By David Rodriguez, Quantitative Strategist ; John Kicklighter, Currency Strategist ; Ilya Spivak, Currency Strategist ; David Song, Currency Analyst ; Michael Wright, Currency Analyst and John Rivera, Currency Analyst
US Dollar Recovery in 2011 at a Tipping Point – DJIA Trend Critical
The US Dollar fell sharply against the Euro on a sudden improvement in Euro Zone sovereign debt markets, but a sharp late-week reversal suggests USD bulls have not yet given up the fight. We have long argued that the month of January is often pivotal in setting the stage for medium term trends, and the fact that the Euro/US Dollar pair was unable to close above its earlier highs bodes well for the Greenback. A relatively empty week of economic event risks leaves volatility expectations considerably lower through the short-term. Yet traders should watch whether the US Dollar is able to hold its lows against the Euro and set the stage for continued reversal through the coming months.
Little foreseeable event risk leaves the Greenback at the whims of broader market flows and developments in ongoing Euro Zone fiscal crises. Possible exceptions include mid-week Housing Starts and Existing Home Sales reports, but it would likely take a substantial surprise in either direction to force important moves in the US currency. One potential market-mover may come from a non-traditional source: the Chinese government will release initial estimates of Q4, 2010 GDP growth on Wednesday night/Thursday morning.
The Asian titan has defied a broader global economic slowdown and continued to grow at impressive double-digit rates, but markets will likely need to see similarly robust expansion into the final quarter of the year. Any significant disappointments could especially affect the Australian Dollar and New Zealand Dollars—forcing them lower against their US namesake.
The month of January is often critical in determining trends for the following 11 months of the year, and the fact that the Euro/US Dollar is essentially unchanged through the first two weeks leaves medium term trends in the balance. The determining factor may come down to whether the US S&P 500 and broader risk sentiment can continue to improve into the New Year. We have made little secret of the fact that we believe the Dow Jones Industrial Average and broader 'risk' may see a substantial correction following robust gains. Yet any attempts at betting on such weakness have done quite poorly through continued rallies. It will be critical to watch the trajectory of 'risk' and its effects on the US Dollar through the final weeks of January. – DR
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Euro Recovery on Rate Expectations and EU Promises Likely Limited
Fundamental Forecast for Euro: Neutral
- EU floats proposals that would dramatically increase the crisis fight
- The ECB turns up the heat on interest rate expectations
- A sharp reversal in EURUSD still holds to a range – improving traders positioning
The euro surged this past week – fully recovering the substantial losses of the opening week of the year. It is difficult to separate the impact that the unusual liquidity conditions had in this scenario from the true fundamental developments. However, the events that have transpired so far this year certainly warrant the level of activity we have seen. When traders first returned to the market, they picked up on the same concerns about a deteriorating financial backdrop for the Euro Zone that they had left off with in 2010. Perhaps noticing the gravity of the situation and the futility of policy officials voicing optimism in the public forum; the heads of state finally stepped up to the problem with an open-ended discussion of drastically expanding the EU's efforts to quell a crisis in the region. And, taking it a step further for the euro, the ECB finally seemed to turn the corner on its neutral policy stance to finally start talking interest rate hikes. The week ahead will be critical as it will tell us just how much influence each of these developments can carry through speculation alone.
It would certainly be remarkable if the EU passed a range of policy steps to expand its stimulus efforts and the ECB started to lift the benchmark lending rate in quarter point steps. In fact, if that were to happen; the euro would surge. And, really, even a strong belief that either or both of these events could occur in the near term would drive the shared currency to new highs. However, are these bullish objectives actually credible? First we start with the more complicated proposals supposedly being debated by European officials. Among the points being discussed are an expansion of the EFSF bailout program, lower rates to access the emergency funds, additional guarantees, the ability to intervene in the bond market, a direct line of credit to Portugal, the purchase of Greek bonds and other enticing endeavors. Again, if all of these were passed; it would be a significant relief from the perceived threat to the region. Yet, why should we believe these are realistic measures that will be taken when there has debate over much smaller points. What's more, does this solve the problem of recessions in some EU member economies and the cost incurred by others? No. The market will be quick to recall this fact should the summit this coming week doesn't produce any tangibles. An estimate of a real results not coming until March sets a realistic time frame.
As for the probability of an ECB rate hike, President Trichet said quite clearly that interest rates were "appropriate" at the outset of his discussion. And, though he noted the risk that near-term inflation could climb; he didn't explicit voice concern about medium-term inflation. Independence is important to the major central banks; and they will express this freedom by suggesting they are willing to fight inflation even when there is a fiscal and economic struggle at hand. However, raising rates in the EU would severely burden member economies that are already truly struggling. Knowing this, policy officials are very unlikely to act on price pressures that are largely centered on food and fuel costs. So while further jawboning inflation may keep the euro buoyant; reality will soon set in.
