Forex Go!

What a week it has been in the currency and equity markets. After selling off aggressively on Wednesday, both currencies and equities ended the week on a very strong note which has instilled hope and optimism in a market desperate for good news.  It was only a few days ago that Italian bond yields spiked above 7 percent and at the time, there appeared to be no end in sight for the European sovereign debt crisis.  Today, the sentiment in the market is very different.  U.S. stocks erased all of this past week’s losses with the EUR/USD coming close to doing so as well.  The recovery was sparked by some much needed leadership change in Europe.  Greek Prime Minister Papandreou has caused more trouble than he is worth and Berlusconi, the longest serving Italian Prime Minister since Mussolini has been a larger part of the problem than the solution.  Both men have offered their resignation with Papandreou being officially replaced by former ECB Vice President Papademos today and Mario Monti a former European Union Competition Commissioner is the front runner to replace Berlusconi if and when he steps down.  Berlusconi has promised to resign once the 2012 Budget has been passed. This morning, the Senate approved the austerity measures and the next step would be for the Lower Chamber to vote for the bill as well.  The currency market is very excited that newcomers Papademos and Monti have extensive financial market experience.  Hopefully without the political pressure of appeasing their constituents, Papademos and Monti will implement their austerity measures quickly and aggressive.   The rally in the euro will be sustained if Berlusconi steps down by Monday but if his pledge to resign is nothing more than another one of his false promises, then the euro and the financial market in general will be in for more trouble.  Even if Berlusconi follows through with a resignation, the European sovereign debt crisis is not behind us.  A lot of work still needs to be done to bring borrowing costs in Italy back down to manageable levels and if they do not slide below 6 percent in the near future, Europe may still have to come to Italy’s rescue. Investors will be watching Italian bond yields closely along with Monday’s bond auction which will be another important test of investor confidence.  

Aside from headline risk, there are also a number of economic reports scheduled for release from Europe.  This includes Eurozone industrial production, consumer prices, the trade balance, the ZEW survey and third quarter GDP. Last quarter was a tough one in the Eurozone as weaker global growth and local austerity measures take a bite out of economic activity and confidence.  Conditions were so difficult that the European Central Bank cut interest rates for the first time in 2 years and warned of more strain on the region’s economy.  The pessimistic outlook by the ECB and the general uncertainties created by the debt crisis is expected to drag down investor confidence.  As for the rest of the economic reports, more weakness is expected than strength but that may matter little in a world where macro news easily overshadows micro trends.  

USD: US DATA RETURNS TO THE LIMELIGHT

The recovery in risk appetite drove the U.S. dollar lower against all of the major currencies including the Japanese Yen.  The big story today in our opinion is the breakdown in USD/JPY which puts the currency pair back into intervention territory.  There was no news or economic data behind the latest push lower but last night’s comments from Finance Minister Azumi who suggested that he was unable to elicit support for intervention from other nations made investors realize that the Japanese will have to go at it alone – which has traditionally been a losing proposition.  The only difference this time is that Japan has an extremely large war chest for intervention and they are not shy about using it.  Even the much better than expected University of Michigan consumer sentiment number failed to lend support to the greenback.  Thanks to the rebound in the equity market and lower gas prices, consumer sentiment rose to its highest level in 5 months. The University of Michigan Consumer Sentiment index hit 64.2 in November, up from 60.9. As retailers gear up for the holiday shopping season, the improvement in sentiment could not come at a better time but the focus remains on the action by policymakers.  If the BoJ refrains from intervening in USD/JPY next week, the only hope for the currency is better than expected U.S. data (and even that may not lend much support as we have seen today).  Unlike this past week where there has been very little U.S. economic data, the calendar heats up significantly this week with the release of retail sales, producer and consumer prices, the Treasury International Capital flow report, Industrial production, the Empire State and Philadelphia Fed reports, housing starts and building permits.  According to the Johnson Redbook Survey, consumer spending declined 0.6 percent last month. The International Council of Shopping Centers reported an increase in demand but the uptick was marginal which means in all likelihood, retail sales growth slowed in October.  Inflationary pressures are also expected to have declined with commodity prices retreating.   There has been growing consensus within the central bank that some type of economic data target is needed and next week’s economic reports will go a long way in helping the Fed decide whether to pull the trigger on policy change in December.  Bernanke and a number of other Fed officials have talked about tying interest rates to the inflation and/or unemployment rate which would be a more moderate step than raising asset purchases.  For once, we expect this week to be as much about the U.S. economy as the Eurozone.  

