The Week Ahead updated December 11, 2009
- The dollar rebound continues, more likely - European debt concerns will subside, eventually - FOMC likely lackluster - Key data and events to watch next week
The dollar rebound continues, more likely
The greenback extended its recovery this past week, as a confluence of fundamental factors undermined other currencies and supported the USD. However, we continue to believe the primary driver of USD strength at the moment is ongoing USD short-covering from excessive positioning levels. Sovereign credit concerns out of Europe struck raw nerves at several points this week (see below), hurting European currencies (EUR, CHF, and GBP). US data generally came in on the positive side, with Nov. retail sales and preliminary Dec. Michigan consumer sentiment in particular posting stronger than forecast gains. Together with some weaker demand at US Treasury auctions, the better data led to higher US yields, as traders advanced expectations on the timing of the Fed's first rate hike. 10-year US Treasury yields are now up around 33 bps since the start of December, providing the buck with additional support. Commodity markets continued to implode, with crude oil prices suffering their longest losing streak (8 straight days) in the last six years. Even in last year's collapse from north of $140 down to around $30/bbl, there were some bounces along the way down. The exodus from commodities is at odds with the 'economy is improving/demand is strengthening' story line contained in the positive data, and also not wholly attributable to the rebound in the USD. Again, we are left with the impression that long-commodity bets are being exited into the end of the year and that there is more to come. The exceptions to the rule this week were the antipodean currencies AUD and NZD, with AUD/USD essentially unchanged on the week and Kiwi up about a cent. Australia benefitted from solid Chinese growth data and a solid Nov. employment report. In Kiwi, the RBNZ slightly shifted its language on the timing of its eventual move to tighten, leading traders to speculate that the RBNZ will hike in April. We remain constructive on Kiwi overall on rates and growth, but would not chase it higher from current levels. The buck cleared some key technical hurdles after a drawn-out mid-week consolidation, but faces new ones ahead. EUR/USD has clearly broken below the dominant trend line that guided the pair higher since the March lows, and is now resistance up at 1.4900/10. The euro briefly tested below the bottom of the daily Ichimoku cloud at 1.4620, but going into the close it looks like that level may hold. In USD/CHF, the daily cloud top at 1.0370 contained the move up (highest about 1.0365/70), while Sterling stubbornly hangs on above the base of its cloud at 1.4225. (However, the cloud base rises to 1.6276 on Sunday/Monday, so an open below the cloud may open up the sluice gates in Cable.) In the broader US dollar index, price never tested the top of the Ichimoku cloud (weekly high at 76.76 and cloud top at 76.94), suggesting that some near-term USD resistance looms. We would look to use any USD pullbacks as buying opportunities as USD short-positioning remains constructive to further gains into the end of the year. USD/JPY was maddeningly difficult to trade, slumping all the way back to about 87.40 after being rejected from the daily Ichimoku cloud bottom last Friday and again on Monday at 90.44. Significantly, however, the pullback in USD/JPY never had a daily close below the Tenkan line, which made a bullish cross of the Kijun line in mid-week (weak buy signal, as price is still below the cloud), finishing out the week at 88.46 with the Kijun line now below at 87.85. That keeps the bias higher and we would prefer to be buyers of USD/JPY on weakness into that 87.50/88.50 area, bailing out on a daily close below 87.85. Quarter end repatriation (JPY-buying) by Japanese corporates may provide such opportunities. The cloud falls slightly further next week, and narrows as a zone of resistance, with the base at starting the week at 90.34 and the cloud top at 91.04.
