Commentary by Kathy Lien: U.S. Dollar: Turning To Leading Indicators For NFP
U.S. DOLLAR: TURNING TO LEADING INDICATORS FOR NFP
The rally in U.S. equities and the fall in bond yields helped to drive the dollar lower for the second day in a row. Although it is encouraging to see an improvement in risk appetite, the rally in the forex markets today is far from impressive and has yet to break the overall downtrend in many of the major currency pairs such as the EUR/USD. With that in mind however, risk appetite can be sustained if tomorrow’s leading indicators for non-farm payrolls reinforce the market’s belief that the U.S. economy returned to job growth last month. The outlook for the U.S. economy and the forex market hinges on positive job growth because at this juncture, mixed economic data has blurred the outlook for the global recovery.
Housing Market Data and Leading Indicators for NFP
For example, this morning’s pending home sales report adds to the list of disappointing economic data released from the housing market over the last month. The number of contracts to buy previously owned homes rose 1.0 percent after plunging 16.4 percent in November. This lackluster rebound following a record decline suggests that housing demand may be fading. Like new and existing homes sales, pending transactions were affected by buyers rushing to take advantage of the $8,000 tax credit originally set to expire on November 30th. The housing market was one of the first sectors of the U.S. economy to recover and if sales have not picked up, it could signal that the pace of the overall recovery is slowing. The primary leading indicators for non-farm payrolls are due for release tomorrow and we believe that they will report the same improvements seen in the jobless claims figures. The day starts off with Challenger Grey & Christmas’ report on layoffs followed by the ADP employment survey and non-manufacturing sector ISM. The rise in manufacturing sector ISM and the uptick in consumer confidence suggest that activity in the service sector may have increased as well.
Currencies on the Discussion Table at G7?
This Friday, finance ministers and central bankers of the G7/G8 nations will gather in Canada to talk about global monetary and fiscal policies. According to Canadian Finance Minister Flaherty, he’s “sure” that currencies will be discussed at the meeting. This is particularly interesting since the finance chiefs agreed in October that big decisions will be made at the G20 meetings. However getting 20 nations to agree on changes in policy is extremely difficult and for the time being, the market is still use to hanging onto the words of the G7. Unlike past meeting, no official statement is expected to be released and the Canadians want to keep the event as informal as possible, but there will be joint press conference on Saturday where questions will be taken. It appears that the Japanese are leading push because according to Flaherty, “The new Japanese finance minister has been clear in his wish that … we have this item on the agenda. So we will have it on the agenda, and we will discuss it together,” “It is a concern when people ask about the weakness in the American dollar, one has to look at the fact that some of the Asian currencies, including the Chinese currency, are artificially constrained.” It is obvious that Japan wants to single out China but in the current environment, it may be hard to avoid talking about the greenback. Any harsh comments on exchange rates could trigger sharp volatility in the foreign exchange markets – but that is something traders will worry about after the NFP report on Friday.
The euro extended its gains against the U.S. dollar on the heels of slightly stronger Eurozone economic data and a recovery in risk appetite. German retail sales rose 0.8 percent in the month of December which was slightly weaker than the market’s forecast, but much better than the 1.7 percent decline in consumption reported the previous month. The holiday shopping season encouraged consumers to spend again but the 0.6 percent downward revision to the November number creates a dark cloud over the report. Meanwhile the market was looking for inflationary pressures on the producer level to remain unchanged but instead Eurozone PPI ticked higher by 0.1 percent, pushing annualized PPI growth up from -4.4 to -2.9 percent. Much of the pressure on the euro has stemmed from the fiscal problems in smaller countries within the Eurozone. In our daily report yesterday, we talked about the euro is not an attractive buy until the PIIGS get their fiscal house in order. Spain is moving forward with their proposals to bring their deficit back to target by reducing spending and the hope is that Greece will do the same. The European Commission is expected to endorse Greece’s plan to reduce their deficit tomorrow by saying that it is feasible despite the risks. Eurozone retail sales are due for release on Wednesday and the rise in German and French consumer spending points to stronger consumption in the region as a whole. Revisions to service sector PMI numbers are also due for release. As for the Eurozone economic outlook, ECB member Weber and the European Commission seem to agree that unemployment is set to rise further before it declines and if they are right, the rally in the EUR/USD may be limited.
The British pound ended the NY trading session slightly higher against the U.S. dollar. The rally is lackluster at best and based upon the rise in EUR/GBP, traders are still weary of being long sterling despite stronger economic data. Construction sector PMI rose to the highest level in 23 months as the housing market continues to contribute to recovery. The index rose from 47.1 to 48.6 in December, which reflects a slower pace of contraction. Although construction companies are continuing to cut jobs, they have done so at the slowest rate since August 2008. With the government expected to reduce spending, there is concern amongst the purchasing and business executives surveyed but it should not undermine the fact that activity is improving. This stronger report follows the uptick in manufacturing sector PMI and suggests that we could see a similar pickup in the service sector activity index, which is due for release on Wednesday. If improvements are reported in all 3 PMI reports, there is a very good chance that the Bank of England will announce on Thursday that additional Quantitative Easing is no longer necessary. Of course the central bank will have to walk a fine line since fiscal restraint by the U.K. government could slow the already weak growth.
