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Daily Market Commentary

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Another Big Week Ahead

Thu, Jan 8 2009, 22:51 GMT
by Kathy Lien

GFT

Another Big Week Ahead

The US dollar surged against all of the major currencies expect for the Japanese Yen following the December non-farm payrolls report.  More than half a million Americans lost their jobs last month but the data was not nearly as bad as the whisper number that ran as high as -700k.  The number of jobs cut was also less than the previous month, which was revised from -533k to -584k.  By all counts, the labor market report was bad, particularly since the unemployment rate soared to 7.2 percent.  Yet the US dollar managed to rally because meeting expectations these days is more positive than negative for a currency.  My friend Andy Busch at BMO said it best, “After the ADP/Monster/Challenger numbers all were horrible, today's data at -525k and 7.2% doesn't seem so bad.  It's like being in Chicago when the temperature is at 10 F for a week and then we get 25 F.  You go outside without a coat and say how warm it is.”  

Modest Rebound in NFP Only a Precursor to More Losses

If you read the non-farm payrolls preview that we published on Thursday, the modest rebound in non-farm payrolls should not be all that surprising.  In the past 5 decades, we have seen a rebound every single time job losses topped 500k, and this time it was no different. The employment component of service sector ISM, one of the most reliable leading indicators for NFP improved last month, also signaling slower job losses. We have just endured one of the worst strings of job losses that this generation has ever seen and unfortunately the pain will continue. Alcoa and Intel have already announced layoffs. The US is in recession and in previous recessions, job cuts have lasted for at least 15 months. So far, we have only seen 12 consecutive months of job losses which mean that non-farm payrolls will not turn positive until the second half of the year.

Big Event Risks for the Upcoming Week

More risks lie ahead for the US dollar in the coming week with retail sales, producer prices, consumer prices, the Treasury International Capital (TIC) flow report, Empire State and the Philadelphia Fed index due for release.  Given that more than a million Americans lost their jobs in the last 2 months, consumers should have been more frugal in the month of December.  However the contraction in spending may not be as bad as the previous month because it was the holiday shopping season and both SpendingPulse and ICSC reported a slower decline in retail sales.  As for inflation, the drop in oil prices and slower global demand will continue to ease price pressures.  Inflation is not a priority for any central bank at this point.  The one number that we are particularly interested in seeing is the TIC report.  Yesterday, we talked about how China could be losing its appetite for US debt.  The TIC data will tell us if that is true and whether other central banks and foreign investors in general are following suit.  

EUR/USD vs. USD/JPY

However with that in mind, the US dollar may trade very differently against the Euro than the Japanese Yen next week.  USD/JPY has had the purest reaction to any US data while the Euro has been impacted by expectations for next Thursday’s ECB interest rate decision.  If expectations for a rate cut continue to grow, the EUR/USD could extend its sell-off despite the problems in the US economy.  As for the dollar’s performance against the other major currencies, that should depend on the market’s risk appetite.  

EUR/USD: WILL THE ECB CUT INTEREST RATES?

With the US non-farm payrolls release behind us, the currency market’s focus will shift to Eurozone and the ECB interest rate decision on Thursday.  After cutting interest rates by 150bp last year, the central bank has hinted that they may refrain from easing again in January.  As a staunch fighter of inflationary pressures, central bank President Trichet has been deathly afraid of the risks of cutting interest rates too much.  In the past, if the central bank is relatively confident about changing interest rates, they would warn the markets weeks in advance.  However, they are entering their pre-meeting quiet period where they avoid any public comments without providing any clear direction.  Economic data has been weak and even Trichet has acknowledged that there has been a significant deterioration in the real economy.  By not cutting interest rates this month, the ECB risks putting themselves even further behind the curve.  We believe that they will buckle down and cut interest rates, albeit begrudgingly.  Although German and Eurozone retail sales rebounded in November, the annualized pace of consumer spending slowed materially. French and German industrial production also tumbled, reflecting the difficult conditions in the manufacturing sector.  In addition to the ECB rate decision, Eurozone consumer prices and the trade balance are due for release next week.  

