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Daily Market Commentary

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The Risks Ahead

Wed, Dec 3 2008, 22:51 GMT
by Kathy Lien

GFT

US Dollar : The Risk Ahead

The volatility in the equity markets has helped the US dollar hold onto its gains. Investors are nervous about the outlook for Friday’s non-farm payrolls report and that is benefitting the low yielders. The Eurozone and UK are expected to cut interest rates tomorrow and weakness in those currencies is pushing the dollar higher. Even though US stocks closed in positive territory, the leading indicators for non-farm payrolls and the Beige Book report tell us that there is a lot to be worried about when it comes to the US economy.

Job Losses Could Hit 400k

The Challenger layoffs report, the ADP employment survey and the employment component of service sector ISM suggest that November non-farm payrolls will be very ugly. The market is currently looking for job losses to hit -330k, but the record low in ADP and the employment component of ISM suggests that non-farm payrolls may have fallen as much as 375k to 400k last month. ADP has track record of undershooting payrolls which is why we expect NFP to drop by more than 250k. We also keep a very close eye on the employment component of ISM because it is one of the strongest leading indicators for NFPs. Reports from the 12 Fed districts confirm the weakness in the US economy and the labor market in particular. There was nothing optimistic in the Beige Book which reported that since mid October, the economy has weakened in all districts. Consumer spending, the housing market and the labor market saw the biggest deterioration. The Federal Reserve takes the Beige Book report into serious consideration when determining monetary policy and given its overwhelmingly pessimistic tone, there is no question that interest rates will be coming down this month. Regardless of how bad non-farm payrolls fare on Friday, it will not be the end of job losses – tomorrow’s jobless claims report should confirm that. Many companies are holding off until right before bonus season to lay off employees which is why zero interest rates in US are becoming a growing reality.

Will Paulson Tap Second Half of TARP Funds?

There is also talk that US Treasury Secretary Paulson could ask Congress for the second half of the $700B bailout package. We are becoming increasingly worried about the economic strategy shifts in the Bush Administration. If you recall, the US government had previously scrapped their plans to buy bad loans from banks only to revisit them later on. Last month, Paulson said that he would not ask for the remainder of the TARP funds to give Obama’s Administration the flexibility to tap the funds immediately when they take over in January. To backtrack on his words and tap the remainder of the funds now would send a troubling message to the market. It would suggest that the economy cannot wait another month and a half for stimulus which would really throw into question the reliability and conviction of Paulson himself.

Automaker Bailout Package Poses Risk for the Dollar

With the grim outlook for Friday’s non-farm payrolls number, one of the few things that could improve risk appetite and trigger profit taking in the dollar is a bailout package for the automakers. General Motors warned that they may be out of business in less than a month if they do not receive an immediate $4 billion loan from Congress. Chrysler is in the same boat and is looking for a $7 billion infusion. The heat is being turned up in Washington and it should be just a matter of time before Congress is forced to fork up the money because the longer they wait the more money the automakers may need. Their request has already been bumped up to $34 billion from $25 billion. The announcement of a bailout package could take some uncertain out of the markets and help to improve risk appetite, which would lead to a temporary correction in the US dollar.

NZD/USD: RBNZ CUTS 150BP, SAYS RECESSION MAY BE OVER

The Reserve Bank of New Zealand cut interest rates by 150bp this afternoon to 5 percent. This is the largest interest rate cut for the central bank and brings their total easing since July to 325bp. Although the degree of the rate cut was not that big of a surprise, the comments from RBNZ Governor Bollard were very interesting. Even though he said that further rate cuts may be warranted, he also indicated that recession in New Zealand may already be over, helping the New Zealand dollar. The economy is still expected to contract until June but at least for New Zealand a bottom may be near. The 30 percent decline in the currency year to date is one of the primary reasons why the New Zealand economy will be able to recover quickly. The combination of a weak currency and another 100bp of expected rate cuts will help to support the economy. Despite a sharp decline in the service sector PMI number and pessimistic comments from Treasurer Swan, the Australian dollar gained strength. Swan saw further downside risks to the economy, which supports our belief that more rate cuts are expected from Australia. There was no economic data from Canada today but trouble is brewing. Canadian Prime Minister Stephen Harper will present his case for maintaining power tonight in a televised address to voters. Political uncertainty is never good for a currency, especially at a time when the economy is weak.

