What to look for in the week ahead

• Risk rally is done
• Fed speculation is misguided
• Earnings still little to write home about
• US unemployment to hit 10% in October
• More QE from the BoE on the cards
• Sterling particularly vulnerable if PMI services disappoints
• ECB could be on the point of reining in enhanced policy measures
• Key data and events to watch next week
Risk rally is done
Last week's lead bullet point was that the risk rally had stalled, for the moment. Lacking any solid technical indications of a reversal, we could only highlight potential for an upcoming correction in risk assets. This week, however, we have no such hesitation and a plethora of technical evidence that a multi-week top in the risk rally has been made. Ultimately, this should be USD supportive, given recent high correlations and excessive USD short positioning. However, the real driver of USD weakness is near-zero US rates, which will not be changing anytime soon. In light of that, the USD recovery should not be in a straight line, but rather fraught with continued choppiness. As a result, we will look to buy the USD on dips in the weeks ahead against all but the JPY. The JPY remains the primary funding currency, and barring a collapse in US rates in the weeks ahead, this should remain the case. As such, we will also look to re-sell JPY-crosses (EUR/JPY, AUD/JPY, GBP/JP, etc) on any rebounds, and the JPY-cross decline is likely to be the most pronounced FX outcome of any risk unwind. Lastly, the outlook for gold remains somewhat confused, given the various forces at work. But our preference is to be sellers while it holds below the 1070/75 area, and we will become more bearishly convinced on a daily close below the 1025/27 level, targeting a move lower to 970/980 initially.
The USD may also benefit from a G20 gathering in Scotland at the end of next week. Market reports suggest European officials, in particular, will press the US to take a firmer tone in defense of the USD, basically asking the US to put some teeth in its much maligned 'strong dollar policy.' Short of threatening market intervention, it is difficult to envision US officials moving beyond verbal intervention to support the greenback. That does leave open the potential for disappointment coming back to haunt the USD. But a chorus of support from the G20 and intensified US rhetoric, coupled with an overall short-dollar position exodus, may be enough to lend the USD additional support.
Fed speculation is misguided
There has been increasing speculation in the market that the FOMC will drop the 'extended period' language from their policy statement next Wednesday afternoon. That view was spurred by comments from an advisor to the NY Fed that he could 'imagine' the Fed dropping the commitment. We do not expect the Fed to alter that language. Recent FOMC member comments and the minutes of the last meeting suggest a majority of Fed officials are increasingly concerned about the trajectory of the economy as stimulus efforts wind down. The retention of that commitment may provide a brief USD setback and perhaps a respite to stock markets, but we think the overall somber tone of the Fed's outlook will keep that short-lived. More intriguing is the prospect that the Fed will single out the beleaguered USD for comment. Traditionally the purview of Treasury, this Fed spoke out in support of the USD last year as it was near its weakest. The Fed may mention USD weakness as a potential headwind to economic recovery, as it may spawn inflation and undermine consumption. If the Fed speaks out on the USD, it would also signal the rest of the G20, and the ECB in particular, that Washington 'gets it' and will be more forceful in defending the dollar. If the Fed statement mentions the word 'dollar' we would expect a significant boost for the buck.
Earnings still little to write home about
With 65% of S&P 500 companies now having reported, the 3Q earnings season continues to look considerably worse. Bottom line earnings (EPS) are indeed beating by 13% on aggregate, but this is down from a 16% surprise one week ago. Meanwhile, sales figures have worsened materially. Last week, aggregate sales figures were about in line with overly conservative estimates. The additional 150 companies or so that reported this week helped ratchet that number down to a -1% surprise. As the sample size grows, it is becoming clearer that EPS was once again driven by massive cost cutting, mainly on the employment front. Organic growth remains non-existent and the consistent +500K prints in the weekly initial jobless claims figures suggest it is still a ways away.
Earnings expectations ultimately drive stock prices and we believe the market is now realizing that perhaps the forecasts in the quarters ahead are overly optimistic. With the S&P 500 trading at a price/earnings multiple well above 20, this makes the case for a short-term top in the equity space even more compelling. The downside pressure in the S&P is alive and well while it trades below the 1050 level and a drop below 1035/1030 suggests a test of the 100-day moving average near 1000 next. Given the US dollar's extremely robust correlation with stocks this year - at better than -90% - we would expect the greenback to continue to benefit from this unwind in risk appetite.
US unemployment to hit 10% in October
The US employment report is due up on Friday and is likely to create a stir as usual. The economic data of late has had the thumbprints of the US government all over it and continues to suggest that without major fiscal stimulus, growth would be non-existent. Employment numbers, however, continue to point to an economy under duress and we expect this theme to show through in Friday's NFP report. The market is expecting a -175K drop in October payrolls on the heels of a steeper -263K decline the prior month. We are a touch more pessimistic and are currently penciling in a -190K outcome. The weekly claims numbers, worrisome as they are, continue to trend slightly lower and suggest that the pace of job shedding is slowing. Continuing claims, however, point to a job market that is still extremely challenging for those that remain unemployed.
