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Daily Market Commentary

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US Dollar: Paulson Comments Are Big Disappointment

Tue, Nov 18 2008, 22:13 GMT
by Kathy Lien

GFT

US Dollar: Paulson Comments Are Big Disappointment

The foreign exchange markets were relatively quiet today despite the big moves in US equities. Stocks hit 5 year lows intraday before reversing violently higher in the last hour of trading. In yesterday’s Daily Currency Focus, we posed the question Is the Dollar Rally Over and we argued that all signs point to more trouble for the global economy. We continue to believe that this is true as the testimony by Paulson and Bernanke before the House Financial Services Committee yielded little results. With 8 weeks to go before the Bush Administration leaves office, Paulson is focused on washing his hands of this mess and defending himself against the criticism that the TARP has failed to effectively support the financial markets and the US economy.

Markets Will Need to Wait 2 Months for Rest of TARP Funds

Bernanke feels much more urgent about dealing with the financial crisis than Paulson because he’ll be staying on as the Chairman of the Federal Reserve while Paulson will be giving up his post to a new Treasury Secretary. However Paulson is the one that has the power to ask for more the second half of the TARP funds from Congress and he has made it painstakingly clear that the market will have to wait at least another 2 months because he does not want to be responsible for tapping the entire bailout package and not being able to take the credit for the results. For the financial markets, the prospect of any delays has been a huge disappointment and one of the primary reasons we remained concern about the US economy. The foreign exchange markets do not like uncertainty and delaying further stimulus has sent investors back into the US dollar and Japanese Yen. Foreclosures were a big topic at the testimony and there is a decent chance that the rest of the TARP fund may be used to directly help homeowners. According to Bernanke, we are still a long way from stabilizing the credit markets and confidence, but it is important to recognize that foreclosures are a symptom and cause of the crisis.

Demand for Treasuries Drive Dollar Rally

Despite the turmoil in the US financial markets, foreign demand for US securities remain robust. Net long term Treasury International Capital flows rose by $66.2 billion in the month of September, up from $21.0B the month prior. Even though the TIC report is a lagging indicator, this set of data was particularly interesting since it covered the month of September which was when Lehman Brothers collapsed. Demand was particularly strong for US Treasuries but foreigners dumped corporate bonds on the fear of default risk. As a testament to China’s growing economic power, they have now surpassed Japan as the largest holder of US debt. In September, increased repatriation led to a net sale of US securities by the Japanese while China accumulated a growing amount of US securities for the third consecutive month. The increase in foreign holdings of US debt helps to explain the dollar’s recent rally because despite higher issuance, demand for US Treasuries remains voracious.

Top 5 Holders of US Treasury Securities

PPI and NAHB Housing Market Data Begs More Rate Cuts from Fed

Producer prices and the NAHB housing market index both dropped to a record low, supporting the need for a further rate cut from the Federal Reserve. According to the Chairman of the NAHB, the latest report indicates that we are in a crisis situation. The NAHB data does not bode well for housing starts and building permits, which are due for release tomorrow. The trouble in the US economy will continue to have a big drag on the real estate market. As for the inflation data, the sharp decline was hardly a surprise because import prices, a leading indicator for producer prices fell as well. However, the jump in core prices was a bit surprising. We do not believe that the uptick in inflation will be sustained as lower headline prices should eventually filter into core prices especially since slowing global demand will naturally drive down prices. Inflation will not stop the Federal Reserve from easing interest rates again in December. The Fed minutes which are due for release tomorrow will shed more light on how much the central bank may ease next month. Consumer prices are also due for release and we expect lower prices at the pump to drag down CPI.

EUR/USD: ECB REMAINS STUBBORN ABOUT RATE CUTS

With Germany, Italy and the Eurozone as a whole in an official recession, we continued to be amazed by the stubbornness of the European Central Bank. ECB President Trichet said today that having fluid communication can reduce the need for larger rate cuts. Although he was clear to say that communication does not replace action and further easing can be implemented if it necessary, he stopped short of promising further rate cuts like the UK. This stubbornness has limited the decline in the EUR/USD today, but we believe that it will come back to haunt the Euro. There is no meaningful economic on the Eurozone calendar over the next 24 hours. The currency pair’s tight consolidation over the past 3 weeks suggests that a breakout may be imminent. Meanwhile even though Swiss retail sales saw a 6.4 percent annualized rise in the month of September it did not stop the Swiss Franc from falling to a 1 year low against the US dollar.

