- The EUR is falling and the USD is weak
- The Fed pauses. So what?
- Credit concerns rise again
- RBA, ECB and BOE rate decisions
- Key data and events to watch next week
The EUR is falling and the USD is weak
The financial media is abuzz with the Great Dollar Recovery story, but the real news traders need to focus on is the fall in the EUR. The USD is relatively stable at weak levels against most other major currencies—AUD/USD is only 150 pips below recent highs; USD/CAD remains mired in a 1.00-1.03 range; GBP/USD is stuck in a 1.96-2.00 range; and USD/JPY is slightly above the 103-105 range that has dominated for the last several weeks. The real mover over the last two weeks has been the EUR, and its southern cousin Swissy, but it gives the appearance that the USD is strengthening as the USD index has moved higher, since it’s nearly 80% composed of European currencies. In last week’s report, I highlighted that the EUR/USD was threatening to break lower and suggested several selling levels, which ultimately proved successful, as well as key support levels that were likely to trigger fresh losses. This past week saw those support levels broken and EUR/USD did extend its decline. The downside continues to attract as Eurozone data continues to print weaker (March German retail sales fell -0.1%; April unemployment rate rose from 7.8% to 7.9%; prelim.-April CPI declined MoM; mixed to weaker EC confidence readings). But most importantly, EU officials continue to speak out on the need for the Euro to weaken further.
ECB Pres. Trichet repeated his concerns that Euro strength could jeopardize economic growth. EU finance chief Juncker was more explicit on Friday, noting that the EUR had declined, but that it needed to weaken further still. French PM Fillon, also on Friday, raised the prospect of a coordinated effort to weaken the EUR and strengthen the USD, saying that Europe could not bear the sole brunt of global currency re-balancing. The G7 statement several weeks ago implicitly noted a specific price level that EUR/USD should return to, namely where it was at the time of the last G7 meeting on Feb 9, around 1.4500. While it seems unlikely that EUR/USD will go there in straight line, it is a reasonable multi-week objective to keep in mind. In the meantime, EUR/USD has fallen further and new technical levels to keep an eye on are resistance between 1.5470 (the top of the Ichimoku cloud—prices have now fallen inside the cloud) and 1.5550 (the low from the prior week). I look for EUR/USD to continue to move lower while that zone of resistance is holds; a daily close back above suggests corrective potential higher. To the downside, the 1.5330/40 level (a key low since the initial break over 1.50, hit on 3/24) is the likely trigger to fresh losses, with the base of the Ichimoku cloud still at 1.5134 as the next objective. (For those unfamiliar with Ichimoku charts, please see my article on the subject from the March SFO magazine located in our ‘Newsroom’, under the ‘About’ tab on Forex.com.) EUR weakness is also evident on the crosses and I also favor selling strength in EUR/JPY and EUR/AUD in particular.
The Fed pauses. So what?
The ostensible rebound in the USD is partly explained by the Fed’s signal that additional interest rate cuts may not happen, but the Fed left itself wiggle-room to ease again as needed’ depending on economic developments. I would suggest that the US economy remains exceptionally fragile and is likely to take a turn for the worse before the outlook improves, so additional Fed cuts are still a possibility. The problem is, another cut of 25 or 50 bps is unlikely to make a material difference to the US outlook and so it becomes largely academic whether the Fed cuts again. For the time being, though, widening interest rate differentials have ceased to be a USD negative. The data this week gave the ‘glass half full’ crowd reason to celebrate that the US downturn is likely to stay mild. But the sub-currents of the data remain troubling, and I would specifically note the employment gauges: the sharp increase in weekly jobless claims (not reflected in the April NFP survey period) and continued rise in continuing claims; sharp declines in the employment components of the Chicago PMI (down about 10 points) and the ISM manufacturing (down about 4 points), which reflect future hiring expectations. So despite the ‘better than expected’ April NFP, forward looking jobs indicators are pointing to greater weakness. Keep an eye on the employment index in next week’s ISM services index.
I’ll stress again that while the worst may be over for the financial sector, and I doubt even that—see below, the broader consumer-led economy remains in dire straits. High and rising energy prices, falling home values, rising unemployment, and tight credit conditions have put the US consumer in a bind that is unlikely to be broken this year. The housing downturn in all likelihood needs to see further price declines before prices can begin to stabilize, and that spells further pain for US households and a likely second round of defaults by even credit-worthy borrowers who simply find themselves in upside down mortgages. The much hoped for boost to the economy from tax rebates seems likely to only dull the pain slightly, but not resolve any of those bigger issues. Keep it in perspective: the current fiscal stimulus plan amounts to about 1.3% of GDP against a backdrop of falling home values, tight credit, rising unemployment and sky-high gas prices; the post 9/11 stimulus package amounted to around 6% of GDP and everything else back then was still pretty hunky dory. US interest rates are going to remain low into 2009 at the minimum and the USD will consequently remain biased toward weakness.