EUR/USD: 50BP VS 75BP RATE CUT

There is no doubt that the European Central Bank will cut interest rates tomorrow, the only question is by how much. Eurozone economic data tells us that the central bank should opt for a larger move but they have been very nimble with rate cuts and that may stop them from delivering what would be the largest single meeting rate cut ever for the ECB. The market is only looking for a 50bp rate cut, but a 75bp cut is what the economy really needs. Eurozone retail sales plunged in the month of October while service sector PMI hit a record low. Compared to neighboring nations, the ECB has not acted as aggressively, dropping rates only by 75bp this year. Now that the region has officially hit a recession, it is possible that they will be more aggressive in easing rates. Although producer and consumer prices have been easing, the central bank is not entirely convinced that the upside risks to prices have alleviated. In addition to the rate decision, ECB President Trichet will be delivering a press conference. His stance on future rate cuts could take the EUR/USD out of its increasingly tight trading range.

GBP/USD: WILL THE BOE CUT MORE THAN 1 PERCENT?

The UK has been one of the most aggressive countries when it comes to cutting interest rates. At its last meeting, the Bank of England delivered a 150bp cut. The contrasting degree of dovishness by the BoE and the European Central Bank is the primary reason why EUR/GBP is headed back towards its all time highs. UK Service, manufacturing and construction PMI reports are all at record lows, reflecting the deep slowdown in the UK economy. Consumer Confidence has also plunged and there is a serious risk that consumer defaults could cripple banks. According to a PricewaterhouseCoopers poll, one in six UK consumers cannot handle their debts. There is a risk of a 125bp rate cut if the Bank of England wants to continue to be proactive. Since their next interest rate cut will certainly not be their last, they may decide to do more now than later. The minutes from the most recent monetary policy meeting in early November suggested that the BoE considered an even larger interest rate cut. With the economy in a recession according to UK officials, interest rates could fall as low as 1% if the crisis continues well into the New Year.

USD/JPY: RALLY IN EQUITIES HELP TO LIFT YEN CROSSES

The yen remains relatively quiet, as the threat of risk aversion has stalled temporarily. In fact, the Japanese have released little today that would impact the currency market. The range for USD/JPY was only 100 pips, a small amount compared to prior moves. The last two days of price action may show some hint of exhaustion in the big moves that have proceeded. As we get deeper into this month, which is full of important central bank rate decisions, we may receive the catalyst necessary to buck the trend. In the midst of a relatively subdued trading day, Japanese equity indices manage to rally, with the Nikkei posting a 1.8% gain. There are several potentially influential reports scheduled for later today, including Capital Spending, Foreign Buying of Japanese Stocks, and Japanese Buying of Foreign stocks.

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

EUR/USD will be the currency in play for the next 24 hours. There will be no shortage of market moving events scheduled in Europe tomorrow. The most important of which will be the ECB rate announcement at 7:45 am ET or 12:45 GMT. Trichet will also hold a press conference discussing his decision at 8:15 am ET or 13:15 GMT. EZ GDP will be announced at 5:00 am ET or 10:00 GMT.

The EUR/USD has maintained itself within the range zone according to Bollinger Bands for the last few days. Tomorrow’s packed schedule suggests that a breakout may be imminent. Support is firmly in place at the previous lows of 1.2400. A break of this level should add a new leg to the impressive downtrend in the euro. Since we are expecting big moves in tomorrow’s trading, there is another support level worth mentioning at 1.2120. This level should be extremely significant as it is the 50% retracement from early 2000 lows to the all-time high at 1.6037.For resistance, we will count on the 1.3085 level which closely represents two previous highs. If traders are disappointed tomorrow, the downside risk could be substantial if the 1.2120 level fails to hold.

Published on  Wed, Dec 3 2008, 22:54 GMT