Highlights
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Markets are reducing expectations of an Oct. Fed rate cut |
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USD gloom remains post-NFP; carry trades/risky plays prevail |
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Eurozone Finance Ministers to decry EUR strength to little avail |
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BOJ will stay on hold for another meeting |
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US Sept. advance retail sales are the next big clue |
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Commentary
Brian Dolan, Chief Currency Strategist
The USD finally found some support this week and managed to eke out small gains against EUR, GBP and JPY, but it remained weak against the commodity currencies AUD, CAD and NZD. JPY-crosses, the 'carry trade', along with other risky assets such as commodities and stocks, also posted solid gains for the week. In general terms, these developments suggest risk-aversion continues to wane and that should keep the upside open for further gains in JPY-crosses and commodity currencies versus the USD. The price action following the US NFP report was also revealing in that the USD was unable to sustain any of its gains from the data and looks set to finish the day weaker against EUR and GBP in particular. The daily candlestick pattern (a Hammer) from Friday suggests that the downward correction in the EUR/USD has already run its course, opening up the prospect for renewed attempts higher.
While it's always dangerous to attach too much significance to a NFP Friday's price action, the surge of EUR/USD buying interest from just above the pivotal 1.4000 level suggests that Euro buyers remain in control overall. However, the fundamental picture has largely shifted in the opposite direction in favor of the USD. The spread between 10 year US bond/German Bund yields moved further in the USD's favor, up 7 bps on Friday alone, after bottoming at the end of September. Expectations for a follow-up 25 bp rate cut from the Fed at the end of the October were cut back to where it's now more of a 50-50 proposition, down from a 75% probability just as of Thursday, and nearly 85% a week ago, according to Fed Fund futures. In short, the USD remains under pressure despite improving fundamentals and interest rate expectations. Such an environment represents challenging trading conditions for fundamental traders and the best way to approach the market it key off price levels. For EUR/USD the key price level is 1.4000, which represents both a psychological touchstone of USD weakness/EUR strength as well as the 38.2% Fibonacci retracement level of the move up from 1.3548 to 1.4283, which comes in at 1.4002. Until EUR/USD closes below 1.4000 on a daily basis, the pair remains a buy on dips.
USD/JPY is on a different course, having broken above important consolidation resistance at 116.00, which propelled the price into the Ichimoku cloud above. As of Friday, USD/JPY is mid-way through the cloud and the cloud's top is at 117.80/90. Should USD/JPY break above the upper level cloud resistance, a definitive shift higher in USD/JPY is unfolding, opening up potential to trade back into the 120's in coming weeks. USD/JPY's outlook is far more dependent on risk aversion remaining low, and that roughly translates into steady to rising stock markets. Further gains in USD/JPY also have the effect of limiting the USD index's slide, and essentially allow it to stabilize above recent lows.
The expected movements I've outlined above mostly run counter to the official G7 line on currencies, which seeks a stronger JPY and Chinese Yuan. Euro strength has also become an irritant to a number of Euro-13 nations, with French officials leading the charge against further Euro strength. Those protests, however, look unlikely to result in any official action as long as the US Treasury view remains that currency values are best set in open markets. Eurozone finance ministers will meet beginning on Monday next week and traders should expect a fair amount of jawboning critical of Euro strength, and I would look to use any subsequent EUR dips as buying opportunities, so long as the 1.4000 level holds.
For regular readers, I'm not abandoning my overall outlook that the USD is oversold in general, and against European currencies in particular, and should see a correction in the months ahead. But I am acknowledging that market sentiment remains very USD-negative/JPY-cross positive, and that an eventual USD recovery will take longer to materialize. In the meantime, the USD's downside remains vulnerable against all but the JPY.
Friday's Sept. NFP report was solid in all respects, despite some analysts discounting the revision as largely stemming from government employment gyrations due to teachers being re-hired. First to note, July's NFP number, which was earlier revised lower at last month's report, was revised again to the upside, reducing the perception labor markets had slowed precipitously in early summer. The strong revision to August's NFP result was dismissed by some as a return-to-school anomaly, but I would note that service sector firms added +153K jobs in August, which is nothing to sniff at. The September NFP report posted a solid headline reading and service sector businesses added +143K jobs in Sept. Also, average hourly earnings rose by a more than expected 0.4%, bringing the YoY increase to 4.1%, suggesting wages increases are healthy enough to allow US consumers to hang in there. All in all, the data should eliminate fears of a collapse in US job creation and subsequent decline into recession, but that too looks like it will take more time.
Turning to next week's data out of the US, please note that Monday is a US bank holiday and the stock market will be closed, but currency desks will still be trading. On Tuesday morning, Oct. IBD/TIPP economic optimism is expected to rise slightly from 48.2 to 49.0. On Tuesday afternoon, the FOMC minutes of the Sept. 18 meeting will be released and the market will get some fresh clues as to what happened in the debate. However, I would note that the overarching view from recent Fed speeches has been that additional rate cuts are far from certain, with Fed Gov. Kohn on Friday even suggesting that part of the 50 bp rate cut could later be retracted if it turned out to be too much. Wednesday has only weekly MBA mortgage applications and August wholesale inventories. Thursday will see the Aug. US trade deficit, forecast to hold steady at around -$59 bio, and the September import price index, which may provide some clues to how the weaker USD is affecting price pressures. Thursday also sees weekly jobless claims and the ICSC chain store sales report, a measure of consumer spending. Friday is data heavy, with Sept. PPI, advance retail sales, preliminary Oct. Univ. of Michigan consumer sentiment and August business inventories. Fed speakers to note are Poole on Tuesday speaking on the global economy, Yellen on Tuesday on the national outlook, and Pianalto on the mid-west regional outlook. On Wednesday, the Boston Fed's Rosengren speaks on developments in financial and real estate markets.
Eurozone data begins on Monday with German August factory orders. Tuesday sees German and French August trade balance data, along with German Aug. industrial production. French and Italian August industrial and manufacturing production reports are out on Wednesday. Thursday sees final 2Q Eurozone GDP estimates. Friday sees French Sept. CPI and Aug. Eurozone industrial production.
Japanese data starts on Tuesday afternoon with the Sept. Economy Watchers survey. The BOJ MPC starts a two day meeting on Wednesday and is expected to announce steady interest rates on Thursday afternoon. Thursday sees Aug. machine orders, Sept. money supply, and Aug. current account data. Friday sees Sept. domestic corporate goods price index, followed by September consumer confidence in the afternoon.
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