The two major themes mentioned above will almost certainly define the euro's path going forward; but it is the market's assessment of their development that ultimately matters. For that, we should keep a close eye on underlying risk appetite. If investor optimism rises, they will be more prone to believing the bullish chatter; and pessimism will lead traders right back to the underlying problems. As for the economic docket, the focus actually lies on sentiment. Consumer and business optimism will paint the economic picture; but it is the ZEW investor survey that is really interesting. This is polling those that are actually buying European debt. - JK
British Pound May Consolidate On Mixed Batch Of U.K. Data
Fundamental Forecast for British Pound: Neutral
* U.K. Retail Sales Expands At Slower Pace
* U.K Trade Deficit Unexpectedly Widens on Oil Imports
* BoE Holds Rate at 1.00%, Asset Purchase Target at GBP 200B
The British Pound rallied to a fresh monthly high of 1.5888 on Friday, and the exchange rate may continue to push higher over the near-term as investors speculate the Bank of England to start normalizing monetary policy later this year. The economic docket for the following week is expected to show inflation expanding at the fastest pace since May, with market participants forecasting consumer prices to rise at an annualized pace of 3.4% in December, and the stickiness in price growth is likely to spark a bullish reaction in the sterling as the central bank drops its dovish outlook for future policy.
At the same time, retail spending in the U.K. is projected to weaken 0.3% during the same period, while jobless claims are expected to hold flat after slipping 1.2K in November, and the mixed batch of data could lead the GBP/USD to consolidate over the following week as investors eagerly wait for the BoE policy meeting minutes due out on January 26. As price pressures intensify, we are likely to see the MPC turn increasingly hawkish over the coming months, and the central bank may see scope to lift the benchmark interest rate off the record-low as it aims to balance the risk for the region. According to Credit Suisse overnight index swaps, investors expect the BoE to hike borrowing costs by at least 50bp this year, and the rise in interest rate expectations may gather pace over the coming months as the central bank struggles to contain the acceleration in price growth. However, we expect to see another three-way split within the committee as board member Adam Posen anticipates the ongoing weakness in the economy to bear down on price growth, and there could be a growing tear within the MPC as the fundamental outlook remains clouded with uncertainties.
As the recent rally in the GBP/USD tapers off ahead of the December high (1.5910), we may see a corrective retracement unfold next week, and the exchange rate may trend sideways over the coming days as the relative strength index holds below 70. However, another break to the upside should lead the pound-dollar to retrace the decline from back in November, and the British Pound may outperform against its major counterparts next week as interest rate expectations increase. - DS
Japanese Yen Vulnerable with Strong Corporate Earnings Expected
Fundamental Forecast for the Japanese Yen: Bearish
* Domestic corporate goods price index in December rose to 1.2% from 0.9%
* Current account surplus narrowed to 926.2B in November from 1436.2B
* Japanese Finance Minister Yoshihiko Noda threw support behind European Bonds
The Japanese yen was flat on the week against the dollar but saw sharp declines against the Euro and Pound. The single currency gained over 3% against the Asian currency impart due to actions from Finance minister Yoshihiko Noda. The Japanese official stated that it was appropriate to buy bonds from Ireland which followed a similar vote of confidence from China. The apparent global support for the region's debt helped ease concerns over the debt crisis and helped deliver successful auctions from Portugal, Spain and Italy. Rising interest rate expectations in the U.K. and Euro-zone also weighed on the Yen against its European counterparts. However, declining yield expectations in the U.S. kept the greenback from gaining ground as last week's disappointing labor report was followed by misses in retail sales and consumer confidence.
Improving domestic fundamentals failed to generate volatility but dimmed the prospect of more BoJ intervention which opens the door for Yen strength. A rise in whole sales prices to 1.2% should ease deflation concerns for policy makers which are expected to lift growth forecasts at their upcoming meeting. A rise in import cost for raw materials and energy are helping offset Yen strength which led to Japan's current account surplus shrank for the first time in three months in November. The news isn't all good as exporters continue to see demand wane on the back of persistent Yen support. An improvement in the Eco watcher's survey for the second consecutive month reflects an improving domestic economy as the current conditions gauge rose to 45.1 from 43.6 in November.
