Preparing for Better Days?

12/08/2008 11:23 am EST

Focus: FOREX

Brian Dolan

Chief Currency Strategist,

A funny thing happened on the way to the recession. A steady stream of ever-weakening data in the US and abroad failed to see stock markets make new lows. That was so last week! Indeed, many are viewing the S&P low at 750 at the end of November as a pivotal low, and are watching closely as a potential inverted head and shoulders pattern plays out. (An inverted head and shoulders pattern is a bottoming formation after a decline.) Friday's dismal NFP reading was the latest dose of bad-tasting medicine the markets had to swallow, but swallow it they did. Clearly, there is little in the fundamental outlook to inspire confidence, much less a rebound in shares, but the market dynamic may be working its own sort of magic at the moment. Now that it's official that the US has been in a recession for the past year, the feeling is that most of the bad news has already been priced in, which would be largely consistent with this week's market performance—bad, but not as bad as it could have been. Looking ahead, the stage may be getting set for a more sustainable recovery in stocks and investor sentiment as we head into the last weeks of the year.

If you hold the view that the US outlook will begin to improve mid-way in 2009, then the next few weeks represent an opportunity to position for just such a rebound. Stocks are commonly viewed to represent the market's outlook 6-9 months in advance, which points to now as the time to be positioning. There are some concrete reasons unfolding to be more optimistic: government initiatives to lower mortgage lending rates; US automaker rescue package looks to be more viable in light of job losses; government purchases of consumer debt; and a likely massive (talk is centering on $700 billion to $1 trillion, roughly 5-8% of US GDP) fiscal stimulus package from the new administration. I may be utterly premature in this outlook, but the second half of December may see investors move off the sidelines and begin to position for the new year.

Improvement in the Market Will Signal USD Peak

For currencies, the relationship with stocks suggests that an improvement in market performance will signal a peak for the USD and a likely bottom for carry trades (JPY crosses like GBP/JPY and EUR/JPY). Aggressive interest rate cuts from major central banks support the view that economic sentiment may be at its nadir and seems more likely to improve. Economic data reports will not show any improvement likely for months to come, but it is sentiment and confidence that are driving markets at the moment, and the declines in sentiment, as reflected in stock market price action, appear to be receding. A reversal higher in USD/JPY above 94/95 would be the most obvious indication that the tide is turning. Strength in EUR/USD over 1.2850/1.2900 would be another. Next week will likely deliver further reminders of weak sentiment, but we will be carefully watching how markets weather the negativity. Another week of relative resilience in the face of deepening gloom may signify better days into the end of the year.

Key Data and Events to Watch This Week

The US data calendar is relatively busy this week, and kicks off with pending home sales on Tuesday. Wednesday sees wholesale inventories and the monthly budget statement. Thursday has the trade balance and usual initial jobless claims on tap. Friday rounds out the week with top-tier data in the form of producer prices, retail sales, and the University of Michigan consumer sentiment index.

The euro zone calendar sees some important data as well, and starts off the week with German industrial production on Monday. Tuesday sees both German and French trade numbers along with the German and euro zone ZEW economic sentiment surveys. French industrial production is the highlight on Wednesday, while Thursday has French employment lined up. Euro zone industrial production and labor costs round out the week on Friday.

Japan has a characteristically light week ahead, and trade numbers get the ball rolling on Sunday. Monday sees GDP along with the Eco Watchers economic sentiment surveys. The leading index is on tap Tuesday, while industrial production is scheduled for Thursday. Friday closes things out with consumer confidence.

The action in the UK is limited as well. Producer prices are due up on Monday, while Tuesday sees the trade numbers and industrial production. Look for the UK National Institute of Economic & Social Research GDP estimate on Tuesday also.

Canada's week is light, but important at the same time. Housing starts kick things off on Monday. Tuesday sees the critical Bank of Canada rate decision, where the bank is expected to cut rates by -50 bps. The recent deterioration in the Canadian economy coupled with the plunge in oil prices suggests the bank could decide to do more here. Labor productivity is scheduled for Wednesday, while trade and new home prices are due on Thursday. Friday closes out the week with new motor vehicle sales.

Last but not least, it is a little busier than usual down under. Australian business confidence starts it off on Monday. Tuesday sees Australian consumer confidence, while Wednesday has Australian employment and New Zealand business PMI on deck. Thursday rounds out the week with New Zealand retail sales.

By Brian Dolan of

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