$ Dollar - Where Is The Bottom?
€ Euro - How Much Power Left?
¥ Contraction in Japanese GDP Could Lead Yen Lower
? BoE On Hold, Unusual Statement Drives Pound
? Will the Swiss Franc Fall Back Despite a SNB Hike?
C$ Bank Of Canada Pauses, Pencils Out Its Hawkish Bias
AU$ RBA Annual Report to Dominate Aussie Price Action
NZ$ New Zealand Dollar Eyes Critical Event Risk
[B]
Dollar - Where is the Bottom?[/B]
Last week, we wrote "The rate cut issue may be settled once and for all after Non-Farm Payrolls next week. If the employment data once again produces the second sub-100K job performance in a row the rate cut will be almost assured. Despite the soothing rhetoric a weak July NFP would indicate that the economy was already slowing before the sub-prime mess became front page news and the markets will demand action from monetary authorities. Should that occur the greenback will likely weaken against the euro and the other high yielders as markets will begin to price in possibility of a change in policy towards a new loosening cycle."
With the first negative print in NFPs in four years, the question of rate cut appears to have been settled once and for all, although the Fed remains highly resistant to a systematic approach of lowering rates. Inflation continues to stoke the hawkish bias of US monetary policy makers and with oil at $76/bbl and gold over $700/oz they can hardly be sanguine about pricing pressures within the US economy. Yet the Fed is caught between a rock and hard place. The employment data was so incontrovertibly bad that the risk of recession looms very real over the US economy, especially in light of the fact that most of the massive job cuts in the housing sector have yet to be recorded on BLS?s books.
For the first time in weeks, despite carry trade liquidation, the greenback actually lost ground against the euro and the pound as the safe haven story started to fade and the currency market started to worry about the prospect of a US recession. Yet whether the euro or the pound will be able to maintain their gains against the buck will depend to a very large extent on how successfully the rest of the world will be able to decouple from the US slowdown. Once the US consumer goes, he may drag the rest of the G-3 with him especially if high exchanger rates makes imports even less affordable. In short this dynamic could trigger a race to the bottom as every major central bank will scramble to lower rates to stimulate their economies with no clear winner in sight.
Next week, the market will pay very careful attention the Retail Sales numbers to gauge extent of the damage from the collapse of housing on US consumer spending . Yet this story is like a slow motion car wreck and will continue to unfold for months to come. We have the feeling that there will be quite a few more negative surprises to come -BS
[B]Euro - How Much Power Left?[/B]
As expected the ECB left rates on hold given the turmoil that continues to play out in the European money markets where LIBOR rates have skyrocketed as complete lack of confidence in the creditworthiness of their counter parties has pushed three month rates way above their historical levels. Against this background it was little wonder that Jean-Claude Trichet chose to stand down. Yet as we wrote on Friday, "Certainly one gets the sense that most of the G10 monetary authorities would like to hike rates further especially given the double digit growth in M3 monetary aggregates in both EZ and UK. However, the policy makers remain on the defensive due to the unrest in the markets. Indeed we think they will have to no choice but to be reactive rather than proactive, as investors deal with the growing losses in the sub-prime debt market and the concomitant problems of confidence in the money markets as key participants continue to be risk averse. "
Furthermore, signs that EZ growth may have peaked in Q4 of 2006 continue to present themselves. Nowhere was this more evident than in the latest German manufacturing data which saw order dropped the most in at least 16 years in July after a decline in sales of ships, trains and airplanes. Orders, adjusted for seasonal swings and inflation, fell 7.1% from June.