The improving economy is expected to have brightened the outlook in Japanese households with the consumer confidence metric forecasted to rise to 41.6 from 40.4. Industrial production, machine tool orders and nationwide Dept store sales will also cross the wires but traders shouldn't expect significant volatility from the domestic economic docket. U.S. yields continue to have a major influence on the USD/JPY which puts the focus on earnings season. Next week we will see a number of blue chip names report which could impact risk appetite and demand for bonds. If companies continue to show the ability to improve their bottom line then we could see broad based yen weakness. However, mixed results will leave price action to the prevailing broader themes of European debt and U.S. growth which should lose some focus next week but have the potential to generate support for the funding currency if confidence in either deteriorates.-JR
Gold Prices to Fall as ETF Holdings Hit Four-Month Low
Unlike most benchmark assets, gold had largely decoupled from the risk-on / risk-off dichotomy that ruled financial markets in the aftermath of the 2008 meltdown, with the metal managing to remain broadly well-supported throughout. This resilience reflected the prevalence of "extreme" bullish or bearish views on the pace of the global recovery, both of which saw gold as an attractive store of value within their respective outlooks. Both camps increasingly appear to have been off the mark however, hinting the breakneck gold rally may be on the cusp of a major reversal.
For the bulls, the central fear was and is inflation. In their scenario, global growth will snap back faster than central banks are able to mop up the flood of liquidity created through record-low interest rates and quantitative easing. This will see prices soar on a global scale, debauching paper currencies and making a hard asset store of value like gold a very attractive alternative. Meanwhile, the bears didn't believe that mounds of fiscal stimulus would create much more than a temporary reprieve akin to putting a band-aid on a broken arm, forecasting the recovery would fail as soon governments withdrew their support. This would see the spectrum of risky assets "artificially" buoyed by said stimulus collapse anew, making gold attractive for its tangible store of value properties once more.
As we have discussed previously, this has meant that the most reliable long-term driver of the metal's prices over recent years has been the trend in gold ETF holdings. This suffered a major set-back last week, with the Bloomberg gauge of total known holdings snapping the rising trend carved out through the fourth quarter of last year to drop to the lowest since mid-September. The reversal in investment demand seems reasonable. US economic data – the bellwether for the global recovery at large – has materially improved over recent weeks, hinting a back-slide into recession is decidedly unlikely. However, all signs point to a rebound that is slow and uneven, with headwinds in the looming slowdown in China and the lingering debt crisis in the Euro Zone likely to assure the road to broad-based pre-crisis prosperity will amount to a long, hard slog over the years ahead. On balance, this means the "extreme" scenarios at the bullish and bearish ends of the spectrum appear unlikely, opening the door for gold to begin a long-overdue correction lower.
Canadian Dollar Looks to BoC Interest Rate Decision For Direction
Fundamental Forecast for Canadian Dollar: Neutral
- Canadian Dollar Calls for Strength Against U.S. Dollar - Canadian Dollar Shows Little Reaction to Trade Figures
The Canadian dollar pushed higher against its U.S. namesake last week, climbing some 0.41 percent. Indeed, the advance in the loonie marks the four successive week that the currency rallied against the greenback; however, the gain in the Canadian dollar may be short-lived as focus shifts to the Bank of Canada interest rate decision. Furthermore, crude oil's failure to break above 92.60 after testing the level for a third time this past week is hinting at a slight correction.
During this past week, the dismal economic releases in Canada failed to ease strength in loonie against the buck as risk appetite weighed on the greenback. Taking a look at the recent developments, Canadian building permits disappointed in November as figures dropped 11.2 percent amid economics' estimates of a 1.5 percent increase, while housing starts fell to 171.5K in December from a revised 198.2K the month prior. With regards to the former, because of the high outlays needed for construction projects, the reading suggests lower consumer and corporate optimism. Not to overlook, traders also shrugged off Canada's trade deficit which narrowed in November amid a decline in energy imports. Though markets dismissed the data, the release is worrisome due to the fact that Canada relies on exports and the report showed the largest decline in purchases from overseas since March 2009. These developments combined with consumer prices which recently slowed to 2.0 percent in November will lead the Bank of Canada to refrain from raising its key overnight lending rate.
As of late, traders are pricing in a four percent chance that the BoC will hike rates twenty five basis points at its rate decision meeting on January 18th. At last month's meeting, the central bank kept its overnight lending rate unchanged amid uncertainty surrounding its economic outlook and a strong Canadian dollar which may weigh on growth as U.S. which is Canada's key trading partner continues to battle tight credit conditions, a high unemployment rate and subdued wage growth. At the same time, a strong loonie could widen the trade imbalance even further. Though Canada's international ties are worrisome in these market conditions, policy makers last month were not as concerned as many economists surrounding the Euro-zone troubles. I expect the central bank to remain optimistic about growth in the 17 member euro area following the recent bond auction in the bloc. All in all, the Bank of Canada is widely expected to hold its key benchmark interest rate at 1.00 percent; however, comments following the rate decision will likely dictate price action and a slightly more dovish statement will surely add weight onto the loonie. Also on tap will be the leading indicators and retail sales reports.
