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Forex Weekly Review and Outlook − Dollar Weakness and Yen Strength Expected to Continue after G7

Sat, Oct 20 2007, 07:42 GMT
by ActionForex.com Team

ActionForex.com

Forex Weekly Review and Outlook

Dollar Weakness and Yen Strength Expected to Continue after G7

Dollar tumbled across against majors currencies last week and increased expectation for an Oct rate cut, with EUR/USD making another record high while USD/CAD making new 33 year low. Though, both Aussie and Kiwi retreated, dragged down by selloff in yen crosses. Meanwhile, Japanese yen surged across the board on risk aversion and build up to G7 meeting. With no specific mentioning of dollar, euro and yen in the post G7 meeting communique, further yen strength and dollar weakness will likely be seen in the coming week. Technically speaking, the rebound in yen crosses that started in July has likely completed last week and another massive carry trade unwinding could be seen in the coming week, resuming the sharp fall that started in May.

Again, the G7 meeting delivered little consensus among the countries. There were no specific mentioning of dollar, euro nor yen in the communique. Though, the group urged an "accelerated appreciation" of the Chinese yuan as Europe and Canada joined the U.S. in complaining it remains undervalued and threatens their trade balances. The message will likely provide further support to the Japanese yen, which serves as the proxy to Asian currencies. However, it will have little impact to dollar's weakness and euro's strength.

Dollar tumbled across the board on further expectation of an Oct rate cut with Fed Fund futures now pricing in a 90% chance. Markets expect that the Fed is deeply concerned with the worsening of the housing markets downturn and the consequent "significant drag" on growth into 2008 as Bernanke mentioned in a speech last week. Housing data came in much worse than market expected, indicating the housing market slowdown continued to worse. NAHB Housing Market Index of builder optimism dropped another 2 point to 18, worse sentiment since 1985. Housing starts slide further by 10.3% to 1.191M annualized rate, much worse than expectation of 1.285M and hitting the lowest level since 1993. Building permits dropped 7.3% to 1.226M, also missed expectation of 1.298M.

Other data were generally disappointing. The TICs report showed a net -$69.3b of long term US securities were sold by international investors in Aug, i.e. a net -$69.3b capital outflow versus expectation of $60b inflow. This is reflecting the decreasing confidence in the US economy and concerns on deepening housing recession and spillover to the rest of the economy as well as loss of appetite for dollar denominated assets. The last time net capital flow went negative was in Aug 98, another crisis period when Russia defaulted on its sovereign debt and hedge fund (LTCM) was on the verge of going under.

Headline CPI accelerated from 2.8% to 2.1% in Sep. Core CPI remained unchanged at 2.1% yoy. Both were inline with expectation. The steady core CPI suggested that inflations stabilized at a moderate rate and remains under control in near term. Jobless claims surged sharply higher from revised 309k to 337k. Regional Fed surveys were mixed with NY state survey rising strongly to 28.75 while Philly Fed survey dropping to 6.8.

Fed's latest Beige Book showed economic conditions are consistent with recent data. Even though business momentum slowed, there aren't a lot of evidence that slowdown in the economy has intensified. Five of Fed's 12 districts reported slower growth while seven reported unchanged.

From Eurozone, ZEW economic sentiment improved slightly from -20.3 to -19, much better than consensus of -25. HICP is confirmed to have accelerated form 1.7% yoy to 2.1% yoy in Sep. Trade surplus shrank to 1.3B but better than expectation of 0b. The Euro remained strong throughout the week and surged to new record high against dollar at 1.4317 despite retreating against yen and Swissy.

The Japanese yen staged a sharp reversal and surged across the board on risk aversion and build up to the G7 meeting. Yen was additionally boosted by PBoC Governor Zhou's comments that Yuan will eventually be freely convertible. Japan industrial production rose 3.5% mom, 5.1% yoy in Aug, beating expectation of 3.4%, 4.3%. Tertiary industry index rebounded to 1.3% while all industry index rose 1.0% in Aug.

Swiss retail sales rose 3.8% yoy in Aug, much better than consensus of 2.9%, prior at 3.3%. Trade surplus surged to 1.8B in Sep, highest in more than 18 years. ZEW economic sentiments improved from -26.7 to -16 in Oct. Swiss also followed then yen to rise across the board on risk aversion, as well as being supported by SNB Roth's comment that it's wrong to assume no more rate hike from SNB.

It was a very busy week for the Sterling. BoE minutes revealed that BoE members voted 8-1 to keep rates unchanged at 5.75% earlier this month, with Blanchflower being the sole dissenter voting for a precaution cut in rates. CPI rose 1.9% yoy in Sep, unchanged from Aug and below expectation of 1.9%. Core CPI slowed to 1.5% yoy, lowest in 11 months. The inflation data took off some pressure from BoE on risks of re-emergence of inflation.