Next week the EZ Industrial Production data should provide more evidence to the market, If the EZ growth is indeed decelerating euro?s strength will only come from its familiar position as the anti-dollar. Given such a dynamic the upside thrust may be decidedly limited unless US economic situation deteriorates rapidly. BS
[B]Contraction in Japanese GDP Could Lead Yen Lower[/B]
The Japanese yen rocketed higher against the majors at the end of last week, as a strong pullback in US equities following the infamous NFP report sent USDJPY and EURJPY reeling. In fact, USDJPY ended the week down 2.1 percent, a significant drop after the pair meandered in range trade for most of the week. Economic data out of Japan, as usual, didn?t necessarily warrant gains for the low-yielding currency. First, capital spending during the second quarter unexpectedly contracted at a rate of 4.9 percent, after rocketing 13.6 percent during the previous period. The losses were generally contained to the previously-resilient services sector. As a result, Q2 GDP figures that were released just a week ago will likely be revised lower to indicate that the economy contracted. Meanwhile, wages in Japan fell at the fastest pace in three years during July, as monthly wages, including overtime pay and bonuses, dropped for the eight consecutive month at a rate of 1.9 percent. The Japanese labor market has been remarkably tight, but the failure of these improvements to translate into higher pay has hurt consumer spending growth, which accounts for more than a half of the economy, as discretionary income narrows more and more. Consequently, the nation has become even more reliant on exports, which are in danger at a time when the US housing recession threatens demand. Furthermore, the lack of wage growth has limited price pressures, leaving the economy teetering on the edge of deflation and hurting the Bank of Japan’s case for enacting another rate hike in 2007.
Looking ahead to this week, economic data isn?t likely to play much of a role in price action for the Japanese yen pairs, as the condition of the equity markets should remain in control. Traders will probably remain jittery during the week, especially in the US, unless the Federal Reserve comes right out and gives the clear impression that they will indeed cut rates on September 18th. Nevertheless, the economic data on hand at the beginning of the week will not help the case for investors remaining bullish on the yen, as the final reading for Q2 GDP could prove to be dismal. As we mentioned previously, the contraction in capital spending during the quarter is expected to lead expansion to be revised down to -0.7 percent. Though the Bank of Japan uses outlooks in order to make their policy decisions, they will not be able to ignore such dour economic conditions. With their growth forecasts likely to be impacted, the central bank truly has little room by which to navigate and BOJ Governor Fukui may not be able to enact further rate normalization as he so clearly desires. - TB
[B]BoE On Hold, Unusual Statement Guides Pound[/B]
There was a lot going on in the UK this past week. A healthy spread of regular economic indicators was biding currency traders? time while they waited for the central bank?s rate decision at the end of the week. The economic calendar was evenly coated with second tier releases. The first half of the week was dedicated to PMI figures and a consumer sentiment report. In August, purchasing managers in both the manufacturing and construction sectors reported a pick up in activity. This was a promising contrast to similar reports in Europe and the US. The Nationwide Building Society?s consumer sentiment survey stayed out of the sterling?s way with an inline 94 print. The real fundamental action began, interestingly enough, only a few hours before Bank of England announced its monetary policy decision. An industrial production report for July unexpectedly contracted for the first time in five months, a lagging report (considering the PMI) but enough to rouse fundamental traders? interest going into the rate announcement. When Governor Mervyn King officially announced the MPC?s vote to keep the overnight lending rate untouched at 5.75 percent, the market was ready to pass it off as a non-event. However, the committee didn?t leave it at that. In an extraordinary move, the BoE released a statement after announcing its decision. In the short memo to the public, policy makers offered a forecast for inflation to remain close to the 2 percent target over the forecast period? and easing growth. The real motive for the letter was clear a few sentences later though when they suggested concerns over asset-based securities was disrupting money markets. They went on to ensure that policy would be guided only by inflation; but they also said it was too early to determine how big of an impact the disruption in financial markets would have on the basic economic building blocks of growth and inflation.
