Highlights
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Current consolidation range expected to give way next week |
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Heavy data schedule all around; Monday holidays in US, UK, and Europe |
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USD correction higher versus Europe continues to stall |
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Bank of Canada rate announcement on Tuesday morning |
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Commentary
Brian Dolan, Chief Currency Strategist
I, for one, will be very happy to see the month of May finish up next week. Another week of mostly consolidative trading saw the dollar eke out a minor gain on the week, continuing with recent patterns of new highs against the JPY and minor gains against European currencies. The troubling aspect in terms of the USD's recovery, which I mentioned last week, is how minimal the correction has been in light of interest rate changes and stock market gains. The 10 year US Treasury/Bund yield spread widened back out in favor of the USD by about 8-9 bps during the week, as US yields hit their highest levels since the end of January, but appear to have been soundly rejected from the 4.90% level. US equity gains, as seen in the DJIA, also look to be stalling, with several days over 13,500 unable to provoke fresh gains.
The Memorial Day holiday in the US on Monday coincides with the spring bank holiday in the UK and Whit Monday in much of continental Europe, meaning Monday's market liquidity will be much thinner than normal from the Asian afternoon onward. Holiday markets are prone to higher chances of breakouts, given reduced interest and liquidity, and the current sideways consolidation looks especially tempting to resolve with a sharp breakout. A few well placed trades can unleash a flood of stop loss driven orders or breaks of key technical levels that force reluctant traders to step into the market at a disadvantage. Latecomers, who discount the breakout initially, are then forced to go with the move when it fails to retrace, providing a second wave in the direction of the breakout. Be alert for pronounced moves starting with Tokyo trade on Sunday evening and be prepared to go with breaks of significant technical levels, which I would pinpoint as 1.3370/1.3570 in EUR/USD and 120.50/122.30 in USD/JPY.
My own expectation is for the US dollar to resume its slide against Europe, which I have been suggesting for the last several weeks to no avail, while the JPY continues to be treated like the rented mule of major currencies. The US dollar index is showing signs of stalling in its mild four week correction, with the DMI's DI- line crossing up over the DI+ line, suggesting a dollar short position. Daily momentum studies are also pointing to a stall in the dollar's gains, with shorter term periods, such as 4-hours, showing dollar bearish divergences since the middle of this past week. Additionally, implied volatility levels in the major currency pairs are at extremely low levels (10 to 15 year lows depending which currency pair you look at), which also favors a breakout and a sharp rise in volatility.
From the fundamental side of the equation, US data this week was mostly minor, but the housing market reports indicated that the US real estate slump is going to be with us through the end of 2007 at the minimum, reducing the overall prospect for a return to trend level growth in the US. Next week will provide plenty of data ammunition to trade on, but, if I'm correct in my anticipation of a breakout, the move should occur before the most significant data reports at the end of the week, leaving that data to either confirm or reject the breakout. If we get through Monday without a major shake-up, however, additional range trading seems likely in what could be a very slow summer.
Looking at events scheduled out of the US next week, data begins on Tuesday morning with the 1Q and March Case/Schiller home price index followed by May consumer confidence. Wednesday morning sees the weekly MBA mortgage application data and the ADP employment report, which will set expectations for Friday's MFP report. Wednesday afternoon sees the release of the FOMC minutes of the May 9 meeting, and I'll be looking for what the Fed has to say about the pace of declines in inflation and any revisions to their outlook for the 2H 2007 pick-up in US activity. Should the Fed point to receding inflation pressures or downgrade 2H expectations, the dollar would be ripe for a pummeling. Thursday sees the first revision to 1Q GDP, which is widely expected to be downgraded from 1.3% to 0.8%, along with weekly jobless claims and the Chicago purchasing managers index for May. Friday sees the release of the following: April personal income and spending; April core PCE; May NFP; April pending home sales; May ISM manufacturing and prices paid index; and final May Univ. of Michigan consumer sentiment. The only speaker of note is Fed Gov. Kroszner, who will speak on the US economic outlook from Greece before the NY open on Friday.
Eurozone data starts on Tuesday with March Eurozone current account data and May German CPI, with no exact release time scheduled. Wednesday sees May German IFO business survey and April French unemployment data. Thursday will see April French producer prices, May German unemployment, May Eurozone consumer confidence, business climate indicator and May Eurozone CPI. Friday sees April German retail sales, manufacturing purchasing manger indices from France, Germany and the Eurozone, along with preliminary 1Q Eurozone GDP.
Japanese data is also heavy, beginning with April Corporate service prices, a key inflation report, on Monday morning Tokyo time. Tuesday morning will see Japan's April unemployment report, household spending, and retail trade, followed by May small business confidence in the afternoon. Wednesday morning sees preliminary April industrial production. Thursday morning sees the May manufacturing PMI followed in the afternoon by April labor cash earnings and housing starts.
The Bank of Canada will announce its rate decision on Tuesday morning. The market is expecting no change in the official 4.25% benchmark rate, but a shift to more hawkish rhetoric given recent rises in inflation and economic growth data. Should the hawkish language not materialize, USD/CAD is set for a major corrective rally.
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