Futures are pricing a strong equity open in the U.S. session, which may be detrimental for the dollar against EUR, AUD, NZD and even CAD as risk appetite returns to the market. The exception will be USD/JPY as carry trades are revived due to the return of risk appetite--courtesy of strong US retail sales.
USD/JPY gains after U.S. retail sales and ex autos rose 0.2%, overcoming worries of a disappointing figure. The decline in department stores was offset by a surprise 0.6% increase in building materials. The report may end up being a mixed outcome for the markets as it reduces expectations of a December Fed cut at a time when the yield curve is clamoring for further easing--to start as early as next month.
Wholesale inflation softened as PPI rose 0.1% while the core rate remained unchanged. Year on year rate rose 6.1% and 2.5% on the core.
Bank of England Joins Fed in About Turn Six days after Fed Chairman Bernanke made the unusually dovish remark of indicating that U.S. growth would slow "markedly" this quarter and would remain "sluggish" during early 2008, his British counterpart Governor Mervin King stated today growth will “slow sharply in the next year." King spoke after the release of the BoE’s quarterly inflation report, which predicted inflation will move back to its 2% target in 2009 despite surpassing it next year. The predictions are based on a 25-bp rate cut in Q1 to 5.50%. While these reversals in assessment by the heads of the Fed and the BoE are not surprising given the deteriorating economic and capital market environment, it is not the first time these central banks have erred on the optimistic side. Specifically, the Federal Reserve has not only been erroneous in predicting a stability in the housing sector in 2007 (Fed governors’ pronouncements in 2006 and early 2007), but its swift 75-bps in interest rate cuts taking place two months after issuing a neutral economic assessment reflect an overlook of the intensification of the downside risks of the economy. (More on GBP below).
Fed Chairman Bernanke will speak about the Fed’s communications policy this morning.
CLARIFICATION We mentioned in yesterday’s note that the next bout of equity selling could emerge on Nov. 15, which marks the last day of the 45-day notice period at which clients should notify hedge funds to withdraw their money. With the broader market down nearly 7% since the beginning of the quarter, clients may take some money off the table as was the case in Q3 when Aug. 15 was marked with massive selling across all equity indices. At the open of Aug. 15, the S&P500 was down 5.2% since July 2 (open of Q3). Today, the S&P500 is down 3.0% since the beginning of Q4. Given the magnitude of the losses so far this quarter combined with the last day of the 45-day notice period tomorrow may prompt investors to exercise their option to withdraw some of their funds, prompting significant selling by hedge funds in the magnitude of 2-3%, and not necessarily 5%. In this case, we expect renewed rallies in the yen crosses and for the Aussie, kiwi and loonie to come under renewed pressure. The fact that the VIX measure of volatility stood at two-month highs and the S&P 500 is below its medium and long term averages (50, 150 and 200 day) underlines lingering preoccupation in the market. Given the technicals in the U.S. benchmark indices and the ongoing repricing of MBS via credit rating downgrades, we expect the indices to retest their August lows. This means that another 5% decline in the S&P 500 is in store.
Sterling damaged by BoE, hits four-year low vs. Euro Weak U.K. fundamentals continue to hit the British pound, but this time the damage is felt even against the U.S. dollar. In its quarterly inflation report, the Bank of England predicted inflation will move back to its 2% target in 2009. Sterling fell as the Bank of England (BoE) based its forecasts on the assumption of a 25-basis point rate cut next quarter. The currency damage escalated after BoE’s King said in a press conference that the UK is a "pale shadow" of what's been going on in the United States, noting that the pound’s 4% decline against the euro since August and 3% decline in trade-weighted terms despite its surge against the dollar. We have long pointed out the fundamental weaknesses of the British pound and the contrast between its gains versus the dollar and its losses against all other major currencies.
Cable’s rebound was limited at 2.0770, but the latest weakness in U.K. fundamentals implies a more aggressive pullback in sterling versus the dollar during bouts of risk aversion. Support stands at 2.0650, followed by 2.0620. We could see $2.03 as early as next week, especially in the event of protracted selling in global equities.
With such a backdrop, we favor EUR, NZD, AUD and CHF against the GBP. EUR/GBP eyes 71.20 pence, followed by 71.50, with support climbing at 70.65.
Euro powered by fundamentals
Euro makes its second daily rise across the board after Euro zone Q3 gross domestic product rose 0.7% in Q3 for a year on year rate of 2.6%, following 0.3% q/q and 2.5% y/y in Q2. The data have powered up the euro against the dollar despite a retreat in the Aussie, kiwi and sterling against the U.S. currency. With central banks and SWFs eyeing an increased allocation into euro denominated assets, the latest data Euro zone releases continue to show no considerable drag on growth as has been the case in the United States and the UK.
EUR/USD shrugs robust U.S. sales, now eyeing further gains past the $1.47 figure, but a breach of $1.4715 will be determined by the extent of risk appetite throughout the U.S. trading session. Trend line support stands at 1.4650, followed by 1.4620. Gold’s recovery past $810 has also boosted the single currency.
USD/JPY gains on US sales, capped at 112
U.S. retail sales strength lifts USD/JPY past the 111.40 resistance to a 111.70 high after the pair was rudely interrupted during the European lunch break. Despite the figures, we note persistent downside risks to the U.S. economy and the onset of renewed market selling risks calling up the 110.60 support. We expect downside to extend towards 110.25. Upside is capped at 111.50.
Ashraf Laidi Chief FX Analyst CMC Markets USa.laidi@cmcmarkets.com