The economic calendar for the coming week is distinctly front-ended. Monday opens with an upstream inflation release. The producer price index series? August numbers are expected to see similar results to the previous month?s data. The output numbers will be key in shaping forecasts for front line price pressures. The greater market-mover for the week though will likely be Wednesday?s labor data. Official expectations for the net jobless claims, unemployment rate and earnings numbers are all expected to be unchanged. However, the greatest threat of event risk often lies in forecasts of complacency. With inflation cooling and financial market volatility soaring, it may only be a matter of time before firms rein in wage growth and job offers. While the market skips between these few scheduled economic indicators, savvy trader will also keep up on the BoE?s money market activity. Though the central bank left the overnight lending rate untouched, the MPC did promise to provide credit markets 4.4 billion pounds this week if money market rates held near their highest levels in 9 years. - JK
[B]Will the Swiss Franc Fall Back Despite a SNB Hike?[/B]
The Swiss franc rallied last week as national GDP unexpectedly accelerated, while a significantly weaker US dollar helped drive USDCHF down 1.7 percent by Friday?s New York close. Economic expansion during the second quarter showed a 2.8 percent annual pace of growth, marking the fastest rate of expansion this year. However, Swiss growth is considerably cooler than it was in 2006, and with expansion cooling throughout the Euro-zone - Switzerland?s biggest trade partner - heady growth trends may be exhausted, especially if the recent global credit rout takes its toll. This less optimistic outlook is support by the recent pick up in the unemployment rate, which hit 2.6 percent, up from a five-year low of 2.5 percent. The question is: do current conditions warrant further rate normalization?
The Swiss National Bank will be the judge of that on Thursday, when the central bank is estimated to raise their target range for the three-month Libor rate 25 basis points to 2.25 - 3.25 percent. While headline inflation has remained remarkably tepid at an annualized rate of 0.8 percent, the import and producer price index recently hit 11 month highs, and these undercurrents have not escaped the vigilant eye of policy officials. Furthermore, recent volatility in the financial markets is unlikely to dissuade Roth from normalizing rates, as he said on August 20th, “We hope that volatility stays higher. What we had was not normal, namely, practically no volatility?Markets cannot be a one-way street, or you will get excess.” With a 25 basis point rate increase priced in for the September meeting, traders will likely be proved correct as the Swiss National Bank keeps their rate normalization schedule intact. However, SNB decisions do not typically have a huge impact on the Swiss franc, but if we see the central bank shifts their outlook to reflect that they may stay neutral going forward, USDCHF could see a decent boost. - TB
[B]
Bank Of Canada Pauses, Pencils Out Its Hawkish Bias[/B]
The Canadian dollar was little changed last week against the US currency despite a swell of economic activity from both economies. For Canada, the economic calendar was populated by a few, heavy hitting indicators. The least influential of the reports also has the greatest potential for problems in the future. Building permits through the month f July dropped 11.3 percent. Noteworthy within the report was the drop in the total value for municipality bookings from a record high C$6.94 to C$6.16. This could be the first sign that the Canadian housing market is starting to suffer from its close ties to the US economy and the credit woes that have clearly moved beyond the boundaries of their subprime mortgage market. Naturally, the most interesting data for the week was Friday?s labor survey. Statistics Canada reported a moderately stronger than expected 23,300-person increase in payrolls that kept the jobless rate at its 33-year low 6.0 percent. Bulls were most impressed though by the acceleration in average hourly wage growth to 4.0 percent, a six-year high. However, all was not well. Looking a little more critically at the data it is clear that overall job growth is slowing. What?s more, part-time jobs are once again filling in for the big gaps in full-time employment.
Outside of the indicator realm, the Bank of Canada was exacting a heavy hand on price action. As was the trend for the week, the Canadian central bank left its overnight lending rate untouched while making note of recent credit problems that had circled the globe. An unstable credit climate was a footnote in nearly every comment policy makers made. So, though their was a mention of growth above expectations, there was a quick disclaimer that market conditions should temper? domestic demand and was already weighing on the US market (its biggest trade partner). Not surprisingly the previous reference for the need for another hike was dropped and in its stead was a promise that policy makers would closely monitor? markets in the weeks ahead.