Taking a look at price action, the pair continues to trade in a descending channel on the daily chart. Indeed, the price action provided a false breakout on the hourly chart, but as daily studies enter oversold levels, traders should not rule out a reverse in course. It is also worth noting that our speculative sentiment index stands at 6.65 and signals for additional losses in the near term. -MW
Australian Dollar Carves Head-And-Shoulders Top in 2011
Fundamental Outlook for Australian Dollar: Bearish
* Queensland Floods Pressure the Australian Dollar
* Australian Job Growth Cools in December
* The Threat of a Surge in Risk Appetite Trends Looms Heavy for the Dollar and S&P 500
The small rebound in the Australian dollar was certainly short-lived as the exchange rate fell back below parity on Friday, and the high-yielding currency may continue to depreciate over the following week as the outlook for global growth deteriorates. At the same time, the AUD/USD appears to be carving out a head-and-shoulders top in 2011, and there exchange rate may push sharply lower over the near-term as it looks to complete the right shoulder around 1.0000.
The People's Bank of China raised its reserve ratio for commercial banks by 50bp this week in an effort to contain inflation, and the central bank may continue to aggressively tighten monetary policy throughout the first-half of the year in order to prevent the economy from overheating. As China aims to cool the marked expansion in economic activity, the recent moves by its largest trading partner could dampen the recovery in the isle-nation, and the Reserve Bank of Australia may look to retain its wait-and-see approach throughout the first quarter of 2011 as region copes with the flood in Queensland paired with the slowdown in global trade. According to Credit Suisse overnight index swaps, investors pricing one more rate hike by the RBA for the next 12 months, but interest rate expectations may deteriorate further over the coming months as central bank Governor Glenn Stevens holds a cautious outlook for the region. The RBA said monetary policy was "mildly restrictive" after holding the benchmark interest steady at 4.75% in December, and the central bank may continue to drop its hawkish outlook for inflation as households curb spending and increase their rate of saving.
After topping out at a record-high of 1.0256 in December, the AUD/USD looks poised to weaken further as the recent rebound in the exchange rate fails to push the pair back above the 20-Day SMA at 1.0024. As a result, we expect the head-and-shoulders pattern to pan out over the near-term, and the exchange rate may fall back towards the 100-Day SMA at 0.9766 as it searches for support. As the economic docket for the isle-nation remains bare until the last days of January, risk trends are likely to dictate price action going forward, but the recent rebound in the greenback may gather pace over the following week as the recovery in the world's largest economy gradually gathers pace. In turn, I will look to maintain my short AUD/USD position going into the following week, and the pair may continue to retrace the advance from the previous year as the uncertainties surrounding the global economy bears down on market sentiment. – DS
New Zealand Dollar Volatility Expected on Jump in 4Q Inflation
The New Zealand Dollar joined the Euro and Pound as the biggest gainers on the week with the commodity dollar improving against all of the majors except its two European counterparts. Easing concerns over the debt crisis benefitted the Kiwi as it became the high yielder of choice with its antipode cousin the Australian dollar falling out of favor. Indeed, severe flooding in the Queensland took the luster off of the Aussie, but Kiwi bulls shouldn't forget New Zealand continues to feel the impact from its own natural disaster. The country's worst earthquake in eighty years has economists forecasting a potential double dip recession for the export driven economy and the weak growth outlook could become a weighing factor.
An 8.0% rise in building permits for November helped ease some growth concerns, but the gain was primarily in apartments which detract from the improvement. The trade balance deficit narrowed on the month to –NZ186 million as the drop in imports outpaced a slip in exports. The weaker demand from abroad won't encourage any optimism for future growth as Asian demand is expected to ease with China's efforts to slow their domestic economy. Indeed, the PBOC raised the level of reserve requirements for banks in an effort to put the brakes on growth, as they look to head off inflation. Major Chinese bank will have to hold onto 19% of their assets with medium and smaller institutions accountable for 15.5%. Despite the prospect of slower demand for exports and domestic hurdles, we saw interest rate expectations jump during the week with overnight index swaps now pricing in 65 bps in tightening over the next twelve months, up from 48 bps on January 11th.
