Commentary by Kathy Lien: U.S. Dollar: Will Growth Live Up To Expectations?
U.S. DOLLAR: WILL GROWTH LIVE UP TO EXPECTATIONS?
The U.S. dollar extended its gains as risk aversion continues to hang over the markets. The EUR/USD spent most of the North American trading session below the 1.40 level which reflects the overall weakness in the currency pair. Since U.S. equities have sold off and bond yields have fallen, it is clear that the rally in the dollar today is a reflection of fear and not optimism. Yet on a percentage basis, the rally in the dollar has been modest and further gains in the greenback will now be contingent upon Friday’s GDP report. This morning’s U.S. economic data failed to reinforce the credibility of the Federal Reserve. Durable goods orders fell short of expectations while any improvement in jobless claims is met with skepticism. Ben Bernanke was confirmed by the U.S. Senate for the second term so the uncertainty surrounding his nomination will now evaporate.
Will Growth Live Up to Expectations?
There is little debate on the issue of whether the U.S. economy grew in the fourth quarter. Everyone including ourselves believes that the economy expanded and the only question is – by how much. In the third quarter, we know that the economy grew by 2.2 percent and in the fourth quarter, the consensus forecast favors a 4.7 percent expansion. These expectations are extremely lofty and will therefore be difficult to meet let alone beat even if retail sales picked up in the last 3 months of the year. There are 3 primary inputs into GDP – retail sales, trade and inventory buildup. Although consumer spending dropped by 0.3 percent in December, it had risen 1.8 percent in November and 1.2 percent in October. On average, these figures reflect more aggressive spending compared to the third quarter. So far, only the October and November trade numbers have been released, but based upon those reports, the trade deficit widened slightly. Durable goods orders have been weak but the service and manufacturing PMI reports indicate that companies have increased their inventories. There are many reasons to believe that the U.S. economy grew at a faster pace in the fourth quarter, but it is difficult to imagine that the economy could have grown by more than 4.7 percent. It will be much easier for Q4 GDP to miss than beat expectations. When the U.S. economy stopped contracting and started growing after the recession in the early 2000s and 1990s, it took many quarters before the economy managed to grow more than 4 percent. Yet after the recession in the 80s, GDP grew at very healthy rates throughout 1983. Should growth fall short of expectations, expect the dollar to continue its slide against the Japanese Yen but if it manages to beat expectations, expect a strong rally in the U.S. dollar. GDP is one of those numbers that could shift the market’s focus from risk appetite to economic outlook but USD/JPY is still the better currency pair to trade GDP because it tends to have a cleaner and more logical reaction to U.S. economic reports. Following the GDP report, Chicago PMI and the final University of Michigan Consumer Sentiment survey for the month of January will be released.
Durable Goods Orders Fall Short of Expectations, Job Losses Recede
Based upon today’s economic reports, it is hard to believe where the Fed’s optimism stems from. Durable goods orders rose 0.3 percent last month, which was significantly less than the market’s 2.0 percent forecast. Excluding transportation, durable goods orders rose 0.9 percent which was more than the market’s 0.5 percent forecast but weaker than the prior month’s 2.1 percent rise. The biggest drag came from the transportation sector which saw orders plunge for the second month in a row. Although demand for vehicle and vehicle parts increased, orders for non-defense aircraft fell 38.2 percent. This decline was particularly surprising considering that Boeing had previously suggested that there was a rebound in orders in December. Shipments of non-defense capital goods orders rose 3.7 percent, the largest increase since December 2007. On balance, the report was disappointing and suggests that demand for big ticket items may start to slow. Meanwhile weekly jobless claims continued to fall. The number of people filing for unemployment benefits dropped from 478k to 470k. Continuing claims also declined from 4.659 million to 4.602 million. Given the recent layoff announcements by companies like Verizon, it is difficult to share the Fed’s optimism about the outlook for the U.S. economy. Even though the number of people receiving extended benefits also dropped, we are inclined to believe that this reflects the complete expiration of benefits for some Americans and not acquisition of new jobs.
The euro came under additional selling pressure after a former adviser to the Chinese central bank said that China should not rescue Greece by buying its debt. After the strong demand for Greek bonds earlier this week, everyone believed that Greece would have no problems raising the 53 billion additional euros needed to fund their deficit. There was even talk that the country was wooing China to come in as a potential investor but after today’s comments from the former Chinese adviser, the Greek Prime Minister denied that they were in discussions with China. They also reassured investors that their fiscal problems will not push them out of the Eurozone. As much as the rest of the nations within the European Monetary Union feel that Greece has to deal with their own problems, the recent sell-off in the EUR/USD indicates that investors are also expressing their concerns about Greece in the currency that they all share. Therefore we believe that the Economist Magazine’s report that European governments are discussing how to bailout Greece is accurate and will probably be the result that ends up pacifying the markets. Yet don’t expect the weakness of the EUR/USD to alarm European policy makers. A weak currency will be very supportive of growth in the current economic environment. Meanwhile Eurozone economic data beat expectations with the number of people filing for unemployment claims in Germany rising less than expected and confidence in the region improving. Eurozone unemployment and consumer price estimate are the only pieces of noteworthy economic data from the region that are due for release on Friday.