Most importantly for consumer confidence will be the headline-grabbing unemployment rate. The indicators we have in hand on this front suggest we could very well see that ominous double-digit print. The market remains optimistic that the rate will only increase to 9.9% from 9.8% previously. However, one of the best leading indicators of the unemployment rate - the Conference Board's jobs plentiful minus jobs hard to get index- sank to a new cycle low of -46.2 in October from -43.4 last month. Moreover, employment indicators in regional manufacturing/services surveys have showed no improvement (despite better headline prints in some cases).
Bottom line is that an improvement in the headline NFP is likely priced in by the market, but a 10% print on the unemployment rate could hurt risk appetite and consumer confidence further. This will come just in time for the holiday shopping season and the dent in confidence this would elicit, coupled with the potential that gasoline pump prices will be closer to $3/gal, will send shockwaves throughout the retail sector. It could be a very painful month for the risk trade.
More QE from the BoE on the cards
The accuracy of the -0.4% q/q print of the UK Q3 GDP data has been widely questioned. Even so the shockingly poor data has wielded opinion in favour of an increase in QE at the BoE's Nov 5 MPC meeting. A Reuters poll has indicated that two thirds of economists expect some expansion, though they are evenly split between whether it will add 25 or 50 billion pounds. The fact that an addition to QE has been so widely touted suggests the immediate impact on the pound from an announcement should be subdued. That said, with the BoJ having announced it will stopping buying corporate bonds this year, with the Fed having completed its USD300 bln Treasury bond purchase plan and given the suggestion from the ECB's Weber that the ECB may do no 12 mth auctions next year, a step up in QE from the BOE could leave GBP struggling to make further headway vs. the EUR near-term.
Sterling particularly vulnerable if PMI services disappoints
Speculation that the UK Q3 GDP report will be revised higher on Nov 25 has been sufficient to allow EUR/GBP to move below its pre-GDP levels. The basis of the speculation relating to the GDP figure stems from the recovery in the UK services PMI data in Q3 which pointed to a positive outcome for growth. Sterling could thus be particularly vulnerable on any signs of weakness in the Oct PMI release, but there is likely now greater scope for a negative reaction if any of the forthcoming data disappoint.
ECB could be on the point of reining in enhanced policy measures
Bundesbank Chief Weber has suggested that the ECB may not continue with its 12 mth auctions next year, though one more has been scheduled for 2009. The addition of liquidity at the short-end has been the mainstay of the ECB's enhanced policy responses to the financial crisis. QE has been small. At the most recent auction for 12 mth funds, demand was well below expectations. The ECB took the view that this indicated that the improved health of financial institutions meant reduced dependence on the ECB for liquidity. If ECB President Trichet confirms on Aug 5 that the 12 mth auctions will be withdrawn by next year, this is the tone that he is likely to take. The absence of any inflationary pressure in Eurozone CPI suggests that the ECB's refi rate will be maintained at its 1% low for many months yet suggesting impact on the EUR should be limited.
Key data and events to watch next week
The calendar is the United States is very busy. Monday kicks it off with ISM manufacturing, pending home sales and construction spending. Factory orders and vehicle sales are due Tuesday while Wednesday brings the ADP employment change, ISM services, crude oil inventories and the FOMC press release (more on this above). Productivity and the usual jobless claims are up Thursday and Friday rounds out the week with the all-important NFP report, wholesale inventories and consumer credit.
The Eurozone is a touch lighter, but has important releases due out nonetheless. Monday starts with EZ PMI manufacturing and then we wait until Wednesday to get PMI services and EZ producer prices. Thursday brings EZ retail sales and the ECB rate meeting while Friday has the French trade balance and German factory orders.
It is an important week for the UK as well. The Hometrack housing survey and PMI manufacturing are up on Monday. Wednesday has nationwide consumer confidence and the PMI services index on tap while industrial production and the Bank of England rate meeting are scheduled for Thursday. The week ends with producer prices on Friday.
Japan has an extremely light week ahead. The Bank of Japan meeting minutes on Thursday and the employment report on Friday are the only noteworthy releases.
Canada is also very light. Building permits and the Ivey PMI index are scheduled for Thursday while Friday sees the all-important employment report.
The calendar down under is on the busy side. The action kicks off Sunday with Aussie performance of manufacturing. New Zealand hourly earnings are due Monday while the RBA rate meeting is the highlight on Tuesday. The New Zealand employment report is on tap Wednesday along with Aussie retail sales and building permits. Thursday closes things out with Aussie trade numbers.