The likely culprit for the brighter yield outlook is the forecast for inflation to have accelerated to 4.0% from 1.5% in the fourth quarter, well above their 1%-3% target. Consumer demand is also expected to have rebounded in November by 1.2% following a 2.5% drop the month prior which should ease some domestic growth concerns. However, although the rise in consumer prices makes the case for future tightening, it also warns of lower consumer spending which could be bearish for the Kiwi considering the dimming outlook. -JR
US Dollar Recovery in 2011 at a Tipping Point – DJIA Trend Critical
The US Dollar fell sharply against the Euro on a sudden improvement in Euro Zone sovereign debt markets, but a sharp late-week reversal suggests USD bulls have not yet given up the fight. We have long argued that the month of January is often pivotal in setting the stage for medium term trends, and the fact that the Euro/US Dollar pair was unable to close above its earlier highs bodes well for the Greenback. A relatively empty week of economic event risks leaves volatility expectations considerably lower through the short-term. Yet traders should watch whether the US Dollar is able to hold its lows against the Euro and set the stage for continued reversal through the coming months.
Little foreseeable event risk leaves the Greenback at the whims of broader market flows and developments in ongoing Euro Zone fiscal crises. Possible exceptions include mid-week Housing Starts and Existing Home Sales reports, but it would likely take a substantial surprise in either direction to force important moves in the US currency. One potential market-mover may come from a non-traditional source: the Chinese government will release initial estimates of Q4, 2010 GDP growth on Wednesday night/Thursday morning.
The Asian titan has defied a broader global economic slowdown and continued to grow at impressive double-digit rates, but markets will likely need to see similarly robust expansion into the final quarter of the year. Any significant disappointments could especially affect the Australian Dollar and New Zealand Dollars—forcing them lower against their US namesake.
The month of January is often critical in determining trends for the following 11 months of the year, and the fact that the Euro/US Dollar is essentially unchanged through the first two weeks leaves medium term trends in the balance. The determining factor may come down to whether the US S&P 500 and broader risk sentiment can continue to improve into the New Year. We have made little secret of the fact that we believe the Dow Jones Industrial Average and broader 'risk' may see a substantial correction following robust gains. Yet any attempts at betting on such weakness have done quite poorly through continued rallies. It will be critical to watch the trajectory of 'risk' and its effects on the US Dollar through the final weeks of January. – DR
How far do you think the dollar will rally? Discuss the dollar's future in the DailyFX Forum.
For more timely FX market analysis, take advantage of the DailyFX Real Time News service.
DailyFX provides forex news on the economic reports and political events that influence the currency market.
Learn currency trading with a free practice account and charts from FXCM.
Euro Recovery on Rate Expectations and EU Promises Likely Limited
Fundamental Forecast for Euro: Neutral
- EU floats proposals that would dramatically increase the crisis fight
- The ECB turns up the heat on interest rate expectations
- A sharp reversal in EURUSD still holds to a range – improving traders positioning
The euro surged this past week – fully recovering the substantial losses of the opening week of the year. It is difficult to separate the impact that the unusual liquidity conditions had in this scenario from the true fundamental developments. However, the events that have transpired so far this year certainly warrant the level of activity we have seen. When traders first returned to the market, they picked up on the same concerns about a deteriorating financial backdrop for the Euro Zone that they had left off with in 2010. Perhaps noticing the gravity of the situation and the futility of policy officials voicing optimism in the public forum; the heads of state finally stepped up to the problem with an open-ended discussion of drastically expanding the EU's efforts to quell a crisis in the region. And, taking it a step further for the euro, the ECB finally seemed to turn the corner on its neutral policy stance to finally start talking interest rate hikes. The week ahead will be critical as it will tell us just how much influence each of these developments can carry through speculation alone.
It would certainly be remarkable if the EU passed a range of policy steps to expand its stimulus efforts and the ECB started to lift the benchmark lending rate in quarter point steps. In fact, if that were to happen; the euro would surge. And, really, even a strong belief that either or both of these events could occur in the near term would drive the shared currency to new highs. However, are these bullish objectives actually credible? First we start with the more complicated proposals supposedly being debated by European officials. Among the points being discussed are an expansion of the EFSF bailout program, lower rates to access the emergency funds, additional guarantees, the ability to intervene in the bond market, a direct line of credit to Portugal, the purchase of Greek bonds and other enticing endeavors. Again, if all of these were passed; it would be a significant relief from the perceived threat to the region. Yet, why should we believe these are realistic measures that will be taken when there has debate over much smaller points. What's more, does this solve the problem of recessions in some EU member economies and the cost incurred by others? No. The market will be quick to recall this fact should the summit this coming week doesn't produce any tangibles. An estimate of a real results not coming until March sets a realistic time frame.
As for the probability of an ECB rate hike, President Trichet said quite clearly that interest rates were "appropriate" at the outset of his discussion. And, though he noted the risk that near-term inflation could climb; he didn't explicit voice concern about medium-term inflation. Independence is important to the major central banks; and they will express this freedom by suggesting they are willing to fight inflation even when there is a fiscal and economic struggle at hand. However, raising rates in the EU would severely burden member economies that are already truly struggling. Knowing this, policy officials are very unlikely to act on price pressures that are largely centered on food and fuel costs. So while further jawboning inflation may keep the euro buoyant; reality will soon set in.
