The 17% decline in oil prices so far this year has recalibrated the foreign exchange equation, bolstering expectations that U.S. consumer-led stability will mitigate housing’s downside risks. This has considerably diminished chances of a March Fed funds rate cut and manifested itself across European and Asian currencies. The role of oil’s rebound has been such that it took center stage in FX markets, shadowing a string of positive economic data from the Euro zone and the United Kingdom. Aside from freeing up U.S. consumers’ wallets, falling oil prices have reduced the Sep-Nov trade deficit by more than 17%, which is likely to contribute as much as 0.7% to fourth quarter gross domestic product (GDP).
Now that record high winter temperatures may be behind of us, we can expect prices to remain stable as long as the OPEC members of the Arabian Gulf succeed in blocking supply cuts beyond the already implemented 1.2 million barrels per day and 500,000 bpd scheduled for next month. The most likely outcome is for OPEC to assess prices on Feb. 1 and examine the market impact of the scheduled 500,000 cut. But there stands the risk that prices may slump towards the mid $40s before Feb. 1, especially given the larger than expected builds in U.S. supplies.
Increased U.S. forces in Iraq increase Saudi peace of mindIt is becoming established that the U.S. allies of the Arabian Gulf--especially Saudi Arabia--are heeding Washington’s calls and extending the recent decline in oil prices to prevent a hard landing for the U.S. economy. A U.S. hard landing would force the Federal Reserve into cutting interest rates at a time when combating inflation remains its priority. In return, the increase of U.S. forces in Iraq preempts the Iran-backed insurgency from spilling over to Saudi Arabia. A Saudi Arabian official had already expressed his worry last week from the Iran threat in Iraq, demanding U.S. State Secretary to clarify the U.S. position on how long it plans to retain troops in Iraq. This oil diplomacy has managed to filter through financial markets, with Washington using key allies to prevent higher energy prices from exacerbating the housing slowdown.
Industrial production seen offsetting TICSWednesday’s U.S. data will start with the December producer price index (PPI), expected to slump to 0.6% from 2.0% and the core PPI to sink back to 0.1% from 1.3%. We do not expect these low figures to be dollar negative. Similarly, we expect the TICS report to show a sharp decline in net capital inflows to as low as $30 billion November following $62.2 billion in October mainly because of the dollar’s 4.0% November slump. The data may likely destabilize the U.S. currency, but industrial production could provide renewed stability. Any figure of more than 0.1% is expected to be positive. We expect industrial production to rise by as high as 0.3% and capacity utilization to 81.9% from 81.7%. An optimistic account of the Fed’s beige book should also give additional late session boost to the U.S. dollar, with the immediate positives seen to be stabilization in real estate, brisk holiday sales and firm pricing power.
EUR/USD to target 1.2815 before end of weekThe relative lack of data from the Euro zone will render the EUR/USD pair largely dependent on the flood of U.S. economic reports and Fed Chairman Ben S. Bernanke’s Congressional testimony on tax issues, none of which are expected to hinder the dollar’s retreat. Any interim gains towards the 1.2970s will likely encounter solid resistance, which should turn into aggressive dollar buying, targeting the 100-day moving average of 1.287. Stops are seen breaking the bids into 1.2820.
AUD/USD targets 0.7760 Despite its 6.25% yield advantage and chatter of an additional RBA rate hike, we expect AUD/USD to gradually retreat towards the 0.78 figure, resuming where it left off last Friday. A breach of the key 0.78 support is highly possible by the array of U.S. data and scheduled speeches from the Federal Reserve. A break of the figure is seen prolonging the slide towards the 0.7760s.
Gold eyes $617We expect gold to have already topped out for the week, with the downside as the only likely path from here. Initial target at $620 should give way to the 200-day moving average, and expect $615 before end of week.
Despite surging U.K. inflation and expectations of a February rate hike by the Bank of England, we expect a negative week for GBP/USD, with the immediate target standing at $1.9570, followed by 1.9530. Upside seen capped at 1.9720.
Ashraf LaidiChief FX AnalystCMC Markets US140 Broadway, 30th FloorNew York, NY 10005(212) 644-4220(212) 644-4222 fax
a.laidi@cmcmarkets.com
