The Fed’s future path still seems more bullish than the European Central Bank. If so, the yiel...
USD Consolidating for Now; Key Levels to Watch
09/01/2008 12:00 am EST
The USD largely consolidated its recent gains this week, but not before making marginal new highs against the most beleaguered currencies (EUR, GBP, and AUD). Data continued to come in showing further deterioration in both current conditions and future outlooks in the UK and Europe. In contrast, US data continued to come in mostly better than expected (existing homes sales, consumer confidence, durable goods, 2Q GDP, and Chicago PMI all beat expectations). This is a theme we have been following for several months now, and it finally seems to have taken hold among analysts in the broader market. In contrarian thinking, that would suggest the bulk of the USD's moves are done for the time being. But I'll argue later that this is most likely simply a period of consolidation that will be followed by further USD gains. In the meantime, traders need to be prepared for more consolidation and relatively choppy conditions, subject to key levels I'll outline next. .
- In EUR/USD, the intra-week low at 1.4570 effectively achieved the 'measured move' target indicated by the double-top pattern from just above 1.6000. Depending how one measures the distance between the neckline and the double top, as well as the level of the neckline itself, the pattern indicated a 'measured move' objective of about 750 points, making 1.4540 the target. Last week's low effectively hit that target and subsequently prices began to correct. The 1.4500-50 area is an obvious 'round number', psychological source of support and it's not surprising that EUR/USD should hesitate on its first attempt down there. Weakness below 1.4500 will signal further declines to the 1.4300-50 area initially, and then target 1.4000 next. The 1.4850-1.4950 area remains the level to establish new short positions.
- In GBP/USD, what looks to be unfolding is the fallout from a rather gnarly looking 'head and shoulders' top. The neckline was broken with the drop under 1.9400 and targets a 'measured move' objective of 1,870 points to 1.7530. Cable is currently probing daily closing low support at 1.8160-70 from June of 2006, and once that level is broken, I would expect losses to quickly extend to 1.8000, which looks likely to fall like a house of cards, opening the way to the 1.7500-50 target area. The 1.85-1.86 area is the dream level to re-sell on any correction.
- AUD/USD has also reached a significant support level that is likely to lead to a period of consolidation. The past week's intra-day low was just below 0.8500, another 'round number' source of psychological support. 0.8508 is also the 61.8% Fibonacci retracement level for the move up from the 0.7676 spike low just over a year ago to the all-time high at 0.9850. A daily close below 0.8500-08 should signal further weakness initially to the 0.8280-0.8320 area marked by a major low from Sept. 2007, but ultimately weakness toward 0.8000 is expected. 0.87-88 remains the best levels to consider selling on bounces.
The USD Will Continue to Strengthen
Recent data has painted a very clear picture of deteriorating growth prospects in G7 economies outside of the US, while US data has shown increasing signs of stabilization. Still, nagging concerns remain about the US outlook. It's as if we're paddling down an uncharted river and we're not sure if the rocks we see up ahead are just shallow rapids or the edge of large waterfall. This uncertainty is the most likely driver of the current period of consolidation, and with major US data out next week (Beige Book and August NFP, in particular) there are plenty of near-term risks to contend with. The data will eventually reveal itself to us, but as we have argued in recent weeks, US consumers have retrenched and look able to weather the storm, as long as it doesn't last too long. This view, contrasted with eroding outlooks elsewhere, keep us fundamentally biased toward further USD gains.
The other major USD support going forward stems not from currencies as a barometer of national outlooks, but rather from currencies as an asset class. Over the last five years as the USD weakened, US investors increasingly sent investments abroad. With stumbling economic outlooks in Europe/UK/Japan and fresh signs of slowing in Asia ex-Japan, US investors will increasingly be repatriating assets back to the US. The sudden rebound in the USD has likely caught many investors flat-footed, meaning the bulk of USD asset repatriation has yet to hit the market. These flows will be an ongoing source of USD support over the next several months, regardless of what the US data suggests for the here and now. (And we're not talking a few billion here, but rather trillions of dollars in off-shored investments.) Next Friday's August NFP will likely be a case in point. We will be watching closely to see if the USD is able to rug off another expected job loss, which would be another indication of the long-term nature of the current USD recovery. Should the USD react more negatively, we'll take it as an indication that consolidation is ongoing.
RBA, BOC, ECB and BOE
Rate Decisions Next Week It is a busy week for central banks with the RBA, BOC, ECB and BOE all due to decide on interest rates. Below we offer a summary of what to expect from each meeting and the likely reaction in currencies.
