[B][U]The Week Ahead
Monday, September 24, 2007 - Friday, September 28, 2007[/U][/B]
[B]What to look for in the week ahead[/B]
� USD weakness is now excessive
� Commodity run-up raises inflation risks
� US consumer, job market stable despite housing slump
� RBA, ECB and BOE to hold rate-setting meetings
� BOJ Tankan on Monday; US NFP on Friday
[B]The USD was hammered again this week[/B], and you can pick your reasons why: a sharp drop in US consumer confidence; further declines in housing data; increased fears of a US recession leading to lower US rates; skyrocketing commodity prices; the sun rose in the East yet again. [B]You name it and it was a reason to sell the USD[/B]. Never mind that US stocks finished their best month since 1998, or that Aug. US consumer spending gained more than expected, or that weekly ABC consumer sentiment improved from -20 a month ago to -11 in the latest week, or that jobless claims data have yet to confirm the labor market weakness evident in the Aug. NFP report. [B]Ignoring positive data and embracing negative data are the hallmarks of a downtrend and that certainly seems to be the current situation for the greenback. [/B]
Last week I wrote that USD-bearishness had reached a fever pitch, and that the likelihood of a USD reversal was close, but still not at hand. USD-negativity increased even further this week and [B]the USD broke some significant historical technical levels[/B] and this keeps me wary about picking a bottom. The US dollar index lifetime low of 78.20 was tested on Thursday and Friday�s weakness saw a decisive daily, weekly, and monthly close below that level around 77.70. EUR/USD looks set to close above the Sept. 1992 synthetic high of 1.4240 (based on EUR-predecessor currencies� levels), which leaves scope to the all time high of 1.4536 (USD/DEM 1.3455 seen in March 1995). With USD- sentiment and short-positioning at extreme levels, I continue to expect a turnaround in the USD in the next few weeks. However, given the relentless selling pressure on the USD, it�s better to wait for the market to signal a reversal rather than trying to pick the bottom in advance.
[B]The dollar�s decline has been most evident against EUR[/B], with most other currencies (GBP, AUD, JPY) slightly below or just matching recent highs against the USD, with CAD the exception. Since the Sept. 18 Fed rate cut pulled the carpet out from under the USD, EUR/USD gains have also been fueled by a series of barrier options that began just below 1.4000 and extended to 1.4250 so far. When those price levels are taken out, option traders become shorter EUR/USD, which generates additional EUR/USD buying interest, fueling further gains. Likely option barrier triggers remain at 1.4300 and higher, so we may not yet be done with the upside. Additionally, there has been a fair amount of monthly cyclicality to USD weakness, with the dollar tending to turn softer in the second half of the month when US housing data is highlighted. This effect was exacerbated this week by end-of-month and end-of-quarter portfolio flows that were broadly USD-negative. The flip side of those flows is that they are now past, removing one of the sources of USD selling pressure.
[B]Going into October, there are a number of sources for a potential rebound in the USD[/B]. Foremost among these are interest rate decisions by the ECB and the BOE. (The RBA is also meeting, but not expected to change rates.) Recent sentiment indicators out of the Eurozone and the UK are pointing to a further weakness in the outlooks for these two regions. Continued credit market concerns and the strength of the EUR all but assure the ECB will skip raising rates when they announce on Thursday. While I believe the ECB is likely to remain on hold for the remainder of 2007 at the minimum, it will be a difficult balancing act for M. Trichet to signal this given signs inflationary pressures are rising again. For the BOE, no one is expecting a rate cut from them next week, but that is the direction they are increasingly expected to move in the future. There are likely to be some MPC members in favor of a token �% rate cut, but that will only become evident with the release of the MPC minutes on Oct. 17. Finally, on Friday, US Sept. NFP data will be reported, along with any revisions to the disappointing Aug. report. Market estimates are for a +100K increase in non-farm jobs, with a number of analysts calling for an even stronger number. If such gains materialize, it will undermine the impression that the US labor markets are deteriorating and call into serious question the chances of further Fed rate cuts, especially as commodity prices are soaring. A combination of reduced interest rate expectations for the UK and Eurozone, along with an increase in steady US rate expectations could provide the basis for a significant turnaround in the USD outlook.
[B]The final source for a turnaround in the USD will come from the political realm.[/B] Euro strength has clearly reached levels where it will undermine export competitiveness and risks upending the overall economic outlook in the Eurozone. Eurozone finance officials are becoming increasingly vocal in their opposition to further gains. On Friday, Luxembourg�s Juncker, the head of the Eurozone finance ministers group, indicated that the strength of the Euro would be a topic for discussion at the upcoming G7 meeting in Washington on Oct. 20-22. While it is far from certain that the G7 will resolve to take any concrete action at that meeting (US Treasury appears firmly laissez faire so far), the risks of concerted opposition to further EUR strength/USD weakness going into the meeting will likely see EUR gains tempered at the minimum.
[B]To recap, the USD decline has reached sensitive levels, politically, historically, and in terms of sentiment and positioning, and this increases the chances for a near-term bottom in the USD[/B]. Price action, however, has given no sign of an end to the USD downside and this makes picking a bottom exceedingly risky. Better to wait for the market to signal a reversal than to catch a falling knife. The first week of October may provide just such a signal, but the resolution will remain suspect until US Sept. NFP data is out.
Turning to the US data calendar, Monday kicks off with Sept. ISM manufacturing and prices paid indexes. Tuesday sees only Aug. pending home sales, a leading indicator for existing home sales. Wednesday will see the ADP national employment report, which may trigger some revisions to NFP forecasts, and Sept. ISM non-manufacturing index. Thursday has weekly jobless claims and August factory orders. Friday will see the Sept. NFP, which is currently forecast to show a rise of +100K, but also an increase in the unemployment rate to 4.7%. (The unemployment rate nearly rounded up to 4.7% in August.)
[B]Eurozone data begins on Monday with manufacturing PMI�s for individual countries and the Eurozone as a whole[/B]. Tuesday sees Eurozone PPI for August. Wednesday sees Service sector PMI�s for individual countries and the bloc, along with Aug. Eurozone retail sales. Thursday�s highlight will be the ECB rate announcement and guidance from ECB pres. Trichet. Friday concludes with Aug. OECD leading economic indicators for the Eurozone.
Japanese data for the week is light but kicks off on Monday with the 3Q BOJ Tankan survey of corporate sentiment. Estimates are for slight declines in the major indexes, but stronger than expected industrial production data may lead to a surprise steady-to-higher readings. Monday afternoon sees August labor and overtime earnings. Thursday sees weekly MOF stock and bond flow data and official reserve assets. Friday afternoon sees preliminary August leading economic index.
UK data begins with money supply and lending data for August on Monday, along with the manufacturing sector PMI survey. Tuesday sees construction sector PMI and Sept. Nationwide Building Society consumer confidence, which is forecast to drop from 94 to 90. Wednesday sees the service sector PMI and the Sept. BRC shop price index, a retail inflation gauge. The BOE will announce its interest rate decision on Thursday morning EDT, with no change currently forecast.