Credit concerns rise again
The Fed, ECB and SNB (Swiss National Bank) today announced another increase and extension of liquidity operations to un-stick still sticky credit markets. This is both good—they’re still working to provide liquidity—but also bad, because credit market conditions have not improved. Despite massive capital infusions, with more likely to come, banks continue to hoard cash and remain reluctant to lend to each other much less Main Street. On top of that, fresh concerns surfaced on Friday when a major US bank appeared to back off from guaranteeing the debt of the largest US mortgage lender, which the bank is acquiring, leading to that debt being downgraded to ‘junk’ status. Nearly every day as I look at the news headlines I see ratings downgrades to various RMBS (residential mortgage backed securities) issues flash by, meaning the value of RMBS debt continues to erode. The financial sector is chasing a moving target (and yes, it’s moving lower) as they seek fresh capital to cover prior losses, new losses continue, requiring still more capital-raising and cash-hoarding and non-lending.
While I would like to believe in the stock market break to the upside this past week, I think it has been rejected with Friday’s price action. In particular, I would note a significant candlestick pattern on the S&P banking index (a doji, potentially a shooting star), suggesting at the minimum indecision on the break higher, and more ominously a failure and rejection lower. If it is a failure, what does that mean for FX? In all likelihood another increase in risk aversion, potentially leading to a sharp move lower in the JPY-crosses. In particular, I would favor selling EUR/JPY and GBP/JPY on strength, as both EUR and GBP are likely to experience relative weakness going forward, due to expected interest rate cuts and slowing growth outlooks. This view also favors the one global region where indications are still positive—Asia. A daily close back below 104.80/105.00 in USD/JPY is a good clue that the JPY-crosses have peaked.
RBA, ECB and BOE rate decisions next week
Three key central banks are set to announce interest rate decisions next week: the RBA on Tuesday afternoon Sydney-time, and the BOE and ECB on Thursday morning NY- time. Market expectations are for all three to hold rates steady, but there is still the potential for significant currency impact depending on the guidance offered by each. The RBA had been expected to raise rates one more time in the current cycle, but slower global growth and deteriorating business confidence amid slower global growth may take that rate hike off the table, hurting AUD in the process. The BOE would certainly be justified in cutting rates again, but markets are expecting a delay until the June meeting. Still, the risks are that weaker interim data have swayed the MPC to cut now. The ECB will definitely hold rates steady, but Trichet may be more vocal about the need for the EUR to soften further or highlight recent declines in sentiment and suggest that the growth outlook has deteriorated further, adding to EUR-downside pressure.
Key data and events to watch next week
US data begins on Monday with the April ISM non-manufacturing (service sector) sentiment index, which covers the other 85% of the economy outside manufacturing. Tuesday sees only weekly ABC consumer confidence, which just hit a new cycle low in the last week at -41. Wednesday sees preliminary 1Q non-farm productivity, unit labor costs, March pending home sales and consumer credit. Thursday sees weekly jobless/continuing claims and March wholesale inventories. Friday sees only the US March trade deficit. There are numerous Fed speakers, but most appear to be addressing mortgage foreclosures and not the economic outlook or interest rates. Former Fed chair Greenspan speaks on Thursday afternoon NY time and could drop some bombs.
Eurozone data begins on Monday with only the May Sentix Investor Confidence index. Tuesday sees final-April Eurozone services PMI’s and March Eurozone PPI. Wednesday sees March Eurozone retail sales and German March factory orders. Thursday sees German March trade balance and industrial production, followed by the ECB rate decision and press conference. Friday sees French and Dutch March industrial production.
UK data starts on Tuesday with the April Services PMI in the morning, followed at midnight by April Nationwide Building Society consumer confidence. Wednesday morning sees March industrial and manufacturing production and the April BRC shop price index, a private inflation gauge. Thursday see only the BOE MPC rate decision.
Japanese markets will be closed until Wednesday for the Golden Week Holidays and no data is scheduled until Friday morning Tokyo-time and then only the preliminary March Leading Economic Index is of note.
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