- Reserve Bank of Australia
The Reserve Bank of Australia is set to announce on Tuesday at 04:30 GMT and the broad consensus is that the bank will reduce the current 7.25% target rate by 25 basis points. Economic activity has slowed in recent months with retail sales slipping to an annual growth rate of 3.2% in June-the weakest run-rate since October 2005. Meanwhile, slowing global growth will continue to put pressure on red-hot commodity prices, which will impact the Australian economy's terms of trade notably. We have seen this first and foremost in the US with weakening gasoline demand driving oil prices down more than $30 from the all-time highs. The key for this event will be what the RBA says or hints about the future path of rates. If they allude to further rate cuts from here we would expect sharp selling in AUD/USD with the 0.8500 zone vulnerable. On the flipside, no rate cut should see Aussie back up towards the 0.8700 mark.
- Bank of Canada
The Bank of Canada's rates confab is scheduled for 13:00 GMT on Wednesday and the consensus is unanimous in calling for no change to the 3.00% policy rate. Inflation, at an annual rate of 3.4%, is running well above the bank's target of 2.0% while economic data have been mixed. In the latest month the unemployment rate fell to 6.1% in July from 6.2%, June building permits were crushed -5.1% from 2.0%, while core retail sales jumped 1.4% for June after a 0.6% result -- to name a few. The uncertainty over the economic outlook coupled with uncomfortably high inflation augurs for a BOC on hold. That said an unexpected rate cut would probably see USD/CAD test daily trend line resistance near the 1.0720-30 area, which goes back to the 1.1880 highs in February 2007.
- European Central Bank
The European Central Bank is up on Thursday at 11:45 GMT with the usual press statement following at 12:30 GMT. The consensus is for the bank to leave rates on hold at the current 4.25% level. As such, the press statement will once again be in focus. Recent comments from ECB member Axel Weber that a rate cut is currently premature are likely to resonate in Trichet's post rate decision comments. That said, Trichet will also have to acknowledge that economic growth has clearly slowed with 2Q GDP printing negative and recent business surveys like the German IFO-which plunged to 94.8 in August from a prior 97.5, suggesting no speedy recovery in 3Q. While likely to be similar to the prior press statement which harped on inflation worries and downgraded growth slightly, we would expect a potential bounce in EUR/USD if Trichet suggests rate cuts are out of the question. In this case we would look to sell post-Trichet EUR bounces as reality sinks in that the Euro-zone economy remains on shaky ground.
- Bank of England
Last but not least, the Bank of England will decide on rates on Thursday at 11:00 GMT. The consensus here is unanimous that the bank will leave rates at the current 5.00% level. If this happens, the release will turn out to be a non-event as the BOE does not provide a press statement unless they make a change to rates. The meeting will likely prove to be contentious as per the latest musings from BOE member David Blanchflower who noted the very real risk of the UK plunging into a recession. Indeed he said that he expects "negative growth" for "several further quarters.'' While the risk of a rate cut is an extremely low probability event, this would be the only thing to shake up GBP/USD in a big way. On such a surprise we would expect Sterling to see a sharp leg-down towards the 1.8000 area.
Key Data and Events to Watch Next Week
There are a plethora of top-tier US indicators due up in the week ahead. ISM manufacturing and construction spending kick things off on Tuesday. Factory orders and the Fed's Beige Book are due up on Wednesday. We will provide a detailed report on what to expect from the Beige Book next week. ADP employment, productivity and the usual weekly jobless claims data are due on Thursday while Friday closes out the week with the all-important NFP employment report. There are also a number of Fed speakers on tap next week with Kroszner and Hoenig up on Monday, Rosengren on Wednesday, and Fisher and Yellen scheduled for Thursday.
The Euro-zone also sees a very busy week, which starts on Monday with German retail sales and Euro-zone PMI revisions. Tuesday has Euro-zone PPI on deck while Euro-zone retail sales are up on Wednesday. French employment and German Factory orders are due on Thursday. The highlight on Thursday, however, will be the ECB rate decision (see write-up above for details). German industrial production rounds out the week of data on Friday.
The action in the UK is on the light side but is important nonetheless. Consumer lending data kicks off the week on Monday with consumer confidence following on Tuesday. The all-important BOE rate decision closes out the week on Thursday. The market expects no change to rates, which would mean a non-event here (more details above).
It is extra light in Japan next week with labor earnings data due up on Monday and capital spending on Thursday the only noteworthy reports. Bank of Japan Governor Shirakawa is due to speak on Tuesday as well.
Canada has limited economic events also, with the BOC rate decision the highlight on Wednesday. Friday closes out the week with the top-tier employment report and Ivey PMI index.
It's modestly busy down under but it is all Australia as New Zealand sees no noteworthy data releases. The week kicks off on Sunday with the AIG manufacturing index followed by the current account balance on Monday. Tuesday has building approvals and the all-important RBA rate decision on tap. Data for the week ends with 2Q GDP on Wednesday and the trade balance on Thursday.
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