The Reserve Bank of Australia shocked the markets last night by leaving interest rates unchanged at 3.75 percent, triggering a sharp decline in the Australian dollar. Based upon the statement, the decision to hold back additional tightening was due less to current economic conditions, which they believe is still strong and more to the risks that lie ahead. They noted that Chinese policymakers are taking efforts to slow their economy and the Australian economy has become extremely sensitive to Chinese growth over the past few years. They also noted that it is too early to gage how the economy has been affected by the previous rate hikes. It certainly looks like the RBA wants to postpone additional tightening until there is evidence that the economy is able to handle slower Chinese growth and prior rate hikes. We originally expected the RBA to pause in March and their decision to pause in February suggests that a rate hike in March is not a done deal and will be contingent upon how the economy performs over the next few weeks. However in the meantime, the AUD/USD has recovered nearly 50 percent of its earlier losses and if service sector PMI or the trade balance surprise to the upside, we could see a further recovery in the Aussie. Meanwhile gold and oil prices have moved higher, helping to lift the New Zealand and Canadian dollars. Optimistic comments from Canadian Finance Minister Flaherty added fuel to the rally in the loonie. According to Flaherty, the economists that he consulted before next month’s budget raised their 2010 growth forecast from 2.3 to 2.6 percent and reduced their unemployment rate forecast to 8.5 from 9 percent. There are no economic reports due for release from Canada tomorrow but New Zealand will be releasing their latest employment report. Based upon the PMI numbers, we expect joblessness to fall which should spark a further rally in the kiwi.
The Japanese Yen strengthened against all major traded currencies except for the New Zealand dollar. Although USD/JPY retreated today, a series of higher lows suggests that the currency pair has officially shed its downtrend. Not only is it holding the 90 level, but it also managed to remain above the 10, 50 and 100-day SMA which are all converging around the 90.20 to 90.25 level. With the markets slowly stabilizing and the VIX index which measures the volatility in the equity markets falling, the positive sentiment in the financial markets has been reflected in the recent recovery in USD/JPY. A continued rally in the currency pair is therefore also contingent upon the continued improvement in risk appetite. The Japanese government is still looking for ways to support the economy through appropriate and flexible policy. So far Japan has benefitted from the recovery in Asia but with China taking active efforts to slow growth, Japan may have to look inward. Domestic demand has long been one of the sore points for Japan and in order for the country to continue to recover they need to get people in Japan to start spending. This may be easier said than done as earnings fall for the 13th month in a row. Lower labor cash earnings contribute to the deflationary spiral and prevent demand from recovering. There was big story in the NY Times this past weekend about how noodle shops in Japan are staging a price war. This type of dynamic is exactly what the Japanese government wants to avoid.
GBP/USD: Currency in Play for Next 24 Hours
The GBP/USD will be the currency pair in play for the next 24 hours.. Nationwide Consumer Confidence and BRC Shop Price Index will be released at 00:01GMT or 7:01PM EST this evening followed by the U.K.’s Service PMI report at 9:00GMT or 4:00AM EST. The U.S. will release Non-Manufacturing ISM from U.S. at 15:00GMT or 10:00AM EST. After breaking below the psychologically important 1.60 level, the GBP/USD has set itself well within the Sell Zone which we determine using Bollinger Bands. Despite the recent rally in the currency pair, as long as the GBP/USD holds below 1.6050 on a closing basis, the downtrend remains intact. The closest support level is at 1.58, which is a prior low.
Commentary by Kathy Lien: U.S. Dollar: Weak Rebound in Pending Home Sales, All Eyes on Testimonies in Washington
Consider today’s price action in the currency market to be the calm before the storm. This morning, the U.S. dollar is virtually unchanged against most of the major currencies but with 2 more interest rate decisions this week and non-farm payrolls on Friday, this consolidative price action is not going to last. The lack of market moving data today explains the mixed performance of the U.S. dollar. Pending home sales was the only number released this morning and it came out right in line with expectations.
The number of contracts to buy previously owned homes rose 1.0 percent after plunging 16.4 percent the prior month. This lackluster rebound following a record decline suggests that housing demand may be fading. Like new and existing homes sales, pending transactions were affected by buyers rushing to take advantage of the $8,000 tax credit which was originally set to expire on November 30th. With pending home sales behind us, traders will now be focusing on Geithner’s Testimony to the Senate Finance Committee (10am EST or 1500 GMT) and Volcker’s testimony before the Senate Banking Committee (2:30pm ET or 1930 GMT). Volcker’s support more regulation for the financial industry could lead to mild risk aversion.
What Australia’s Rate Decision Means for Europe
All of the action today is concentrated in the Australian dollar, which fell more than 1 percent after the Reserve Bank surprised the markets by keeping interest rates unchanged. What is important about the Australian rate decision is what it could mean for the upcoming European rate decisions. The RBA is slowing down because business credit has continued to fall, companies are continuing to reduce leverage and lenders have imposed tighter lending standards. If this is happening in Australia, a country that been outperforming others, there is a good chance that these same problems could be plaguing weaker nations as well, prompting them to could err on the side of caution. The Australians were also worried about China’s efforts to reduce stimulus to their economy which will be something that is also on the minds of European policy makers.