The two major themes mentioned above will almost certainly define the euro's path going forward; but it is the market's assessment of their development that ultimately matters. For that, we should keep a close eye on underlying risk appetite. If investor optimism rises, they will be more prone to believing the bullish chatter; and pessimism will lead traders right back to the underlying problems. As for the economic docket, the focus actually lies on sentiment. Consumer and business optimism will paint the economic picture; but it is the ZEW investor survey that is really interesting. This is polling those that are actually buying European debt. - JK
British Pound May Consolidate On Mixed Batch Of U.K. Data
Fundamental Forecast for British Pound: Neutral
* U.K. Retail Sales Expands At Slower Pace
* U.K Trade Deficit Unexpectedly Widens on Oil Imports
* BoE Holds Rate at 1.00%, Asset Purchase Target at GBP 200B
The British Pound rallied to a fresh monthly high of 1.5888 on Friday, and the exchange rate may continue to push higher over the near-term as investors speculate the Bank of England to start normalizing monetary policy later this year. The economic docket for the following week is expected to show inflation expanding at the fastest pace since May, with market participants forecasting consumer prices to rise at an annualized pace of 3.4% in December, and the stickiness in price growth is likely to spark a bullish reaction in the sterling as the central bank drops its dovish outlook for future policy.
At the same time, retail spending in the U.K. is projected to weaken 0.3% during the same period, while jobless claims are expected to hold flat after slipping 1.2K in November, and the mixed batch of data could lead the GBP/USD to consolidate over the following week as investors eagerly wait for the BoE policy meeting minutes due out on January 26. As price pressures intensify, we are likely to see the MPC turn increasingly hawkish over the coming months, and the central bank may see scope to lift the benchmark interest rate off the record-low as it aims to balance the risk for the region. According to Credit Suisse overnight index swaps, investors expect the BoE to hike borrowing costs by at least 50bp this year, and the rise in interest rate expectations may gather pace over the coming months as the central bank struggles to contain the acceleration in price growth. However, we expect to see another three-way split within the committee as board member Adam Posen anticipates the ongoing weakness in the economy to bear down on price growth, and there could be a growing tear within the MPC as the fundamental outlook remains clouded with uncertainties.
As the recent rally in the GBP/USD tapers off ahead of the December high (1.5910), we may see a corrective retracement unfold next week, and the exchange rate may trend sideways over the coming days as the relative strength index holds below 70. However, another break to the upside should lead the pound-dollar to retrace the decline from back in November, and the British Pound may outperform against its major counterparts next week as interest rate expectations increase. - DS
Japanese Yen Vulnerable with Strong Corporate Earnings Expected
Fundamental Forecast for the Japanese Yen: Bearish
* Domestic corporate goods price index in December rose to 1.2% from 0.9%
* Current account surplus narrowed to 926.2B in November from 1436.2B
* Japanese Finance Minister Yoshihiko Noda threw support behind European Bonds
The Japanese yen was flat on the week against the dollar but saw sharp declines against the Euro and Pound. The single currency gained over 3% against the Asian currency impart due to actions from Finance minister Yoshihiko Noda. The Japanese official stated that it was appropriate to buy bonds from Ireland which followed a similar vote of confidence from China. The apparent global support for the region's debt helped ease concerns over the debt crisis and helped deliver successful auctions from Portugal, Spain and Italy. Rising interest rate expectations in the U.K. and Euro-zone also weighed on the Yen against its European counterparts. However, declining yield expectations in the U.S. kept the greenback from gaining ground as last week's disappointing labor report was followed by misses in retail sales and consumer confidence.
Improving domestic fundamentals failed to generate volatility but dimmed the prospect of more BoJ intervention which opens the door for Yen strength. A rise in whole sales prices to 1.2% should ease deflation concerns for policy makers which are expected to lift growth forecasts at their upcoming meeting. A rise in import cost for raw materials and energy are helping offset Yen strength which led to Japan's current account surplus shrank for the first time in three months in November. The news isn't all good as exporters continue to see demand wane on the back of persistent Yen support. An improvement in the Eco watcher's survey for the second consecutive month reflects an improving domestic economy as the current conditions gauge rose to 45.1 from 43.6 in November.
