U.S. dollar unfazed by slowing GDP
Market attention returns to the United States ahead of this morning’s advanced (first estimate) third-quarter gross domestic product (GDP) report expected to show 2.0% growth following 2.6% in the second quarter and 5.6% in the first. It would be the slowest quarterly growth since 1.8% in the fourth quarter of 2005, when economic activity slowed due to Hurricanes Katrina and Rita. Although the report will be preliminary, without the complete data for the quarter yet in hand, it holds considerable weight in shaping expectations in the treasury market for future monetary-policy action due to the sharp slowdown in growth since the first quarter. In other words, market participants who are not yet convinced that the Fed is done tightening after Wednesday’s Federal Open Market Committee (FOMC) policy statement may revise their expectations due to the sharp slowdown in growth. An expected cooling in the inflation measures of core personal consumption expenditures (PCE) price index to 2.5% from 2.7% should also help contain inflationary nervousness.
But one possible reason that a 2.0% reading may not be especially negative for the U.S. dollar is that the bulk of the third-quarter slowdown is seen emerging from a double-digit drop in residential investment and from a the rise in the trade deficit; a result of high U.S. oil imports. Meanwhile, the all-important U.S. consumer is expected to remain largely unhinged, showing a rebound of 3.0% in the personal consumption expenditure component from 2.6% in the second quarter GDP report. Thus, the dollar could remain stable as traders argue that GDP report suggests a soft landing in the U.S. economy that will keep the Fed on hold into the first quarter of 2007.
The other data item of the day is the final October University of Michigan sentiment survey, expected to have edged up to 92.7 from 92.3. Foreign exchange and bond markets will focus on the one-year inflation expectation component, which has slowed in the last two months (3.8 in August, 3.1 in September and 2.9 in preliminary October).
Yen drops vs. high yielding USD & AUD after CPI
The yen is pressured against the high yielding USD and AUD after lower than expected Japanese consumer price index (CPI) further dispelled speculation of rate hike this year. Core CPI rose 0.2% in the year ending in September, less than the 0.3% expected by the market and less than the rate of last 4 months.
USD/JPY is seen stabilizing around the 118.45-60 range, but we can see a bounce towards the 118.80 resistance in the event that third quarter GDP matches expectations. A figure of more than 2.2% in GDP coupled with stronger than expected consumer sentiment may be the impetus need to see 119.10. Disappointing U.S. data could send USD/JPY back towards the lows of 118.30, but ensuing carry trades will solidify that foundation.
Euro consolidates despite strong M3
The Euro began retreating off its highs in Asian trading but is now stabilizing after unexpected acceleration in Euro zone M3 money supply showed a 8.5% increase in September from 8.2% in August. Consensus forecasts expected an 8.0% rise. The European Central Bank’s (ECB) preferred three-month average of M3 annual growth rose 8.2% in the July-September period beating expectations of an 8.0% rise and the 8.1% in June-August. Although money supply remains a reference indicator in the ECB’s policy goals, it does not command the same market scrutiny as does CPI.
Nonetheless, the M3 figures bolster the argument for a 25-basis point rate hike in December to 3.50%, especially after this week’s stronger than expected IFO business sentiment survey from Germany and hawkish comments from ECB president Jean-Claude Trichet. We do not think the central bank will tighten in November mainly due to the retreat in energy prices off their highs and the ECB’s preference to monitoring growth for a month before acting on policy. The December rate policy decision will also coincide with the ECB’s semi annual growth and inflation forecasts. Having said that, next week’s ECB press conference will be crucial in shaping market thinking vis-à-vis the December meeting and further policy action in the first quarter of 2007.
All eyes are on the 1.2715 trend line resistance holding since Aug. 21, a break of which carries the potential to call up 1.2750 and the 1.2764 high of Oct. 3. But momentum indicators suggest a topping out in the pair at just below 1.27. We see profit taking challenging the 1.2640 support, followed by more stable foundation at 1.2620.
Aussie breaks 76.50
AUD/USD’s two-week run hits a fresh 6 1/2 high at 76.64 on a combination of reassessment in Fed policy and more importantly the reemergence of carry trades as the higher yielding Aussie is expected to accumulate further yield luster next month with a 25-bp rate hike from the RBA. Expect resistance at 76.75 to act as a temporary cap on an emerging flag with support lifted to 76.25.
DEVELOPING IRAN STORY: BBC News website has announced reports by Iranian ISNA news agency on Iran’s decision to step up its uranium enrichment program in defiance of international pressure should be dollar negative against European FX but not necessarily the yen. We are seeing both the euro and Swiss franc gaining (at 7:15 am EST). Stay tuned to this development and how it affects FX.