GBP: INFLATIONARY PRESSURES BEGIN TO SUBSIDE

The British pound strengthened against both the U.S. dollar but weakened against the euro.  The outperformance of the euro versus the pound is not surprising considering that today’s optimism stems from the Eurozone. U.K. input prices on the producer level fell in the month of October while output price growth remained flat.  Input prices fell 0.8 percent after seeing an upwardly revised increase of 1.8 percent in September.  Output prices remained flat, following a 0.3 percent increase last month.  These numbers indicate that inflationary pressures are easing and suggest that consumer prices could also decline. The Bank of England has long believed that CPI will fall from its stratospheric levels of 5 percent and the trend is beginning.    Britain’s economy is still at risk of slipping back into recession as the euro-area crisis intensifies and the evidence of lower inflationary pressures provides them with the flexibility to ease again if necessary. The slowing economy is currently experiencing squeezed real incomes and high inflation.  Under these circumstances, a rapid recovery in the housing market is very unlikely in the near term.  There is a great deal of uncertainty but the simple fact that there is a growing population and a shortage in housing supply creates an imbalance that will underpin property values in the future.  In another report, the Confederation of British Industry said the government needs to help boost housing activity.  Next week is heavy with economic releases including CPI numbers, the Bank of England’s inflation report, unemployment numbers and retail sales figures.  The BoE may lower growth projections in the inflation report next week, which Governor King will present at a press conference.  We will also be looking at the Quarterly Inflation Report for clues on future monetary policy.  

AUD: DRIVEN SHARPLY HIGHER BY RALLY IN RISK

All three of the commodity currencies performed well today with the Australian, New Zealand and Canadian dollars appreciating against the greenback.  Canadian Finance Minister Jim Flaherty expressed disappointment in the U.S. State Department’s decision to delay its review of TransCanada Corp’s $7-billion Keystone XL pipeline until after next year’s presidential election.   It may ultimately doom the project and accelerate Canada’s efforts to ship crude oil to Asia.  Oil headed for the longest run of weekly gains since April 2009, on speculation that signs of U.S. economic growth and Europe’s steps to contain its debt will boost demand and this has lent support to the loonie on a day devoid of Canadian data. Gold is also trending higher as traders are the most bullish in at least seven years and accumulate the metal at the fastest pace since August to protect themselves from fallout in Europe.  Canada will be releasing key manufacturing sales and CPI numbers next week.  The market expects Canadian inflation to ease to 0.2 percent after posting 0.5 percent growth last month.  Australia has “room to move” on monetary and fiscal policy as Europe’s worsening debt crisis threatens the global economy, Australia’s Treasurer Wayne Swan said.  Lower global growth will impact Australia but Swan noted that the nation is in a much stronger position than Europe or the U.S.   Australian employers are wrestling with higher wages, falling productivity and increasing labor disputes.   Days lost to industrial disputes tripled in the three months to June 30 as unions sought pay increases and job-security measures amid higher living costs.  The Reserve Bank of Australia will release its Monetary Policy meeting minutes next week for the meeting held on November 1 ^st .  New Zealand’s housing market is still limping along as buyers refuse to over-pay for properties, keeping the volume of sales muted.  The REINZ house price index posted a drop of 0.3 percent in October, following an increase of 1.7 percent last month.  The volume figures for October suggest that the spring ‘lift’ widely expected in the real estate market has been muted.  New Zealand will release key retail sales and producer input prices next week.  The market is expecting a slight softening in both metrics.

JPY: BACK TO PREINTERVENTION LEVELS

The Japanese yen traded lower against all of the major currencies with the exception of the U.S. and Canadian dollar. USD/JPY has broken the 77.50 level and has continued to drift lower. This collapse renewed the concern of an intervention by the Bank of Japan. Since bank’s move to buy dollars and sell yen in October, the pair has fallen back to pre-intervention level. In addition to yen’s appreciation, the tertiary industry activity slowed more than expected in September. The index printed -0.7 percent versus -0.4 percent eyed. Industries that contributed to the decline included retail trade, communications, personal services and finance. The Japanese economy has been hit with waves after waves of disappointing news. The Thailand flood could likely cause more disruptions and put more stress on the recovery just as the manufacturers repaired supply-chain damaged by the earthquake in March. Meanwhile, the Prime Minister Yoshihiko Noda struggled to reconcile the differences within the ruling Democratic Party of Japan (DPJ). The divided opinions on joining the Trans-Pacific Partnership (TPP) remain a key issue for Noda’s administration. Membership of the TPP would wrench open Japan’s closeted agriculture sector to competition, give its major exporters better tariff deals overseas and challenge a political system over which the farm lobby has long held powerful influence. However, the pact could also expand the market for Japanese exports. “As an export-led nation,” Noda said, “Japan has been prosperous. But in order to pass that prosperity to the next generation, Japan has to capitalize on the growing power in Asia.” Looking forward to next week, GDP will be released on Sunday, followed by BoJ’s rate decision on Tuesday and their monthly report on Thursday. With signs of faltering, the Japanese economy could grow less than expected.  The BoJ’s report should point to a weakening recovery that is held back by the yen’s strength and global economic activity.  

EUR/USD: Currency in Play for Next 24 Hours

The EUR/USD will be our currency pair in play for Monday with Eurozone Industrial Production scheduled for release at 5:00AM ET / 10:00 GMT.  

EUR/USD has pared some of its losses from the collapse this week, and is currently trading range-bound which we determined using the Bollinger Bands. The nearest support level is at 1.3494, the lower second standard deviation Bollinger Band. The pair could target its October swing low of 1.3145 if we see any further fallout of the euro. On the upside, EUR/USD& #8217;s climb could see some resistance at 1.3831 (38.2% Fibonacci level). We drew our Fibonacci retracement from the swing high in May to the low in October. Further up, the round number of 1.40 could provide more significant resistance. 

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