The Fed’s future path still seems more bullish than the European Central Bank. If so, the yiel...
The USD Surge Continues—The Outlook From Here
09/15/2008 12:00 am EST
The greenback continued to climb this past week and the USD index broke above the symbolic 80.00 level briefly, but by the end of the week those gains could not be sustained. In EUR/USD, the 1.4000 psychological level was broken, and EUR/USD fell to key weekly trend line support at 1.3870/80, which was highlighted in last week's report. But that level held and provoked a bounce back onto the 1.41 handle, generating increasing signs of a consolidation. For the first time in the entire EUR/USD decline, daily candlesticks posted a reversal signal (a hammer on Thursday) that was later confirmed by Friday's price action. This pattern suggests that some consolidation may be on the horizon.
Significant supports in other pairs have also held on a weekly closing basis: AUD/USD at 0.8000 and GBP/USD at 1.7500. Weekly candlesticks in EUR/USD, GBP/USD, and AUD/USD are all showing 'spinning tops', which is an indication of indecision in the current trend, adding to the prospect of consolidation. At the same time, the overall pattern of USD dips being bought aggressively was also reinforced, with attempts to rally in EUR/USD and GBP/USD on Tuesday being sharply rejected.
On the fundamental side, the primary trends remain intact, namely that growth outside the US is faltering while the US outlook remains broadly stable, though weak. Commodity markets also remain under pressure and have shrugged off events (hurricanes, OPEC production cut, Venezuelan/Russian blustering) that normally would have triggered price gains, suggesting the path of least resistance remains down. Oil looks poised to fall below the pivotal $100/bbl level and will likely do so once Hurricane Ike has passed and Gulf production resumes.
The technicals tell us to anticipate some consolidation/correction lower for the USD (higher for EUR/USD), but the fundamentals suggest continuing to buy the USD on dips/sell EUR, GBP, and AUD on strength.
In EUR/USD, the 1.4250/4300 area looks attractive as a sell-zone, while a drop back below 1.4000/50 likely signals a renewed downside push. In GBP/USD, the 1.7850/7950 area stands out as the sell-on-rally area, and weakness below 1.7600 should signal a return to weakness. In AUD/USD, the 0.8250/8300 area offers an opportunity to get short, while a daily close below 0.8000 suggests another leg to the downside.
Fresh Signs of Slowing Global Growth
This past week provided us with further evidence that global growth is slowing dramatically, as if more were needed. The European Commission (EC), the executive branch of the European Union (EU), slashed its 2008 growth forecast for the whole EU-25 to 1.4%, down from the 1.8% it forecast in April, and for the Euro zone to 1.3%, down from 1.7% previously. The EC did not revise its 2009 forecast, but EC officials warned of a likely 'significant' downward revision when the 2009 outlook is released in November. Private economists are predicting sub-1% 2009 growth in Europe. The EC also forecast that Europe's largest economy, Germany, is likely to experience a recession with 3Q growth to fall -0.2% following the -0.5% contraction in 2Q. The EC also foresaw a 'marked deceleration' in Asian economies, weakening the crutch the Western economies have come to rely on to take up slack left by domestic weakness.
Down under, the RBNZ also noted that NZ was clearly in recession in the first half of the year, and forecast negative growth in the 3Q as well. Strangely, the RBNZ predicted a recovery beginning in the 4Q, but provided no basis for those expectations. This is similar to the ECB's apparent view that growth is bottoming in the current quarter and will likely improve into 2009-optimism with no evidence.
Lastly, in the UK, the August NIESR GDP estimate was -0.2% QoQ, down from the July reading of -0.1%, suggesting the UK is also heading into a recession.
The downward revisions to growth outlooks are just the latest pieces of evidence that the global economy is approaching the brink of recession. (Global growth below 3% is generally equated with a global recession, a very different definition of recession than the two consecutive quarters of negative growth applied to individual national economies.) We continue to look for additional signs of slowing, especially in Asia, that are likely to see forecasts for 2009 downgraded further. Throughout the current downturn, many economists have argued that emerging market growth, typically referring to the BRIC economies (Brazil, Russia, India and China) but also to the rest of emerging Asia, would prevent the G7 economies from falling into recession. However, it's beginning to look like instead that a G7 recession is more likely to pull emerging economy growth down, aggravating the global downturn.
