Despite the Fed’s increased inflation vigilance in yesterday’s Federal Open Market Committee (FOMC), the core personal consumption expenditures (PCE) price index showed to have edged up 0.2% for a year on year rate of 1.8%. This is the fourth consecutive month in which the annual core PCE price index stands below Fed’s upward limit of 2.0%. Consumer spending slowed to 0.3% (exp 0.4%) in September from August’s 0.6%, while personal income rose 0.4% as expected. Because of the PCE data, the dollar is losing ground across the board on grounds that the lackluster September core price index may force the Fed to focus on the downside risks of the economy.
Weekly jobless claims fell 6,000 to 327,000, but the four-week average stands a six-month high of 327,000. The 10 am release of the ISM manufacturing is expected to have slowed to 51.5 last month from 52, which would be the slowest in 11 months. Yesterday’s release of the Chicago PMI showed the October figure falling below 50, the first sub-50 figure since February.
FOMC statement sounding increased inflation vigilance and describing Q3 as “solid,” there exists the possibility that the Committee had access to the September PCE data as well as the October labor market report. Markets are now pricing a 90% chance for the Fed funds rate to remain unchanged at 4.50%. We think it is too early to decide the outcome of the December 11 meeting considering the number of crucial data releases on housing, jobs, retail sales and prices.
Separately, U.S. home foreclosures doubled in Q3 from a year earlier as subprime borrowers failed to meet higher payments on adjustable-rate mortgages; according to Realtytrac over the prior three months, foreclosure filings increased 30%. The negative implications on holders of adjustable rate mortgages facing steeper resets are exacerbated by further gains in long-term yields, as 10-year yields shot up to a week high at 3.9% after the Fed stepped up its concerns on inflation.
EUR/USD supported at $1.44
Euro drops nearly a full cent from its 1.4503 high amid reduced expectations of further Fed cuts this year. Markets are now pricing a 90% chance for the Fed funds rate to remain unchanged at 4.50%. We think it is too premature to rule out future Fed cuts at this point given the “intensification of the housing correction” (exact words used in FOMC statement) and the upside potential in the unemployment rate. It is one thing for the FOMC statement to serve as a pretext for the unwinding of excessive euro longs. One aspect that will help support the single currency is surging Euro zone inflation, whose preliminary October figure hit 2.6%, the highest in two years. With the global economy remaining robust, the ECB is expected to maintain its hawkish tone, making a rate hike a 50-50 event in the next six months.
A robust ISM report of more than 51 would be a surprise given the sub-50 figure in the Chicago PMI, which would likely accelerate euro losses towards past the 1.44 trend line support and onto the prelim support of 1.4360. Upside capped at 1.4460.
USD/JPY recovery hampered by risks
The surge in USD/JPY to a two-week high of 115.90 may face difficulty on the latest U.S. PCE data aid rumors of emerging rumors of significant losses in Citigroup related to subprime mortgages. While the yen has come under broad pressure amid improved risk appetite, the pair will remain torn between the prospects of a steady Fed and further revelations of losses in the subprime front as multiple tranches of outstanding deals have yet to be executed. The 116 figure marks the 61.8% retracement of the 117.93-113.22 decline. We expect losses to extend towards 115, followed by 114.80.
Sterling bubble extends to $2.08 despite prolonged data weakness
Sterling is propelled higher above the $2.08 figure after MPC member Charles Beane further allayed expectations of a near term rate cut. The impact of the falling dollar on the GBP/USD rate shadows prolonged UK data weakness. The October manufacturing PMI slumped to 52.9 from September's 54.7, falling below expectations of 54.3. UK retailers reported their third consecutive month of slowing sales volumes, as the index hit an 11-month low of +10 from September’s +12. Finally, Hometrack realty said the UK housing market predicts the number of home sales to fall by 16.5% in 2008 and net mortgage lending to drop by 18%.
Despite prolonged sterling strength, we view the weakening fundamentals to be the source of an impending correction to as low as $2.03 before mid month. Near-term support stands at $2.08, followed by 2.0760. Upside capped at 2.0870.
Ashraf Laidi
Chief FX Analyst
CMC Markets US
a.laidi@cmcmarkets.com
