the global economy was still reeling from the US Savings & Loan crisis. These forward looking confidence metrics clearly point to more economic pain ahead in the Eurozone.
Talk out of the ECB members this week also suggests rate cuts are in the offing. The most compelling comments were those from ECB Vice President Papademos and council member Constancio. Both said that the central bank may need to reduce rates if inflation falls below the target 2.0% rate. Well wouldn't you know that the CPI inflation estimate for December plunged to 1.6% from 2.1%, the lowest level since October 2006. This result will leave many of the more hawkish ECB members hard pressed to argue that inflation remains a risk near-term. If that isn't enough, ECB President Trichet reportedly indicated that recent data could prompt a rapid response from the ECB to combat the dire state of the economy and use some ammunition it has been saving in case downside risks materialize. Clearly, the evidence points to an ECB that is ready to act.
Key data and events to watch next week
The US economic calendar is busy next week and the action starts on Tuesday with the trade balance and monthly budget statement on deck. Wednesday has the all-important retail sales report due up along with weekly oil inventories. Thursday is a busy one with producer prices, initial jobless claims, NY empire manufacturing and Philly Fed manufacturing all due. Friday rounds out the week with consumer prices, capital flows, industrial production and the University of Michigan sentiment index. There are a ton of Fed speakers on tap as well and the highlight looks like Chairman Bernanke on Monday. Watch for the Fed's Beige Book report on Wednesday as well.
The Eurozone (EZ) calendar is a touch lighter and the highlight is the ECB rate decision on Thursday – see above for analysis. Prior to that we get French consumer prices, German GDP and EZ industrial production on Wednesday. Thursday also has EZ consumer prices lined up while Friday closes out the week with the EZ trade balance.
The UK calendar is extremely light and all of the pertinent economic data are on Tuesday with the BRC retail sales monitor, home prices and trade balance all due up.
It is just a touch busier in Japan. The action starts on Monday with the current account and trade numbers. Tuesday has bankruptcy data on deck and Wednesday closes things out with machine tool orders and domestic corporate goods prices.
Canada has a pretty uneventful week lined up also. Monday has new home prices and the Bank of Canada senior loan officer survey. Tuesday sees international trade data while Thursday has new motor vehicle sales due up.
Last but not least, the calendar down under is also light. Monday has the NZIER business opinion survey due up while Tuesday sees New Zealand building permits. Australian home loans are scheduled for Wednesday. New Zealand home prices and the Australian employment report close out the week on Thursday.