More evidence of rising U.S. inflation underlines the Federal Reserve’s policy bind and raises chances the central bank will stick to non-interest rate easing liquidity solutions for the struggling money market, thus, sparing the U.S. currency from interest rate cuts and helping it from a relative-yield perspective. This does not mean that no more rate cuts are anticipated, but the fact the Federal Reserve Bank may have found new alternatives to the Greenspan put/rate cut may be a temporary boost for the greenback.
November’s consumer price index (CPI) rose 0.8% (exp 0.6%), core rose 0.3%, pushing the year on year CPI up 4.3% and core CPI 2.3%.
Our projections of further dollar strength towards year-end are rapidly materializing, with the Dec. 3 forecasts projecting EUR/USD at $1.42 and GBP/USD at $2.01 by end of month seeming on track as the unwinding of dollar shorts extends into mid December. Last Friday, prior to the U.S. payrolls, we bolstered the rationale of our argument by projecting U.S. 10-year yields to rise from 4.02% in Dec. 7 (before the payrolls’ release) to 4.30% by end of year. Yesterday the 10-year yield rose from 4.10% to as high as 4.20% on stronger than expected U.S. PPI and retail sales.
Seasonal FX reversals do not fail
This is a broad USD play as the currency is also up against the Japanese yen. Year-in-Year out, currency markets have shown a noticeable reversal in December of the trends emerging from mid October to mid November. This has worked consistently in favor of the euro against the dollar in December of 1999, 2000, 2001, 2002 and 2003 as the single currency was sold off during the prior two months in each of those years. 2004 and 2005 saw the opposite formations of these trends, with the euro losing and the dollar gaining in December, reversing their earlier moves in October-December of those years. Year-end repatriation and unwinding of cash and futures positions are behind such seasonal moves. Fundamentally, the argument that the Federal Reserve may intend to stick to its newly adopted liquidity-injecting policy, rather than reducing the Fed funds rate may be less detrimental to the U.S. dollar, while the euro zone is seen moving towards reducing its inflation hawkishness-an element largely responsible to the euro’s recent resilience relative to AUD, GBP, NZD and CAD.
We estimate that it is a matter of time before gold selling catches up with the FX moves and is dragged towards the $750 territory.
Explained later below is the reason to the latest dollar gains overnight against individual currencies.
The morning’s other U.S. release is November industrial production (9:15 am EST expected +0.2% from -0.5% in October and +0.2% in September) is expected to show strength, further boosting the dollar on the rationale of surging inflation risks and stabilizing manufacturing output. The releases could work significantly in extending the euro’s pullback towards $1.44 and sterling towards $2.02.
Euro Deterioration Signals Breach of $1.44
Despite the consistently hawkish remarks on inflation from ECB officials, the more important comment of the day was out of Holland’s Nou Wellink who said the euro zone is experiencing a 'second wave' of credit crisis, which is worse than the first wave, adding that it’s too early to tell whether central banks' actions will work. While the comments do not suggest a rate cut soon due to rising inflation problem, it may signal a message that the ECB is in a policy bind as the central bank is prevented from delivering a necessary reduction in interest rates to relieve struggling business activity in Italy and Spain.
Euro zone November CPI was revised to 3.1% from initial estimates of 3.0%, following October’s 2.6%. German retails ales fell 1.8% from a 0.2% rise, while the Bank of France revised its estimate for Q4 GDP growth down to +0.5% from 0.6%.
EUR/USD is in track for further losses after having failed to breach above the 1.4750 figure. Our projected support of 1.4580 has been breached as the pair breaks below the 50-day moving average of 1.4520, thus calling the next key target at 1.4450. Further losses next week are seen extending towards 1.4350. Upside capped at 1.4520, followed by 1.4550.
USD/JPY at five-week high on weak Tankan
Yen sold off across the board, after Japan’s Tankan sentiment of large manufacturing firms fell to 19 in Q4 from 23 in Q3, reaching its lowest level since Q3 2005. Consensus was for a more modest decline to 21. The index for large non manufacturing firms fell to 16 from 20. The falling yen shrugged the rise in planned capex of all-sized firms for to 6.8% y/y from 4.9% and an upward revision by large firms’ capex 10.5% from 8.7%.
USD/JPY approaches its 200-week MA at 113, which will likely be breached towards 113.60. Support stands at 112.50, backed by 112.00.
High U.S. inflation and Moody’s downgrade of Citigroup may weigh on U.S. equities, which could help in offsetting yen losses.
Sterling dragged from bad to worse, 3 rd weekly loss
Dovish comments from Bank of England’s (BoE) Rachel Lomax and Kate Barker deepened the losses in the British Pound, dealing GBP/USD its third weekly decline, the longest losing run since May of this year. One day after the decline in UK housing prices was finally reported to have spilled onto the resilient London market, MPC member Kate Barker said last night a weaker sterling was good for UK manufacturers, prompting broad selling in the currency. MPC’s Lomax said the Monetary Policy Committee takes into account financial markets in setting rates, adding that UK inflation has come down.
While UK fundamentals are sufficient in supporting the case for further BoE easing into next year (4.50% by end of Q3 2008), GBP selling may be intensified by strong U.S. Indus production later today as well as high inflation figures.
Lower highs and Lower Lows is Classic Bearish Pattern: Cable loses 2¢ in 2 days, eyeing interim support at $2.0220, followed by the last week’s $2.0180. The pattern of lower highs (Nov 9, Nov 29 and Dec 12) accompanied by lower lows is a textbook bearish formation, suggesting further losses to come. Resistance drops to capped at 2.0450, followed by 2.0350, followed by 2.0420.
Loonie at three-month lows, sixth losing week
The Canadian dollar is set to close its sixth losing week against the greenback as USD/CAD breaks above a nine-month trend line resistance of 1.02, eyeing 1.03 as the next key obstacle. Longer term resistance stands at the 200-day MA of 1.0455, which we deem to act as a major ceiling to further USD/CAD gains. Support pushes higher to 1.0210, backed by 1.0185.
Ashraf Laidi
Chief FX Analyst
CMC Markets US
a.laidi@cmcmarkets.com
