One Step Forward, Two Steps Back for USD

01/11/2010 11:30 am EST

Focus: FOREX

Brian Dolan

Chief Currency Strategist,

Or maybe that's two steps forward and one step back. Either way, Friday's US NFP report (more below) should serve as a reminder for those who expect a normal recovery that this rebound is going to be extremely uneven, drawn out, and likely to disappoint as frequently as satisfy. But it's not just uneven US data; it's happening all over. European unemployment just hit 10% and would likely be even higher if not for government programs to prevent layoffs—programs that may be winding down soon. Unemployment in Europe is the highest since 1998, while Swiss joblessness is the highest since 1997. European industrial new orders and retail sales both disappointed last week. Japanese data points to ongoing sluggishness. UK consumer confidence dropped anew in December, while unemployment has edged to nearly 8%. And fiscal and credit concerns remain lurking in the background globally and are liable to rear up unexpectedly. Against this backdrop, it comes down to which economy is doing the least badly, or perhaps showing the best signs of stabilizing. In this light, the US comes out looking a bit more stable recently than Europe, the UK, and Japan. Australia, Canada, and New Zealand continue to stand out as the best performers in the G-10 space.

In terms of currencies, the USD rebound from December has transitioned into an extended consolidation against EUR, GBP, and CHF. The consolidation channel may be a USD bull flag, suggesting greater potential for additional USD gains. In EUR/USD, it's a bear flag, with the base at 1.4250/60 (along with the 200-day MA) and a top at 1.4490/00. We'll be watching closely for a sustained break below 1.4250, which may signal fresh declines below 1.4000 with an initial target near 1.3770/3800; this pattern is negated with strength above 1.4490/4520. US Treasury yields will continue to be an important gauge to watch, and the risk to our view is that yields fall in the wake of the December NFP report and a technical stall occurs around recent highs at 3.85% in the ten-year Treasuries.

Coming Soon: JPY Weakness

Japan's new finance minister, Naoto Kan, has taken office vowing to shake up the venerable Ministry of Finance (MOF), the most powerful bureaucracy in Japan. On his first day in office, though, Kan sent a message to FX markets that a weaker JPY would be welcome. He was subsequently rebuked by his boss, prime minister Hatoyama, but he only slightly moderated his message in later press comments. Our belief is that the MOF does favor a weaker JPY given the disastrous impact on Japanese corporate earnings last fall when Hatoyama first took office and seemed to embrace JPY strength. The hard part is gauging the timing of the JPY weakness, but fortunately, the technicals provide a relatively clear picture of a likely break point. A daily close above 93.50/70 (key daily trend line from 101.40/50 and the 200-day MA) should open up scope for a move to 94.70/95.00 initially. In the meantime, we prefer to buy USD/JPY on weakness, ideally in the 89.50/90.50 area, but 91.50/92.00 may be the best we get from current levels. The JPY has also returned as the primary funding currency for risk on/risk off carry trades, so JPY crosses are likely to continue to reflect moves in stocks and general risk sentiment, rather than the USD. Again, watch Treasury yields for any sign of surrendering the 3.70/3.85 zone, with a move down negative for USD/JPY in particular, and the dollar in general.

US Employment Remains Moribund

The US employment report for December caught both us and the market off guard by printing a sharp -85k decline on the month. Consensus was for a flat read, so the ensuing US dollar weakness was not surprising. The guts of the report are nothing to write home about and do not suggest much in the way of optimism for the US employment picture. While the unemployment rate did remain unchanged at 10.0%, this was only possible because of a decline in the labor force. The all-encompassing unemployment rate (which includes discouraged folks and those working part-time for economic reasons) actually inched up to 17.3% from 17.2% prior. The other data point that stuck out like a sore thumb was the change in household employment, which came in at a dreadful -589K, the worst since September. This metric tends to turn positive in a consistent fashion around turning points, so the sharp drop is cause for concern.