GBP/USD: STRUGGLES TO HOLD ONTO GAINS AHEAD OF BOE MINUTES

The British pound is struggling to hold onto its gains following this morning’s sharp drop in consumer prices. Headline CPI fell 0.2 percent in the month of October, while core prices dropped to 1.9 percent on a year over year basis. The decline from 2.2 percent was the largest since 1997, giving the Bank of England plenty of room to continue cut interest rates beyond 3 percent. Last week, central bank Governor King already suggested that the recessionary conditions in the economy will force them to take interest rates as low as needed and there is a decent chance that UK rates will not hit a bottom until 1 percent. This is why the British pound has had such a hard time rallying because nothing will stop interest rates from heading lower. The minutes from the most recent monetary policy meeting are due for release tomorrow. Since this is the meeting where the BoE shocked the markets with a 150bp rate cut, everything from the balance of votes to the discussions about different sizes of rate cuts could have a big impact on the British pound.

AUD/USD: PROSPECT OF MORE RATE CUTS FAIL TO HURT THE AUSSIE

The Australian, New Zealand and Canadian dollars traded in a very tight range today as US equities oscillated between positive and negative territory. On an intraday basis, crude prices fell to a fresh 22 month low of $53.96 a barrel as commodity prices continued to head lower. The minutes from the most recent RBA meeting was the most anticipated report over the past 24 hours. The good news was that the Reserve Bank is looking to cut interest rates again since they weighed a 50 vs. 75bp rate cut at the last meeting. They ended up choosing to ease by 50bp, which means that another 50 could be right around the corner. The bad news is that they still think the economy is headed lower, which will spell difficult times for Australians. The Assistant Governor is slated to speak tonight and we expect him to confirm the RBA’s dovish bias. Leading indicators and new motor vehicle sales are due for release as well, but the impact on the Aussie should be minimal. New Zealand producer prices were softer than expected in the third quarter with input prices growing 3.7 percent compared to 5.6 percent the prior quarter. Output prices rose 2.8 percent compared to 3.5 percent. Like the rest of the world, PPI is expected to ease. Canada on the other hand will be reporting leading indicators and international securities transactions. Repatriation into US dollars and Japanese Yen should drive money out of Canada.

USD/JPY: BREAKOUT MAY BE IMMINENT

The biggest market mover today was NZD/JPY, which rose a measly 1.06 percent. Despite the volatility in US equities, which oscillated deep within positive and negative territory, the Japanese Yen crosses held steady. A triangle is forming in nearly all of the Yen crosses, suggesting that a breakout may be imminent and the FOMC minutes could be the trigger. Japanese fundamentals remain disappointing. Retailers where hit by a slowing economy, as Nationwide Department Store sales dropped 6.8%. Japanese Leading Indicators came in line with the 89.4 forecast; which suggests that the future of the economy in the upcoming 6 to 9 month will remain steady. For the next 24 hours we expect the Japanese Merchandise Trade Balance. With the economy recession, the Bank of Japan should lower interest rates. Unfortunately, since rates already at 0.3 percent, they have next to no room to ease. According to the US TIC report, the Japanese were net sellers of US securities. This repatriation explains the Yen’s out performance against the US dollar.

USD/JPY: Currency in Play for the Next 24 Hours

USD/JPY is the currency in play for the next 24 hours. Tomorrow, the U.S. is set to release the Consumer Price Index, Housing Starts and Building Permits at 8:30 AM EST or 13:30 GMT. The FOMC minutes will be released at 2:00 PM EST or 19:00 GMT.

USD/JPY is still within the range trading zone, which we determine using Bollinger Bands. With heavy data being released from U.S. in the morning and a triangle in formation, there may be a significant move in the currency pair. Resistance for the pair lies at the top of the triangle which is right around the same level as 10-day SMA and 20-day SMA at 97.40. The support for the pair is at the bottom of the triangle formation which is slightly above the first standard deviation Bollinger bands at a price level between 95.70 and 96.00. A break of the resistance level would open the door for a move to 100.00 while a break of support could send the pair to its October lows.

Published on  Tue, Nov 18 2008, 22:15 GMT