However, growth data were pretty solid. GDP increase 0.8% qoq, 3.3% yoy in Q3, beating expectation of 0.7% qoq, 3.1% yoy. The yoy rate is even higher than prior quarter's 3.1% and is the fastest in over three years. Retails sales grow 0.6% mom, 6.3% yoy, much better than expectation of 0.1% mom, 5.5% yoy. Employment data from UK saw claimant count dropping another -12.8k in Sep, keeping at a two year low of 2.6% in Sep, suggesting that labor market remains tight. ILO jobless rate head steady at 5.4% for the fourth month in a row in Aug. Earnings growth had a mild pickup to 3.7%. The data suggested that impact of the credit crunch was rather limited and is gradually removing the odds of rate cut from BoE in the near term.

It was also a busy week for the Canadian dollar. BoC kept rates unchanged at 4.50% as widely expected. The Monetary Policy Report released later showed somewhat downgraded inflation outlook. Headline CPI in Canada to peak at about 3% in Q4 and then drift lower in 2008. Core CPI is expected to peak in next Q2. Both are expected to move down to the Bank's 2% target in second half of 08, earlier than prior forecast of early 09. CPI data released later was inline with this forecasts, with headline CPI accelerated from 2.2% to 2.5% yoy as expected and core CPI slowed from 2.2% yoy to 2.0% yoy. Based on the current inflation outlook, BoC will be firmly on hold at 4.50%. USD/CAD dipped to new 33 year low of 0.9632, with support from record oil prices.

Data from New Zealand saw CPI moderated further from 2.0% yoy to 1.8% yoy, below expectation of rising to 2.1%, suggesting the RBNZ's four hikes since the start of the year are doing their job. The fall in CPI is attributed to one-off government changes to education and healthcare funding costs as well as the effect of drop in petrol prices in late 06. Both Kiwi and Aussie weakened later in the week, dragged by carry trade unwinding.

The Week Ahead

Economic calendar is relatively light this week. From US, focus will mainly be on new and existing home sales in Sep and durable goods orders in the middle of the week. Focus in the Eurozone will mainly be on Oct Ifo index which is expected to continue to drop from 104.2 to 103.7. German Gfk consumer confidence is expected to drop slightly from 6.8 to 6.5. Japan national CPI is expected to recover slightly from -0.2% yoy but remain negative at -0.l% yoy. Canadian retail sales is expected to rebound by rising 0.5% in Aug with ex-auto sales rising 0.3%.

The bigger market mover could indeed be Australia's CPI release. Markets are gradually building up expectation of another rate hike from RBA in recent weeks. Q3 CPI is expected to remain steady at 2.1% yoy and any upside surprise will solidify the rate expectation and provide support to the Aussie. RBNZ is expected to keep rates unchanged at 8.25%.

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

USD/JPY

After edging higher to 117.93 initially, USD/JPY reversed and tumbled sharply to as low as 114.50. Break of the short term rising channel (now at 116.15) confirmed that rise from 112.58 has already completed at 117.93. This also added much credence to the case that corrective rebound from 111.59 has completed too. In other words, the current fall from 117.93 is tentatively treated as resumption of the sharp decline that started at 124.13.

From a short term angle, initial bias will remain on the downside as long as 115.70 resistance holds. Firm break of 114.01 cluster support (61.8% retracement of 111.59 to 117.93 at 114.01) will encourage a retest of 111.59 low. Above 115.70 will indicate that a short term bottom is possibly in place. But rebounded should be limited below 116.61 resistance and bring another fall.

In the bigger picture, note that prior break of long term rising trend line (101.65, 108.99) indicates the the whole up trend from 101.65 has completed at 124.13 already, with bearish divergence condition in weekly MACD and RSI. Subsequent sharp fall from 124.13 has made a short term low at 111.59 and rebound from there is treated as correction to this fall only. Current fall from 117.93 is tentatively treated as resumption of whole fall from 124.13. Firm break of 111.59 low will confirm this case and bring decline to next cluster support zone of 61.8% retracement of 101.65 to 124.13 at 110.23 and 61.8% projection of 124.13 to 111.59 from 117.33 at 109.58 first.

In the longer term picture, the three wave structure of the up trend from 101.65 to 124.13 suggests that it's corrective in nature. Such development flipped favor to the case that the rally from 101.65 could indeed be the final leg of a long term triangle formation (147.68, 101.22, 135.20, 101.65, 124.13). The break of falling trend line (147.68, 135.20) was merely a throwover in the last leg. Sustained trading below 108.99 low will add more credence to this case and put key long term support zone of 101.22/65 into focus.

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Published on  Sat, Oct 20 2007, 11:37 GMT