Highlights
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Fed Chair Bernanke to update on economic outlook on Monday evening |
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G7 unlikely to take action; speculative positioning to rule in advance of meeting |
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US data continues to weigh against another Fed rate cut |
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ECB speakers ratchet up the hawkish rhetoric |
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US housing data (bad) begins in second half of next week |
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Commentary
Brian Dolan, Chief Currency Strategist
The USD finished the week a bit lower in US dollar index terms, but the real play in the currencies was a renewed push higher in the JPY-crosses, the 'carry trade,' as was suggested in last week's outlook. Commodities also pushed higher, but look set to finish below their highs for the week. In gold, I would note two attempts to surmount $750/oz spot, which have failed for the time being. I will continue to watch that level as near-term trigger to larger gains or for signs of a rejection/reversal. However, I am not expecting next week to be a major breakout week, due to the impending G7 meeting.
The next major event that is lurking in the back of the Forex market's collective brain is next weekend's G7 gathering in Washington, DC. Comments from officials to date suggest the G7 communiqué's currency statement may be identical to the previous one, which singled out China's Yuan as being undervalued, but otherwise retained the traditional language that 'currency volatility is undesirable for economic growth' and that 'currency rates should reflect economic fundamentals.' The main reason to expect no substantive action from the G7 is the lack of any US Treasury support for such moves. US Treasury Sec. Paulson has had numerous opportunities to indicate US displeasure with USD weakness, but he has only repeated the strong dollar mantra, with the weak dollar codicil that exchange rates should be set in open markets based on economic fundamentals. As a result, most market participants are expecting no decisive action from the G7.
Normally, this would be taken as green light to continue selling the USD and to take carry-trades (short JPY/long anything else) on to new highs. However, until the G7 communiqué event risk is out of the way, traders are likely to refrain from acting on that view too aggressively. I'm looking for several attempts to push the USD lower, mostly against European and commodity currencies (AUD, CAD, NZD), and re-test this week's highs in JPY-crosses, in anticipation of an unchanged G7 statement. But I also expect those moves to be subject to short-term rejections amid skittish profit-taking and position adjustment as the G7 meeting approaches. There are also typically several leaks from G7 sources suggesting what will/won't be discussed, which also tend to upset short-term speculative moves. If the G7 repeats the currency statement without any changes, the following week should see fresh USD lows and returns to JPY-cross highs made earlier this past summer.
For another look at how the pre-G7 week may play out, look at the run-up to the last G7/8 meeting in Heiligendamm, Germany this past last June 6-8. Using EUR/JPY as the proxy for the JPY-crosses, in the week two weeks before that G7 meeting, EUR/JPY moved modestly higher in anticipation of no G7 condemnation of JPY weakness. In the week leading up to the meeting, EUR/JPY drifted lower by 2 yen, having peaked at the beginning of the week. The shake-out lower was the result of a market that had gotten too long, too soon, in advance of an expected neutral G7 statement. At the start of the following week, a final flush-out to the downside occurred in the first half of the week, followed by a 4+ yen rally over the next 4 trading days. For traders looking to speculate on the outcome of the G7, it may be prudent to wait for the event risk to pass, and for the initial reaction early the following week to play out, which is frequently counter-intuitive, before acting on what the G7 did or did not say.
Interest rate markets continued to price out expectations of a follow-up Fed rate cut as US data continued to come in on the positive side, though this did little to support the USD. Minutes from the Sept. 18 FOMC meeting were generally upbeat on the growth prospects going forward and buoyed stock market sentiment, fueling further JPY-cross gains. Friday's Sept. retail sales numbers were solid at +0.3% MoM ex-autos, gasoline, and building materials, indicating that the US consumer is still buying, despite generally gloomier sentiment readings. Fed Fund futures have now cut the prospect of another Fed easing on Oct 31 to about 30%, down from 85% preceding last Friday Sept. NFP report. However, as the mid-point of the month passes, US data will return to focusing on US housing sector reports, which are expected to show even further deterioration, and that's usually not a USD-positive theme.
Eurozone finance ministers met at the beginning of this past week and were unable to reach any agreement on the strength of the Euro, with most of the EU-13 heavyweights, anchored by Germany, unwilling to declare Euro-strength a problem. The most they could agree on was to focus on China and copy verbatim the language of the last G7 currency statement. Eurozone central bankers also were active in reminding markets that inflation risks remained to the upside and were likely to increase in the future. The uniform hawkishness of their comments suggest an organized effort to dispel dovish perceptions created by M. Trichet's latest ECB press conference, in which downside growth risks appeared to be dominant. The effect was to push Eurozone bond yields higher, narrowing the spread between European and US rates back in favor of the EUR.
Bank of England Gov. King also gave remarks which were more hawkish than expected, temporarily reducing market expectations of an imminent BOE rate cut. However, with UK inflation back within the BOE's target zone and fresh signs of housing market weakness (RICS Sept. house price balance fell 14.6%, the largest decline in two years), I think the economic cards will eventually compel the BOE to lower rates before the end of the year, hawkish rhetoric notwithstanding. Next week's release of the BOE MPC minutes from the Oct. 6 meeting will be pivotal if there were any votes in favor of a cut.
Turning to the US data calendar next week, Monday sees the Oct. NY Fed's Empire manufacturing index. Tuesday will see the Aug. TIC report, Sept. industrial production and capacity utilization, along with the Oct. NAHB housing market index, which is expected to drop to 19, a new all-time low. Wednesday see weekly mortgage application data, Sept. CPI, Sept housing starts and building permits, followed by the Beige Book in the afternoon. Thursday see weekly jobless claims, Sept. LEI, and the Oct. Philadelphia Fed index. Fed Chair Bernanke will deliver remarks on the economic outlook on Monday evening EDT; Treasury Sec. Paulson will speak on housing on Tuesday; and Treasury undersecretary for international affairs McCormick will give a pre-G7 press briefing on Wednesday afternoon EDT. US Treasury Sec. Paulson will hold a post-G-7 press conference on Friday evening at 1900EDT/2300GMT.
Eurozone data on Monday sees French Sept. business sentiment and Italian final Sept. CPI. Tuesday sees German and Eurozone Sept. CPI and the Oct. Eurozone and German ZEW surveys of investor/analyst sentiment, which are expected to decline further from Sept.'s weaker readings. No data of note on Wednesday. Thursday sees August Eurozone trade balance and construction output reports. Friday concludes with Sept. German producer prices.
Japanese data kicks off on Monday afternoon in Tokyo with final Aug. industrial production and capacity utilization. On Wednesday morning Tokyo-time, the Aug. Tertiary industry (service sector) index will be released, followed by the final Aug. LEI and final Sept. machine tool orders. Thursday sees weekly stock/bond flows from the MOF, followed by department store sales in the afternoon. Friday morning sees only the Aug. All-Industry index.
UK data highlights include Oct. Rightmove house price index on Sunday evening; Aug. DCLG house prices on Monday morning; Sept. CPI/RPI on Tuesday morning; BOE minutes, Sept. employment and wages on Wednesday; Sept. retail sales and money supply on Thursday; and advance 3Q GDP on Friday.
The Bank of Canada will hold a rate setting meeting on Monday and is expected to announce a steady 4.50% rate on Tuesday morning.
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