The "blame it on the weather" crowd was out in full force, casting doubt on the sharp headline decline. While they are correct that the subtraction to jobs from folks who were unemployed due to weather was about 100K larger than usual, one must also keep in mind other statistical massaging the BLS has done throughout 2009. One of the areas of interest is the birth/death additions that have assumed business growth in the face of collapsing commercial real estate and deplorable capital expenditure data. Splitting hairs aside, the December report does not offer up much confidence in terms of any significant rebound in the US jobs market. What is more likely is a similar path as was taken in the post-2000 recession when the words "jobless recovery" entered the lexicon. This time, however, the path back to so-called full employment is likely to be even more drawn out. Indeed, conservative estimates suggest that we will not see the December 2007 employment levels until well into 2015. That is not to say that the economy won't grow during this time, but grow and grow marginally are two very different things.

NEXT: Euro Zone Jitters, Key Data and Events This Week


No Surprises from the ECB

The ECB's regular policy meeting is not expected to bring any surprises. President Trichet can be expected to acknowledge signs of improvement in the euro zone and to global economic outlooks, but his tone will remain cautious. December had brought the last of the ECB's emergency 12-month operations. The take up was a relatively modest EUR96.9 billion. Relatively subdued demand may reflect the less-attractive conditions offered by the ECB, or perhaps the lack of demand for funds from business and consumers, but the ECB is likely to suggest that the moderation in demand reflects a reduced reliance on the central bank for funding. Euro zone inflation has finally returned to positive territory. While this can be attributed mostly to temporary energy effects, it will help chase away fears of disinflation. Trichet can be expected to reiterate that inflation expectations remain firmly anchored. With underlying inflation pressures still very subdued, there will be little need for the ECB to raise rates from their current 1% level for many months yet and most likely after both the Fed and the BoE have acted.

EUR Still Jittery on Greek Budget Issue

EU and ECB officials have spent three days in Greece pressuring the Greek government to step up the pace of austerity. The Greek government earlier this week announced that it will reduce its budget deficit to 3% of GDP (from 12.7% at present) by 2012. The market remains skeptical about the ability of the Greek government to pull such a rabbit out of the hat, but insofar as the market is also of the view that euro zone officials will do all they can to maintain confidence in the EUR, no real threat to coherence of EMU is yet seen. Thus, while the EUR remains vulnerable to bad news on Greece's budget as it is on the possibility of more negative news from Ireland, Spain, Portugal, and the Baltics, the jitters are unlikely to translate into a wholesale selloff in the immediate future. The EUR/USD 1.4250 to 1.4500 range remains in place. We continue to favor USD strength. A break below the 200-day simple moving average at USD1.4250 could trigger a move lower.

Key Data and Events to Watch This Week

The economic calendar in the United States is on the busy side. Tuesday kicks things off with the trade balance, while Wednesday brings the monthly budget statement, the Fed’s Beige Book, and the usual weekly oil inventories. The highlight for the week comes on Thursday with the release of retail sales. This day will also see initial jobless claims, import prices, and business inventories. Friday closes out the week in busy fashion with consumer prices, NY Empire manufacturing, industrial production, and the University of Michigan consumer sentiment index. Watch for a ton of Fed speakers this week as well.

It is an important week in the euro zone as well. French industrial production starts things off on Monday, and this will be followed by French business sentiment on Tuesday. More French data on Wednesday with the consumer price numbers. Thursday is the big day with the ECB rate meeting on deck. That day will also bring industrial production and German consumer prices. Euro zone trade and consumer prices round the week on Friday.

It is not terribly busy in the UK. The RICS home price balance, BRC retail sales monitor, and trade are up on Tuesday. Wednesday brings the balance of the noteworthy data with industrial production and the NIESR GDP estimate due.

Japan has a pretty light week ahead as well. The current account and trade balance start the action off on Monday. The Economy Watchers surveys (current and outlook) are due Tuesday, while Wednesday has machine tool orders on tap.

Canada has some important data lined up. Housing starts/permits and the Bank of Canada Senior Loan Officer Survey are due on Monday. Tuesday brings international trade and home prices, while Friday closes things out with new motor vehicle sales.

The calendar down under is characteristically light. Australia has home loan data on Tuesday and the all-important employment report on Thursday. New Zealand sees the NZIER business optimism survey on Monday, building permits on Wednesday, and credit card spending on Thursday.

Be on the lookout for some Chinese data that could impact markets as well. The trade surplus is scheduled to be released Saturday, while Thursday has foreign exchange reserves on tap.

By Brian Dolan, chief currency strategist,

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