So far, all of the week's U.S. data reports have come in worse than expected, at a time when the FOMC once again is expected to draw a relatively upbeat note on the economy, while keeping its emphasis on a clearly softening inflation.
The U.S. dollar is pulled lower by the bigger than expected drop in U.S. durable goods orders, which fell 2.8% in May (expected down 1%) following three-consecutive monthly gains, while the ex-transportation figure (ex aircrafts) fell unexpectedly by 1.0% from an upward revision to 2.5% from 1.9%. The upward revision in the headline figure stood at 1.1% from a 0.8%. Although the series is notable for its volatility, the broad decline in the ex-transportation and ex-defense items raises questions on the extent of the recovery in second quarter gross domestic product (GDP). With the personal consumption expenditure component already expected to weaken in second quarter from first quarter’s one-year high, sluggish capex may also remain on the low side.
An emerging risk to the U.S. economy remains the threat to the U.S. consumer that would weigh on personal consumption expenditure. Despite the sharp slowdown in U.S. first quarter GDP to 0.6% from 2.5% annualized, personal consumption rose to 4.4% from 4.2%, its highest since first quarter 2006. But this consumer-driven foundation of the U.S. economy could be jeopardized by prolonged declines in U.S. equities—such as a 7% decline in the S&P 500 past the 1,475 level-and threaten the equity-driven foundation of the U.S. consumer, at a time when rising oil prices and increasing mortgage costs are already disrupting demand.
The major byproducts of unwinding carry trades and reduced risk appetite are here:
Broad recovery in the Japanese yen; initiated by comments from Japanese officials showing concern with the multiyear lows in the yen which raises the risk of rapid bounce back and threaten Japan’s recovery.
Broad pullback in high yielding FX of AUD, GBP, NZD; as the funding of these currencies is jeopardized by a rising yen.
Remarkable failure of global equities to follow up on earlier intraday gains; is not only eroding masses of liquidity and reducing risk appetite, but could deteriorate during a challenging earnings season.
10-year/two-yield spread is at highest level since October 2005; extending the normalization of the yield curve after one year of inversion, conveying the path towards a protracted slowdown and the need for Fed rate cuts later in the year.
Continued decline in gold; as traders cash in their insurance in the safe haven metal
Yen seen challenging 122
The Japanese currency pushed through the 122.50s, but stabilized at the 122.40 obstacle we projected in yesterday’s chart note. Avoiding further excess yen weakness at this point is more paramount than pressuring China on its own currency. This is mainly because the combination of escalating yen declines along with mounting risks of a systemic fallout from sub-prime investments on the earnings of U.S. banks and U.S. consumers could trigger a fast unwinding of carry trades similar if not worse than that of 4 months ago. But if the Japanese currency continues to stabilize off its lows, than the fall out from such unwinding of carry trades will be less pronounced. Yet at this point, with the yen well below the lows of 3-4 months ago, there is much room for rapid unwinding to the preliminary support levels of 121 and 119.50.
We expect further declines past the 122.30 support to encounter temporary stability near 122.10, but risk of breaking below 122 looms ahead of Thursday’s FOMC decision.
Euro drops on reduced risk, boosted by weak U.S. data
EUR/USD extends losses past the 1.3450s amid a general unwinding of carry traders who were also behind the gains in EUR/JPY. Despite comments from ECB's Wellink reiterating that tightening has not reached its end, the single currency drops on general fall in risk appetite. EUR/USD support stands at the trend line support of 1.3410, followed by 1.3380. Upside remains capped at 1.3465 and 1.4950.
CAD supported expected to last
While the Canadian dollar has been strained by reduced risk appetite, we expect it to remain supported ahead of Friday’s release of April GDP seen up 0.3%. We reiterate that FX traders continue to take advantage of pullbacks in the Canadian dollar as a buying opportunity amid expectations of a rate hike from the Bank of Canada next month. The periodical gains above the 1.07 remain limited at 1.0725-30. USD/CAD initial resistance slips to 1.0720, followed by 1.0735. A decline in U.S. new home sales that is not accompanied by equity losses is likely to drag USD/CAD below 1.0680 and onto the 1.0660 support.
Ashraf Laidi Chief FX Analyst CMC Markets US 140 Broadway, 30th Floor New York, NY 10005(212) 644-4220a.laidi@cmcmarkets.com
