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Forex Weekly Review and Outlook − Dollar Hammered on Rate Cut Speculation. Services, NFP and Central Banks in Focus

Sat, Dec 2 2006, 19:44 GMT
by ActionForex.com Team

ActionForex.com

Forex Weekly Review and Outlook

Dollar Hammered on Rate Cut Speculation. Services, NFP and Central Banks in Focus

Dollar consolidated for the initial half of last week after a gap low before staging another sharp decline trigger by surprisingly weak manufacturing data on Thursday and Friday. Sterling was strong across the board, breaking to new 14 year high against the greenback. Meanwhile, despite finally rising against dollar, the Japanese yen remains pressured across the board and dropped to new record low against Euro again.

After a gapping lower on Monday, dollar consolidates Tuesday and Wednesday with mixed data. Durable goods order dropped much more than expected in Oct by 8.3%, largest decline since Jul 2000. Conference Board Consumer Confidence also weakened to 102.9 in Nov. New home sales also came in weaker than consensus. However, dollar was still supported by better than expected existing home sales and strong upward revision in Q3 GDP growth from 1.6% to 2.2%.

However, Chicago Fed index dropped to 49.9 in Nov, the first sub-50 contractionary reading since Apr 03. This has triggered sharp selling in dollar across the board, which was further fueled by weak ISM manufacturing index on Friday, which dropped to 49.5, another sub-50 contractionary reading, first in more than 3 years. Construction spending also dropped much more than expected.

With a clearly slowing housing market, as well as contracting manufacturing industry, speculation has greatly increased that Fed's next step will be a rate cut. In fact future prices are now betting with a greater than 80% odd that Fed will have a cut to 5% by the end of Mar. This week's ISM non-manufacturing index and Non-farm payroll will be crucial.

Eurozone M3, the broad measure of money supply, remained solid and grew at same rate as previous month’s 8.5% rise despite missing consensus of 8.7%. 3 months averages increased to 8.4% growth form 8.2%, still far above 4.5%, where ECB believed is consistent with medium term price stability. European finance ministers said that Euro's strength doesn't yet threaten the growth in Eurozone and the countries can "live with the current exchange rate." Other data from Eurozone were solid with above forecast business climate at 1.5. Q3 GDP grew 0.5% while HICP increased 1.8% in Nov, both inline with consensus. In short, ECB will likely raise rates, at least at the same pace, in early 07. Focus will turn to this week's ECB rate decision and press conference.

Data from UK were far from impressive, except with stronger than expected house price inflation that increased 1.4% in Nov versus consensus of 0.7%. Also, Sterling was firmly supported after after U.K. Chancellor of the Exchequer Gordon Brown said economic growth will exceed the government's earlier forecast of 2.2% to 2.5% this year.

Despite much stronger than expected industrial production, inflation data from Japan was disappointing. National CPI growth retreated from 0.6% to 0.4% in Oct. The CPI inflation figure has been hovering between 0% and 1% in the pass few months. There is no clear sign of inflation in Japan. Based on inflation, the odds for rate hike in December continues to look slim, not even early next year.

The Week Ahead

The most important data and event of the coming week will be US ISM non-manufacturing index and Non-Farm Payroll as well as ECB rate decision and press conference. After disappointing manufacturing data, weakness in services sector and employment will fuel further speculation that Fed will cut rate by early next year. The implication is that a 25bps rate cut will bring Fed fund rate to 5.00% level. The will be at par with BoE's rate if BoE keeps rate unchanged.

ECB is wildly expected to raise rate by 25bps to 3.50% this week as Trichet has signaled by using the 'V' word in last meeting. While this rate hike is priced in, the focus will be on ECB's forecasts for 2007 and indications on next year's monetary policy.

BoE and RBA will also be making rate decision this week and both are expected to keep rates unchanged. Speculation for further hike from BoE was toned down after last quarterly inflation report. However, opinion on whether BoE will raise rate again next Feb is still divided and this week's data, including UK services PMI, retails sales, industrial and manufacturing production will be closely watched.

Read full report (EUR/USD, GBP/USD, USD/CHF, USD/JPY) here.

GBP/USD

Cable staged another powerful rally last week, breaking through 1.9554 resistance (04 high) and made new 14 year high at 1.9846 before closing the week strongly. From a short term angle, initial bias this week remains on the upside as long as cable stays above 1.9634 support and further rally is still in favor to follow despite overbought condition and bearish divergence in 4 hours RSI. Next upside target will be 138.2% projection of 1.8090 to 1.9142 from 1.8517 at 1.9971. Below 1.9634 will suggest a short term top is formed and could bring correction to 4 hours 55 EMA (now at 1.9398) or lower. But downside should be contained above 1.9168 resistance turned support and bring another rally.

In the long term picture, cable's multi year up trend from 1.3680 has completed at 1.9554 and subsequent correction finished at 1.7047 after being supported by 55 months EMA. Break of 1.9554 high added much much credence to the case that this multi-year up trend from 1.3680 has resumed. However, the three wave structure of the rise from 1.7047 to 1.9024 is still giving some doubt that this medium term rally from 1.7047 is just part of a large scale consolidation from 1.9554. Hence this is not confirmed to be a long term rally resumption yet.

Nevertheless, medium term up trend from 1.7047 is still treated as in force before a break of 1.8834 support or clear reversal pattern forms. Hence, at this moment, we'd still expected the medium term rise from 1.7047 to continue. On the upside, 2.0106 cluster resistance (1992 high, 100% projection of 17047 to 1.9024 from 1.8090 at 2.0067) will be the key resistance to watch out for. Decisive break of this resistance will confirm that long term up trend from 1.3680 has resumed.

Published on  Sat, Dec 2 2006, 19:47 GMT