For currencies, further global slowing will continue to see the USD supported and non-USD currencies stay under pressure as markets keep selling them on the expectation of lower interest rates outside the US. Slower global growth also translates into weaker commodity demand, and that keeps the outlook for oil and gold to the downside, which is another source of USD support. The major risk to this outlook is that US growth falters anew. But as we've argued in recent weeks, we think the US consumer has retrenched in a healthy fashion, saving stimulus checks and cutting back on discretionary spending. Lower oil and gasoline pump prices aid US consumers further, and the housing downturn may have reached a critical turning point with the US government takeover of Fannie/Freddie, which we discuss in the next section.
What Does The Fannie/Freddie Takeover Mean For The Dollar?
The Freddie and Fannie government bailout is likely to have a limited impact on the US dollar going forward, in our view. While many disagree with the move on a philosophical level, the evidence suggests that the bailout will likely stabilize US housing some more (USD positive) while the impact to the US budget (USD negative), is likely to be negligible.
In terms of housing, this move will help stem the flood of foreclosures hitting the market daily. By effectively lowering mortgage rates, this will allow many of the folks facing resets to stay in their homes via refinancing towards a more stable monthly payment. There has also been chatter that many US Senators are now urging Freddie and Fannie to freeze foreclosures altogether. This stem in foreclosure activity should help in setting a higher floor for home prices. While doubtless that declines in home prices are likely to continue, the decrease in supply to the market from fewer foreclosures will help limit the downside here. This will have a positive impact on mortgage-backed paper as well, and help limit the write-downs faced by financial institutions.
The implications for the US budget deficit seem daunting, but the probability that we will see a massive increase is quite low, in our view. Taking the current default rate of about 1% on Freddie and Fannie mortgages, the impact to the budget would be roughly -$50 billion. This would take the deficit to about -3.2% of US gross domestic product from a current market estimate of -3.0% in 2008. If default rate rises to a more elevated 3%, the impact to the budget would be roughly -$160 billion. This would take the deficit to about -4.0% of GDP, near where it was back in early 2004. But while not an unprecedented level, the USD would likely come under some pressure in this case.
Overall, the positives outweigh the negatives in terms of the impact to the buck from this measure. The better outlook for housing, and subsequent quicker bottom in this market, helps the US economic outlook while overseas economies continue to trend lower. Meanwhile, the financial sector should find at least some relief from this, which will help speed up the recovery in the credit markets. The impact to the budget is likely to be negligible-barring a worst case scenario event-and will in turn, have little implications for the greenback. Thus net-net, while there is likely to be bumps on the way, we remain of the view that the dollar will continue to push higher.
Key Data and Events to Watch Next Week
The calendar in the US in bustling next week and the highlight is the FOMC rate decision and press statement on Tuesday. The market is looking for no change to the 2.0% policy rate, and as such, the statement will be closely watched for signs of future rate direction.
The NY Empire manufacturing index and industrial production kick off the week for data on Monday. Tuesday sees consumer prices, foreign transactions in US securities, and the homebuilder sentiment index. Wednesday has the current account and housing starts/permits due up. Thursday rounds out the week of data with initial jobless claims, the Philly Fed manufacturing index, and the index of leading economic indicators.
It is only modestly busy in the Euro-zone next week and the action kicks off with Euro-zone labor costs and the French current account on Monday. Tuesday brings Euro-zone consumer prices and the ZEW surveys. The Euro-zone trade balance is due up on Wednesday, and Friday rounds out the week with German producer prices. Also of note, the EU foreign ministers will hold a meeting on Monday and ECB President Trichet speaks that same day.
The UK has a modestly busy upcoming week as well. Consumer and retail price indices kick off the week on Tuesday. On Wednesday look for jobless claims, average earnings and the CBI industrial trends report. Thursday ends the week of data with the all important retail sales report. Additionally, look for the Bank of England meeting minutes on Wednesday, and a speech from the BOE's Dale on Thursday.
Japan has a typical light week ahead. Consumer confidence indicators start the week off on Tuesday. Wednesday has the tertiary industry index and the BOJ rate decision on tap. We expect the rate decision to elicit little market reaction. Department store sales and machine tool orders round out the week on Thursday, with BOJ Governor Shirakawa also set to speak that day.
Canada has a modest week lined up as well. New vehicle sales start things off on Monday, while manufacturing shipments are slated for Tuesday. Wednesday sees international security transactions. Thursday closes out the data week with leading indicators and wholesale sales. Bank of Canada Deputy Governor Murray is on tap for Friday.
It is a light week down under. New Zealand's performance of services index is up on Monday. Tuesday has the RBA meeting minutes, while Wednesday brings the Westpac leading economic index. New Zealand's current account is due Thursday, and Friday has New Zealand credit card spending data. Last but not least, RBA Governor Stevens speaks in Sydney on Wednesday.
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