GBP/USD: RECESSION DEEPENS BUT PRICES ARE RISING

The British pound strengthened against the Euro for the fifth consecutive trading day.  The market is starting to realize that the ECB will have its hands full with battling an economic crisis when the Bank of England is beginning to reap the benefits of the aggressive fiscal and monetary stimulus.  Even if they refrain from lowering rates next week, the ECB will have to reduce interest rates in February.  UK economic data was mixed.  Industrial production dropped 2.9 percent, matching the largest decline since 2002.  The recession in the manufacturing sector and the economy as a whole has deepened as demand slows to a halt.  However, price pressures are rebounding.  Input and output prices rose in the month of December as lower gasoline prices were offset by higher tobacco and alcohol prices.   The recent weakness of the British pound could also be contributing to the higher price pressures.  The uptick is not much of a concern for the central bank because they believe that inflation will ease significantly in the coming months.  Next week the UK economic calendar is very light with only the trade balance and BRC retail sales due for release.  

USD/CAD: CANADIAN UNEMPLOYMENT HITS 3 YEAR HIGH

The double blow of falling oil prices and slowing growth in the US is having its toll on Canada.  The labor market has deteriorated significantly with the unemployment rate rising to 6.6 percent, the highest level since January 2006.  With more than 34k Canadians losing their jobs last month, the Canadian dollar sold off aggressively.  Although this number may seem small compared to the staggering loss in the US, it is important to realize that Canada’s population is one tenth of the US.  This should be the beginning of more job losses to come. Canadian officials were out in force today talking about the economy and stimulus measures. Finance Minister Flaherty said that Canadians should expect substantial job losses in the months to come and that the deficit will be huge.  Prime Minister Harper promised 3 to 5 years of economic measures which will surely turn the country’s budget surplus into the big deficit mentioned by Flaherty.  With that in mind, the Bank of Canada is expected to bring interest rates below 1.00 percent. Canadian trade balance and Australian employment are the most important event risks for the 3 commodity producing countries in the coming week.  Interestingly enough, the employment component of service, manufacturing and construction sector PMI all improved in Australia last month.  

USD/JPY: YEN CROSSES PLUNGE POST PAYROLLS

Unfortunately, the brief sense of relief initiated by a weakening yen has all but diminished. As we cap up a three-day winning streak for the yen against the dollar, fears have reignited about the ability of the Japanese economy to sustain itself if the dollar weakens further. Japanese equities are feeling the morbid effects of a strong currency, as Japanese equities are off for the second day in a row. This is after a promising seven day rally that brought the Nikkei up more than 8.0%. If the troubling news coming out of the US economy is not quickly offset by something surprising, talks about a BoJ foreign exchange intervention will be reignited.  However, such policy actions will probably be used in the worst case scenario, as it is likely that they will have to act alone in devaluing their currency. We were finally privileged to the first piece of economic data in what seems like weeks. As a promising start to the year, the Leading Index came in as expected at 85.2. However when considering the figure fell 3.7 from last month, we are hesitant to call the figure a success. The coincident indicator, a measure of current business conditions, also came in as expected at 94.9. Next week the Japanese economic calendar will be picking up with the Trade Balance, Current Account, Eco Watcher’s Survey, and Machine Orders due for release.

USD/CAD: Currency in Play for Next 24 Hours

The currency in play on Monday will be USD/CAD. This is due to Canada’s release of New House Prices at 13:30 GMT and 8:30 EST and their Business Sales Future Outlook at 15:30GMT or 10:30AM EST.

The pair is currently trading within the Sell Zone, which was determined using our Bollinger Bands. Our current support level is placed around 1.1660, which is a 50% retracement of September low and December high, in addition to 100-day SMA. The pattern will be negated upon the break of resistance, which is placed at the high of the day around 1.1970. The break of resistance will drive the pair away from the sell zone and appreciate past 61.8% retracement of September low and December high.  

Published on  Sun, Jan 11 2009, 22:28 GMT