Over the past few trading days, the British pound has been confined to a very tight trading range and it is looking ever more likely that the GBP/USD will break to the downside. This morning, Standard & Poor’s announced that “We no longer classify the United Kingdom (AAA/Negative/A-1+) among the most stable and low-risk banking systems globally” which is extremely bearish for the pound. S&P had already lowered the U.K.’s place in its Banking Industry Country Risk Assessment gauge to Group 3 from Group 2 on Dec. 21. The risk of investing in the U.K. is now on par with the risk of investing in countries like Portugal, Saudi Arabia, Ireland, Chile and Austria. You can imagine what this means to investors looking for a place to put their money. On top of that, the outlook for consumer spending is quite dismal. In our daily report yesterday we talked about how the CBI retail sales index fell by the largest amount since August 2009 which suggests that U.K. consumers cut back spending after the holiday shopping season. There is a very good chance that this weakness will feed into the retail sales report and therefore we remain skeptical of the rally in the GBP/USD and believe that the odds are skewed towards a move down to 1.60.
The Australian, New Zealand and Canadian dollars continue to have a difficult time rallying against the greenback. It certainly doesn’t help that oil and gold prices have ended the day virtually unchanged. The only piece of meaningful economic data released from the 3 commodity producing countries over the past 24 hours was New Zealand’s trade deficit which turned into a tiny surplus in the month of December. Imports and exports both increased as the deficit shrank from 269M to 2M. Although the good news was tempered by a decline in building permits, the improvement in trade reflects a continued recovery in New Zealand. Meanwhile the rally in USD/CAD has been extremely impressive. For the 8th trading day in a row, the currency pair has ended the day either unchanged or higher. The rally shows no signs of losing steam as USD/CAD end the day near its highs. Canadian GDP is due for release tomorrow and given the decline in retail sales and the trade balance, it is hard to believe that the economy managed to expand at a faster rate in the month of November. Following the recent disappointments in economic data, the odds favor a slowdown in growth which would help fuel further gains in USD/CAD. Meanwhile leading indicators are due for release from Australia and given that the report is from November, we expect stronger numbers because the Australian economy was running on all cylinders towards the end of the year.
The risk aversion in the financial markets today drove the Japanese Yen higher against all of the major currencies. Over the past few weeks, the Yen has consistently been the best performing currency despite little improvement in Japan’s economy. Based upon the latest economic reports, consumer spending contracted significantly in the month of December which indicates that the holiday shopping season was particularly dismal last year. Retail sales fell 1.2 percent on a monthly basis which translates into a 0.3 percent decline on an annualized basis. In the latest attempt to spur the weak economy, Japan’s parliament passed a second extra budget of ¥7.2 trillion. Finance Minister Naoto Kan claims that the latest package would add 0.7 percentage points to the economy over the next year while helping to fight the deflationary spiral. However, the nation is running out of room to spend liberally as their debt to GDP ratio is the highest amongst developed nations. Weak domestic spending remains Japan’s central problem. More economic data are due for release this evening including manufacturing PMI, the jobless rate, household spending, consumer prices and industrial production. Mild improvements are expected in most of these reports but as usual it will be risk appetite and not Japanese data that drives the performance of the Yen.
USD/CAD: Currency in Play for Next 24 Hours
USD/CAD will be the currency in play for tomorrow. Canada and the U.S. will release their respectful Gross Domestic Products at 13:30GMT or 8:30AM EST. This will be followed by the Chicago PMI and U. of Michigan Confidence numbers at 14:45GMT or 9:45AM EST. After forming a double bottom earlier this month, USD/CAD has propelled itself into the Buy Zone, which we determine using Bollinger Bands. The closest resistance level in the currency pair will be the December high of 1.0746 which will then be followed by the 38.2 percent retracement of last year’s low and July’s high at 1.0785. The uptrend in USD/CAD remains intact as long as the currency pair does not break below the first standard deviation Bollinger band and the 23.6 percent retracement of the same extremes at 1.0660. If that level is broken, the door is open for a move back down to 1.05
Germany has triggered a near-panic flight from southern European debt markets by warning that there will be no EU bail-outs, even though it fears the region’s economic crisis has turned dangerous and could prove “fatal” for the entire eurozone
The yield on 10-year Greek bonds blasted upwards by over 40 basis points to 7.15pc in a day of wild trading. Spreads over German Bunds reached almost four percentage points, by far the highest since Greece joined the euro, and close to levels that risk a self-feeding spiral. Contagion hit Portuguese, Spanish, Irish, and Italian bonds.
The deeper concern is Spain, where youth unemployment has reached 44pc and the housing bust has a long way to run. Nouriel Roubini – the economist known as ‘Dr Doom’ – said Spain is too big to contain. “If Greece goes under that’s a problem for the eurozone. If Spain goes under it’s a disaster,” he said.