Nearly 24 hours after the Federal Reserve Bank’s shock-and-awe rate cut of 75 bps, the Japanese yen is back near the highs attained before the Fed’s move, while U.S. equity futures and European stocks are down more than 2.0%. Anticipation that the European Central Bank (ECB) and Bank of England (BoE) will not follow the Fed’s aggressive easing strategy is weighing on European equities, while lower sales forecasts from Apple are helping to drag U.S. markets.
Although the Fed is set to cut by an unprecedented 125 bps in a matter of a week (50 bps next week after yesterday’s 75 bps), U.S. markets remain vulnerable, suggesting that another 10% to 15% in declines may be in store for the major indexes in the next three to five months. We had been calling for stocks to drop by 12% to 15% in the first quarter. This decline has already taken place when measuring performance from the November highs. The downgrade of two U.S. leading bond insurers, fresh reports of lower than expected earnings from major U.S. banks, deteriorating sales from U.S. automakers and a collapse in highly predictive Philadelphia Fed index to -20 from -1 all suggest that recession is here.
Just as the Fed attempted to shore up confidence among U.S. banks by injecting liquidity and relieving the cost of inter-bank funding, will the central bank manage to lift confidence among U.S. consumers and businesses, encouraging them to spend? The projected cash back to U.S. consumers and tax incentives to stimulate capex by business may do the trick. But the lack of certainty regarding the extent of remaining write downs among U.S. banks and shaky sales outlook of non-bank sector (technology, consumer staples and industrials) is expected to drag on the major indices.
Last week we changed our forecast for U.S. interest rates to fall by 175 bps from an initial forecast of 100 bps. We had explained our forecast was based on the widening spread differential between 10- and two-year yields to 120 bps. After Tuesday’s Fed cut, the spread has widened to 140 bps, bolstering our forecast to expect the Fed to slash the Fed funds rates by an additional 100 bps to 2.50%.
Yen cancels all of its post-Fed losses vs. USD
Renewed losses in U.S. and European indexes are weighing on risk appetite, lifting the yen against all currencies currency, and erasing all of the 100 points accumulated by USD/JPY to 107.35. The pair is now near its two-and-a-half-year lows of 105.60. Continued erosion of market confidence is spreading to overseas, especially amid increased speculation of subprime losses in Chinese banks are helping the yen flex its risk appetite muscle. We warned readers yesterday prior to the Fed cut: ”Yen longs are warned of any sharp yen declines in the event of significant liquidity injections by central banks and/or an unexpected rate cut from the Fed.” The Fed’s rate cut has come and gone and so did the decline in the Japanese yen. Renewed gains are especially seen extending against GBP (205) and CAD (101.80).
Until next week’s Fed cut and State of the Union of Address by President Bush, the trend in USD/JPY will remain firmly on the downside. Traders will likely begin to test the 105 figure. Support stands at 105.30, backed by 105 and 104.70. Upside capped at 105.80.
Euro rises as Trichet sticks to the script
Countering speculation that the ECB may be considering a rate cut, central bank President Jean-Claude Trichet said today: "In demanding times of significant market correction and turbulences, it is the responsibility of the central bank to solidly anchor inflation expectations to avoid additional volatility in already highly volatile markets.” While the statements reduce chances of a looming ECB cut, we caution against any signs of dissent and mixed messages from the ECB as the slowdown down takes its toll individual euro zone nations. Such signs may be relatively discreet, such as those by Yves Mersch who said inflationary pressures must not be “over dramatized.”
We expect EUR/USD to add to losses towards 1.4520. Key foundation stands at 1.4480. Upside capped at 1.46.
Sterling fails to follow
The minutes of the Bank of England showed the Monetary Policy Committee voted eight to one to keep rates unchanged earlier this month. Although it was a surprise that only David Blanchflower had voted for a rate cut, considering the dismal UK reports issued on the week of the BoE decision, markets are pricing a 100% chance of a 25 bps cut to 5.25% next month.
Separately, UK Q4 Preliminary GDP rose +0.6% q/q from 0.7% in Q3 and 2.9% y/y.
Sterling’s patterns of the past three weeks continue to show the market is increasingly selling any temporary gains. This was manifested last week upon the release of the unexpected decline in retail sales, and it is taking place again today. Cable has retraced 50% of the post Fed cut gains, eyeing interim support at 1.9460, with the possibility of adding to losses at 1.9410. Upside firmly capped at 1.9535.
More losses for the Canadian dollar
USD/CAD eyes 1.0340 - The loonie is under severe pressure across the board after Canada’s leading indicators index fell 0.1% in December following no change and expectations of the same. Traders ignore yesterday’s stronger than expected retail sales and take today’s data as another sign that more rate cuts are in store especially that the BoC cut by 25 bps rather than 50 bps.
USD/CAD is set to extend gains towards the 200-day moving average of 1.0320, with 1.0350 seen viable for the day. Support stands at 1.0240. CAD/JPY is expected to extend losses below 102, eyeing 101.60 especially in the event of accelerating losses in equities.
Ashraf Laidi
Chief FX Strategist
CMC Markets US
a.laidi@cmcmarkets.com