The calendar will not skimp on the economic fodder in the days ahead, though whether they move the market or not is debatable. Offering a second look into the health of the housing market after last week?s permits data, the August starts report and July new home index are still both expected to improve. The trade account will update the market on demand for Canadian raw materials and the effect the high currency is having on cross boarder demand. Later in the week, the second quarter capacity utilization rate and labor productivity figures will come at inflation pressures at a different angle compared to the conventional CPI numbers. However, all this data will likely be passed through the same filter: whether the US economy is staring to have a greater influence on Canada. - JK
[B]
RBA Annual Report to Dominate Aussie Price Action[/B]
The Australian dollar finished materially higher on the week, as remarkable rallies in gold prices trumped carry trade tumbles and pushed the AUDUSD near monthly highs. Stronger than expected economic growth likewise served to boost the Aussie?s prospects, while a later Reserve Bank of Australia interest rate decision did little to alter the currency?s path. The net result was to send the A$ significantly higher against its US namesake, while it forged even more impressive heights against its New Zealand neighbor. Gold prices breached the psychologically significant $700 mark, with spot prices forging 14-month highs of $706 through Friday trade. Given that the precious commodity remains as one of the country?s top exports, any continued rallies can only boost the Australian dollar further. Other sectors of the economy likewise look bright, with the second quarter reporting impressive 0.9 percent quarter-over-quarter expansion?far above consensus forecasts of a 0.5 percent rate.
Taking a look at the implied yields on interest rate futures, predicted domestic LIBOR rates are expected to remain stable at 6.9 percent?boosting the currency against key counterparts. Indeed, the Reserve Bank of Australia is unlikely to move rates lower in the face of strong consumption and overall growth. This stands in contrast to the US Federal Reserve, which is predicted to cut domestic interest rates by as much as 75 basis points through the year?s end. All else remaining equal, this will add continued bidding pressure on the AUDUSD pair. Of course, such an outlook will greatly depend on the coming week?s Annual Report from monetary policy officials. The much-anticipated text will likely clarify interest rate expectations for the Australian economy.
The coming week of event risk will center around the RBA Annual Report due on the 12th, with otherwise second-tier data unlikely to cause major moves across AUD pairs. The likely exception will come on Monday night Home Loans figures, which could potentially shift outlook on the country?s high-flying real estate sector. Analysts clearly expect borrowing to drop through the period, as rising mortgage rates will deter new purchases or refinancing from the Australian consumer. Yet any positive surprises could easily spark AUD gains and boost outlook for housing. We will watch Home Loans and listen to the RBA Annual Report with great interest, as any major surprises could easily force medium term extension for the Australian dollar. - DR
[B]
New Zealand Dollar Eyes Critical Event Risk[/B]
The New Zealand dollar continued its losing ways through the past week of trade, falling further against its downtrodden US namesake. It remained one of the few major currencies to fall against the greenback on Friday?s pronounced US$ tumble?emphasizing bearish sentiment on the NZ$. Much as we argued last week, the trend clearly remains towards Kiwi selling. A virtually empty week of event risk allowed the Kiwi to move lower against most counterparts, but the coming days will see a remarkable pickup in economic activity. A positive surprise in key economic figures and/or a hawkish central bank leaves scope for a Kiwi recovery, but we believe that there remains further risks to the downside for Kiwi trading.
The calendar for the coming days of trade will be an especially busy one, with Sunday night?s Producer Prices reports to highlight inflationary trends ahead of a later-week central bank meeting. Consensus forecasts show expectations of fast-dropping prices, which certainly gives the Reserve Bank of New Zealand to remain neutral on its outlook for inflationary pressures. Yet the central bank may retain its tightening bias on the fast-falling New Zealand dollar exchange rate. Given the small island economy?s dependence on foreign goods and services, unusually volatile currency depreciation will cause undue stress on import prices. The central bank may find it difficult to justify easing domestic interest rates against such a backdrop, but futures nonetheless price in at least 25 basis points in interest rate cuts through December. Outlook will clearly depend on what the central bank says and does through its Wednesday night meeting, with further currency volatility likely to follow.
That same night, Statistics New Zealand will release the results for Retail Sales growth in July. This will be another key piece in the puzzle for the future of NZ rates and may likewise drive sharp moves in the domestic currency. The report may arguably be overshadowed by the earlier interest rate decision, but it remains clear that consumer spending trends will remain at the forefront of interest rate considerations for the small Asia-Pacific economy. - DR