The improving economy is expected to have brightened the outlook in Japanese households with the consumer confidence metric forecasted to rise to 41.6 from 40.4. Industrial production, machine tool orders and nationwide Dept store sales will also cross the wires but traders shouldn't expect significant volatility from the domestic economic docket. U.S. yields continue to have a major influence on the USD/JPY which puts the focus on earnings season. Next week we will see a number of blue chip names report which could impact risk appetite and demand for bonds. If companies continue to show the ability to improve their bottom line then we could see broad based yen weakness. However, mixed results will leave price action to the prevailing broader themes of European debt and U.S. growth which should lose some focus next week but have the potential to generate support for the funding currency if confidence in either deteriorates.-JR
Gold Prices to Fall as ETF Holdings Hit Four-Month Low
Unlike most benchmark assets, gold had largely decoupled from the risk-on / risk-off dichotomy that ruled financial markets in the aftermath of the 2008 meltdown, with the metal managing to remain broadly well-supported throughout. This resilience reflected the prevalence of "extreme" bullish or bearish views on the pace of the global recovery, both of which saw gold as an attractive store of value within their respective outlooks. Both camps increasingly appear to have been off the mark however, hinting the breakneck gold rally may be on the cusp of a major reversal.
For the bulls, the central fear was and is inflation. In their scenario, global growth will snap back faster than central banks are able to mop up the flood of liquidity created through record-low interest rates and quantitative easing. This will see prices soar on a global scale, debauching paper currencies and making a hard asset store of value like gold a very attractive alternative. Meanwhile, the bears didn't believe that mounds of fiscal stimulus would create much more than a temporary reprieve akin to putting a band-aid on a broken arm, forecasting the recovery would fail as soon governments withdrew their support. This would see the spectrum of risky assets "artificially" buoyed by said stimulus collapse anew, making gold attractive for its tangible store of value properties once more.
As we have discussed previously, this has meant that the most reliable long-term driver of the metal's prices over recent years has been the trend in gold ETF holdings. This suffered a major set-back last week, with the Bloomberg gauge of total known holdings snapping the rising trend carved out through the fourth quarter of last year to drop to the lowest since mid-September. The reversal in investment demand seems reasonable. US economic data – the bellwether for the global recovery at large – has materially improved over recent weeks, hinting a back-slide into recession is decidedly unlikely. However, all signs point to a rebound that is slow and uneven, with headwinds in the looming slowdown in China and the lingering debt crisis in the Euro Zone likely to assure the road to broad-based pre-crisis prosperity will amount to a long, hard slog over the years ahead. On balance, this means the "extreme" scenarios at the bullish and bearish ends of the spectrum appear unlikely, opening the door for gold to begin a long-overdue correction lower.
Canadian Dollar Looks to BoC Interest Rate Decision For Direction
Fundamental Forecast for Canadian Dollar: Neutral
- Canadian Dollar Calls for Strength Against U.S. Dollar - Canadian Dollar Shows Little Reaction to Trade Figures
The Canadian dollar pushed higher against its U.S. namesake last week, climbing some 0.41 percent. Indeed, the advance in the loonie marks the four successive week that the currency rallied against the greenback; however, the gain in the Canadian dollar may be short-lived as focus shifts to the Bank of Canada interest rate decision. Furthermore, crude oil's failure to break above 92.60 after testing the level for a third time this past week is hinting at a slight correction.
During this past week, the dismal economic releases in Canada failed to ease strength in loonie against the buck as risk appetite weighed on the greenback. Taking a look at the recent developments, Canadian building permits disappointed in November as figures dropped 11.2 percent amid economics' estimates of a 1.5 percent increase, while housing starts fell to 171.5K in December from a revised 198.2K the month prior. With regards to the former, because of the high outlays needed for construction projects, the reading suggests lower consumer and corporate optimism. Not to overlook, traders also shrugged off Canada's trade deficit which narrowed in November amid a decline in energy imports. Though markets dismissed the data, the release is worrisome due to the fact that Canada relies on exports and the report showed the largest decline in purchases from overseas since March 2009. These developments combined with consumer prices which recently slowed to 2.0 percent in November will lead the Bank of Canada to refrain from raising its key overnight lending rate.
As of late, traders are pricing in a four percent chance that the BoC will hike rates twenty five basis points at its rate decision meeting on January 18th. At last month's meeting, the central bank kept its overnight lending rate unchanged amid uncertainty surrounding its economic outlook and a strong Canadian dollar which may weigh on growth as U.S. which is Canada's key trading partner continues to battle tight credit conditions, a high unemployment rate and subdued wage growth. At the same time, a strong loonie could widen the trade imbalance even further. Though Canada's international ties are worrisome in these market conditions, policy makers last month were not as concerned as many economists surrounding the Euro-zone troubles. I expect the central bank to remain optimistic about growth in the 17 member euro area following the recent bond auction in the bloc. All in all, the Bank of Canada is widely expected to hold its key benchmark interest rate at 1.00 percent; however, comments following the rate decision will likely dictate price action and a slightly more dovish statement will surely add weight onto the loonie. Also on tap will be the leading indicators and retail sales reports.