European debt concerns will subside, eventually
The past week started off with a Fitch ratings downgrade of Greece followed by S&P moving Spain's credit outlook to negative, though its ratings were affirmed. The moves rattled investors' nerves and weighed on the EUR and other European currencies. The financial media filed the obligatory 'risk of a sovereign debt default' and the 'euro could come undone' stories, adding to concerns on Europe. However, we think the ratings moves are simply a short-term blow to sentiment which dovetailed nicely with the Euro cresting at the beginning of December. There is little immediate concern of a debt default as seen in Greek government debt yields, which while about 2% higher than German yields, are not in panic territory at about 5.2%. Indeed, should the worst come to pass it would likely only be later next year and lead to a rescue package from the IMF or the EU. European leaders were consistent in admonishing the most deficit-heavy countries to address budget issues urgently, and leaders of those nations' seemed to get the message, but they also indicated that they would mutually address any terminal credit crisis. As for the fate of the EUR, there is zero chance of EMU coming undone or Greece being thrown overboard, given treaty obligations. In that sense, the impact on the EUR is largely psychological, but that doesn't mean it can't weigh on the common currency further, which is why we also see scope for further EUR weakness ahead. We think fears may begin to subside in the New Year as investors conclude the risks are overblown and assets get put back to work in the new calendar year.
FOMC likely lackluster
The FOMC is scheduled to release their interest rate decision next Wednesday and the market is unanimous in expecting no change to the current 0.25% level. Thus all of the attention will once again be on the press statement. While we anticipate little fanfare, there is always a risk that the Fed makes a market moving change in its communiqué. In terms of the economic outlook, we anticipate that the committee will note once again that economic activity has continued to pick up and that employment continues to decline at a slower pace. The inflation outlook will remain rather benign - especially given the drop in inflation expectations of late - and we think they will note that price pressures will remain subdued for the foreseeable future. The only area where we could see some change is in the asset purchases program. While the probability is quite low that the Fed will tweak any part of the statement, if they were to do so it would be here. Our base case is that they will leave in the line that the committee will gradually slow the pace of its purchases of both agency debt and agency mortgage-backed securities and anticipates that these transactions will be executed by the end of the first quarter of 2010. However, some Fed speakers of late have shown an interest in extending the program beyond 1Q. Most notably, St. Louis Fed president Bullard (will be a voter on the FOMC in 2010) said he supports extending the MBS purchases beyond 1Q in order to give the Fed more flexibility to changing market conditions. We think merely extending the time frame would have little impact and we would need to see an increase in the $1.25 trillion MBS purchase size to elicit any significant US dollar weakness. Bottom line, we think the FOMC meeting next week will be mostly a non-event in what is quickly becoming a market in holiday mode. If there is one risk, however, it is that they tweak their asset purchase program for fear of a relapse in the US housing market. We view this as more of a 1Q event however.
Key data and events to watch next week
The US calendar heats up again in the week ahead. Tuesday is quite busy with producer prices, NY Empire manufacturing, international capital flows, industrial production and the NAHB housing market index. On Wednesday we will see consumer prices, the current account, housing starts/permits and the usual weekly crude oil inventories. The FOMC rate decision is also due that day and we expect this to be a non-event (see above for more). Thursday rounds out the week with initial jobless claims, leading indicators and the Philly Fed manufacturing index. It is also busy in the Eurozone. Employment, industrial production and the French current account kick things off on Monday. The ZEW surveys, French consumer prices and German ZEW are due up on Tuesday while Wednesday has the PMI surveys on deck. Friday closes out the week in busy fashion with the trade balance, French business confidence, German producer prices and the German IFO business surveys. In the UK it is a touch lighter. Home prices are up on Monday while Tuesday brings consumer prices. Wednesday has the employment report lined up and Thursday sees the all-important retail sales numbers. Business investment and mortgage approvals close out the week on Friday. Also look for the Bank of England quarterly inflation survey on Thursday and the financial stability report on Friday - these could prove market moving. Japan has some important top-tier data lined up. The Tankan manufacturing surveys start things off on Sunday while industrial production is due Monday. The tertiary industry index is scheduled for Tuesday and Wednesday brings machine tool orders data. Thursday has the leading index on tap while the BOJ rate decision (likely non-event) and department store sales close things off on Friday. Canada is characteristically on the light side. Leading indicators and motor vehicle sales are due Tuesday while consumer prices and international securities transactions are up on Thursday. Friday rounds out the week with wholesale sales. Look for a speech by BOC Governor Carney on Wednesday as well. It is a pretty typical week for data down under. Australia has the RBA meeting minutes and the leading index on Tuesday, GDP on Wednesday and new home sales on Thursday. New Zealand is lighter with the government's fiscal/economic forecasts due Tuesday and business confidence up on Thursday.
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