With the U.S. dollar index falling 20 points short of its all time low of 78.19, we expect a temporary reprieve in the currency as the euro retreats off its 1.4120 high on signs of cooling economic growth. With gold prices are now exceeding our forecasts of $730 to $735 per ounce, we expect the metal to begin a slow retreat lower as it is surpassing the historical maximum margin over its 200-day margin average. A pullback towards the $710 to $705 level may be accompanied with a retreat in the euro and a temporary reprieve in the U.S. dollar. Such occurrence is most likely to take place in the event of fresh market turbulence, a pattern that proved to be dollar positive in the past. Fresh gold gains would then resume towards the end of November when the next phase of dollar weakness is likely to emerge as the Fed is forced to cut rates further.
The rationale of anticipated declines in equities is based on renewed nervousness about the U.S. housing market (housing starts at 12-year lows and rest of home price indexes were all down) and that the Fed’s front loading of rate cuts may not be sufficient in tackling the medium term erosion in housing and long-term implications for U.S. consumption and the economy. As the U.S. yield curve steepens beyond the current 70-basis point differential between 10- and two-year yields, the bite on adjustable mortgage owners will escalate, offsetting the positive impact on banks.
Next week’s key U.S. data on existing and new sales, consumer confidence and personal consumption/income will provide with much awaited info on the spending in light of the deterioration in home sales and falling prices. Yet the bulk of the negative impact on consumption may not fully materialize until next year’s reset adjustments.
EUR/USD: Pausing for breath or a bigger a retreat? Euro surged to a fresh all time high of 1.4120 before a bigger than expected decline in the Euro zone’s September PMIs dragged the currency across the board. The services PMI tumbled by 4 points to 54.0, reaching its lowest level since August 2005, while the manufacturing PMI fell to 53.2, lowest since November 2005, from August's 54.3. The reports present the most compelling evidence to date of a slowing in the Euro zone economy from the financial market turmoil, especially considering the PMI’s strong track record in foretelling GDP growth.
Signs of a peak in domestic Euro zone growth coupled with an appreciating currency (especially from the falling sterling) are likely to drag periodic phases of pullbacks especially as speculators pare down their net longs and the European Central Bank (ECB). Aside from expectations of further U.S. rate cuts, the euro’s recent gains have emerged on a series of hawkish remarks from the ECB stressing the importance of maintaining vigilance on inflation.
More signs of a peak in Euro zone growth are likely to extend the pair towards $1.3940 and 1.3850 by next week. Interim support stands at 1.40. Upside capped at 1.4070.
GBP/USD capped at $2.0180 Sterling made a sharp rebound in the face of a pullback in the euro as real money flows and Middle Eastern accounts seen picking up the currency at its $2.0000 lows. We expect the $2.0180 resistance to act as a prolonged obstacle for the currency whose central bank is increasingly expected to make a policy U-turn later this year by cutting interest rates to 5.50%. Preliminary signs of slowing pay and reduced bank lending add to last month’s bigger than expected drop in inflation should strengthen the position of the doves at the Bank. But no easing may be considered unless consumer demand begins to falter, which is not currently the case as seen in the latest retail sales report showing a 0.6% rise in August.
GBP/USD sees support 2.0120, followed by 2.0070. Upside capped at 2.0180. Key resistance stands at 2.0120.
USD/JPY to revisit key 116.40 resistance The lack of key US economic data means that US stocks are likely to avoid the second straight day of selling, which should help USD/JPY regain the 116 level and major trend line resistance 116.35-40. Emerging signs of a temporary peak in gold are also likely to feed fresh gains in USD/JPY. Yet it is probable to see gold rally on a temporary reduction of risk appetite, which is also a positive for the pair. Support stands at 115.20, backed by 114.80.
USD/CAD to rebound from below parity after retail sales After dropping below parity to 0.9940, USD/CAD rebounds to 1.0044 on a 0.8% decline in July retail sales (expected 0%) following a 1.1% decline in June. Ex autos fell 0.3% versus expectations of a 0.3% rise. The loonie extended its gains after the US session when Finance Minister Flaherty said the currency strength is reflected in strong demand for Canada’s commodity exports and weakness in the US economy. When public officials affirm that currency rates must be left to the market traders reinforce the existing move. Though Mr. Flaherty did note the negative impact on manufacturing, markets were unfazed.
With oil prices back on the rise hitting $84.10 per barrel, the post-sales decline in CAD is to be limited. USD/CAD faces interim resistance at 1.0070, followed by 1.0090. Support seen stabilizing at 1.0010.
Ashraf Laidi Chief FX Analyst CMC Markets US a.laidi@cmcmarkets.com