Taking a look at price action, the pair continues to trade in a descending channel on the daily chart. Indeed, the price action provided a false breakout on the hourly chart, but as daily studies enter oversold levels, traders should not rule out a reverse in course. It is also worth noting that our speculative sentiment index stands at 6.65 and signals for additional losses in the near term. -MW
Australian Dollar Carves Head-And-Shoulders Top in 2011
Fundamental Outlook for Australian Dollar: Bearish
* Queensland Floods Pressure the Australian Dollar
* Australian Job Growth Cools in December
* The Threat of a Surge in Risk Appetite Trends Looms Heavy for the Dollar and S&P 500
The small rebound in the Australian dollar was certainly short-lived as the exchange rate fell back below parity on Friday, and the high-yielding currency may continue to depreciate over the following week as the outlook for global growth deteriorates. At the same time, the AUD/USD appears to be carving out a head-and-shoulders top in 2011, and there exchange rate may push sharply lower over the near-term as it looks to complete the right shoulder around 1.0000.
The People's Bank of China raised its reserve ratio for commercial banks by 50bp this week in an effort to contain inflation, and the central bank may continue to aggressively tighten monetary policy throughout the first-half of the year in order to prevent the economy from overheating. As China aims to cool the marked expansion in economic activity, the recent moves by its largest trading partner could dampen the recovery in the isle-nation, and the Reserve Bank of Australia may look to retain its wait-and-see approach throughout the first quarter of 2011 as region copes with the flood in Queensland paired with the slowdown in global trade. According to Credit Suisse overnight index swaps, investors pricing one more rate hike by the RBA for the next 12 months, but interest rate expectations may deteriorate further over the coming months as central bank Governor Glenn Stevens holds a cautious outlook for the region. The RBA said monetary policy was "mildly restrictive" after holding the benchmark interest steady at 4.75% in December, and the central bank may continue to drop its hawkish outlook for inflation as households curb spending and increase their rate of saving.
After topping out at a record-high of 1.0256 in December, the AUD/USD looks poised to weaken further as the recent rebound in the exchange rate fails to push the pair back above the 20-Day SMA at 1.0024. As a result, we expect the head-and-shoulders pattern to pan out over the near-term, and the exchange rate may fall back towards the 100-Day SMA at 0.9766 as it searches for support. As the economic docket for the isle-nation remains bare until the last days of January, risk trends are likely to dictate price action going forward, but the recent rebound in the greenback may gather pace over the following week as the recovery in the world's largest economy gradually gathers pace. In turn, I will look to maintain my short AUD/USD position going into the following week, and the pair may continue to retrace the advance from the previous year as the uncertainties surrounding the global economy bears down on market sentiment. – DS
New Zealand Dollar Volatility Expected on Jump in 4Q Inflation
The New Zealand Dollar joined the Euro and Pound as the biggest gainers on the week with the commodity dollar improving against all of the majors except its two European counterparts. Easing concerns over the debt crisis benefitted the Kiwi as it became the high yielder of choice with its antipode cousin the Australian dollar falling out of favor. Indeed, severe flooding in the Queensland took the luster off of the Aussie, but Kiwi bulls shouldn't forget New Zealand continues to feel the impact from its own natural disaster. The country's worst earthquake in eighty years has economists forecasting a potential double dip recession for the export driven economy and the weak growth outlook could become a weighing factor.
An 8.0% rise in building permits for November helped ease some growth concerns, but the gain was primarily in apartments which detract from the improvement. The trade balance deficit narrowed on the month to –NZ186 million as the drop in imports outpaced a slip in exports. The weaker demand from abroad won't encourage any optimism for future growth as Asian demand is expected to ease with China's efforts to slow their domestic economy. Indeed, the PBOC raised the level of reserve requirements for banks in an effort to put the brakes on growth, as they look to head off inflation. Major Chinese bank will have to hold onto 19% of their assets with medium and smaller institutions accountable for 15.5%. Despite the prospect of slower demand for exports and domestic hurdles, we saw interest rate expectations jump during the week with overnight index swaps now pricing in 65 bps in tightening over the next twelve months, up from 48 bps on January 11th.
The likely culprit for the brighter yield outlook is the forecast for inflation to have accelerated to 4.0% from 1.5% in the fourth quarter, well above their 1%-3% target. Consumer demand is also expected to have rebounded in November by 1.2% following a 2.5% drop the month prior which should ease some domestic growth concerns. However, although the rise in consumer prices makes the case for future tightening, it also warns of lower consumer spending which could be bearish for the Kiwi considering the dimming outlook. -JR
