25 bp cut from the BOE on tap. USD picture still looking for clarification with EURUSD In the middle of the range.
MAJOR HEADLINES – PREVIOUS SESSION
Overnight developments:
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New Zealand Q4 Unemployment Rate dropped to 3.4% vs. 3.6% expected and 3.5% previously
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Australia Jan. AiG Performance of Construction Index fell to 58.3 from 59.2.
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Switzerland's Jan. Unemployment Rate was steady at 2.8% as expected
THEMES TO WATCH – UPCOMING SESSION
Key event risks today (all times GMT):
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Norway Dec. Industrial Production (0900)
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UK Dec. Industrial and Manufacturing Production (0930)
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Germany Dec. Factory Orders (1100)
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UK BOE Interest Rate Decision (1200)
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EU ECB Rate Decision (1245)
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EU ECB's Trichet to hold Press Conference (1330)
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US Fed's Lockhart to speak about credit markets (1330)
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US Weekly Initial Jobless Claims (1330)
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US Secretary of Treasury Paulson to testify before congress (1500)
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US Dec. Pending Home Sales (1500)
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US ISCS Chain Store Sales (1830)
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Japan Dec. Machine Orders (2350)
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Japan Jan. Eco Watchers Survey (0500)
Market Comments
It's showtime for the ECB and BOE today, with the ECB of more interest as the BOE almost always simply announces their rate decision, only to release the minutes 2 weeks after the fact. A 25 bp cut from the BOE is almost fully priced in, as are approximately 50 bp of further cutting over the next 6 months. The ECB is a more interesting case. Again and again we've seen the stark, inflation-fighting rhetoric from Trichet that seems to always surprise the market with its vehemence. And yet the forward rates market is trying to "call his bluff" by firmly predicting that the ECB will already have eased 50 bps by mid summer. Will Trichet finally nod his head at the risks to growth? Our best guess is that he does, but with all manner of caveats that any future policy easing can only take place if inflation is seen as stabilizing with no second round effects, etc. See Charts below for a look at the indecisive EURUSD chart, which we expect will move on Trichet. As we noted yesterday, even if Mr. Trichet doesn't begin to sound any dramatic notes of caution, the EUR may see little upside response to hawkish rhetoric as the market may see this as potentially increasing the downside risks to the EuroZone economy further out.
On the risk/carry trade front, the negative momentum we built up on the US ISM Non-manufacturing release eased remarkably yesterday - is this just a pause before we renew this trade or is it a troubling sign that we will be stuck in a rangy environment for now? As always, watch equity markets for direction. The NZD is running away to the upside again after a positive employment report, but we still feel its days of strength are very numbered. NOK and CAD look on the defensive yesterday after the swoon in energy markets.
The Fed's Plosser dished up a remarkable dose of candor and "reality" yesterday that was a refreshing change from the usual Fedspeak. Plosser is a voting member of the FOMC and is generally considered a hawk, along with Lacker. His comments pointed out the troublesome aspects of this economic downturn for the Fed: that monetary policy "cannot solve the bad debt problems in the mortgage markets. It cannot reprice the risks of securities backed by subprime loans [nor can it] solve the problems faced by those financial firms at risk of being given lower ratings...because some of their assets are now worth much less than previously thought."
This is precisely why we fear that the US recession this time around will be a more difficult animal to deal with than the 2001 dip Greenspan was faced with - a "mere" business spending recession. When Greenspan gutted rates then, the consumer responded - but now things are different as the credit crunch / asset deflation feedback loop will not stimulate consumption to the same degree this time around. And even when consumers want to borrow, they have a hard time finding reasonable credit terms at their banks as the banks are less willing to extend credit on favorable terms, low rates are no. They are simply too strapped with liquidity issues from the overextension of credit due to previous irresponsible lending activities. Also, Plosser appropriately warned that the Fed's "damn the torpedoes" approach to slashing rates aggressively was a risky proposition as ignoring inflation "risks undermining our ability to achieve economic growth over the long run", and, as history has shown that "slow economic growth and lower inflation do not necessarily go hand in hand.". Well said, Mr. Plosser. More strong inflation data would cause the Fed plenty of discomfort and could mean a "v-shaped" rate trajectory even in the face of economic weakness if the Fed's hand is forced by stagflationary tendencies. The oddest thing about Plosser's speech is that he did not entertain the possibility that the US would enter a recession, when it already has entered one in our (and many other observer's) view.
Chart: EURUSD
Is it decision time for EURUSD. The pair is trading smack in the middle of recent ranges ahead of the ECB decision and Trichet's press conference. The 0.618 Fibo retracement at 1.4590 held the pair back from further downside, but a break of this level could lead to a try toward the bottom of the range at 1.4400. The key upside resistance zone lies between 1.4750/90.
