US DOLLAR: STABILIZATION?

In the face of today’s 200 point positive and negative swings in the Dow, it could be argued that the US dollar has been relatively stable if you only look at the daily change of the 3 major currency pairs. The EUR/USD rallied 100 pips, the GBP/USD was unchanged while USD/JPY fell 75 pips. This compares to multi hundred pip moves for all 3 currency pairs on Wednesday. Even the largest market movers had a far milder move today than yesterday. On a percentage basis, the largest market mover was AUD/JPY which dropped 1.09% while it was CAD/JPY yesterday which dropped five times that amount. These moves however masks the volatility that we are still seeing on an intraday basis; the EUR/USD hit a new 20 month low while the GBP/USD fell to a fresh 5 year low. Although it may be very tempting to say that the dollar has hit a top, especially against the Euro, in order for this EUR/USD rally to be real and for investors to be convinced to stop selling higher yielding currencies, we need to see stabilization in the financial markets and a return of confidence.

Keep an Eye on Job Losses

Even though the non-farm payrolls report is not due for another 2 weeks, all signs point to serious job losses and for that reason we are still concerned about the outlook for the US economy and by extension we are also wary of today’s rally in US equities. According to the Financial Times, more than 78,000 people could be laid off from Wall Street. For the world outside of finance, massive job cuts have also been announced by companies like Yahoo, Merck and General Motors. Although we will not get to the double digit unemployment rates that we saw during the Great depression, we do expect the current unemployment rate to climb to a new 5 year high. Since consumer spending is the backbone of the US economy, a weak labor market will depress spending, which should in turn lead to softer growth. Therefore even though buyers have returned to the equity markets, there will be plenty of reasons for them to bail once again.

Emerging Markets to Welcome any Dollar Correction

Any correction in the US dollar will be cheered by the emerging market nations who have had to take drastic measures to combat the dollar’s strength against their own currencies. The rally in the greenback has taken a big toll on the Brazilian Real, South African Rand, Hungarian Forint, Turkish Lira and Polish Zloty. In order to avoid a mass exodus out of their local currencies, central banks of some of these countries have been forced to raise interest rates. Since the strength of the dollar has been the primary catalyst for the sharp decline in these currencies, a correction would be welcomed by all of these nations because it would help stabilize their currencies and make their jobs a lot easier.

Oil Prices Could Bottom on OPEC Production Cuts

US existing home sales are due for release tomorrow but the biggest event risk is undoubtedly the emergency meeting by OPEC. Oil prices have firmed up today on the expectation of a 1 million to 1.5 million production cut from the oil producing nations. The price of crude has fallen more than 50 percent since its July highs, giving the OPEC nations a valid reason to cut interest rates. However since 2000, whenever oil prices have fallen by more than 20 percent on a rolling 6 month basis, production cuts have marked major turning points for oil prices. There is a decent chance that we have seen the bottom in oil prices and for the currency market that could fuel a rebound in the Euro and Canadian dollar.

EUR/USD: WILL THE EUROZONE FOLLOW IN SWEDEN’S FOOTSTEPS WITH A 50BP CUT?

Since the beginning of the week, the EUR/USD has fallen by as much as 6 percent. Having declined for 3 days straight, the currency pair has taken a much needed breather. Despite the continued liquidation of high yielding currencies, the EUR/USD escaped unscathed. A better than expected Belgium business confidence report suggests similar stability for the German IFO index of business confidence. Even though the Eurozone current account deficit increased significantly, French consumer spending jumped in the month of September, catching everyone by surprise. On balance, the economic reports from the Eurozone are encouraging but in no way are they great. In fact, one of the better explanations for the EUR/USD’s rally is the rebound in oil prices ahead of the emergency OPEC meeting. In long run, interest rate expectations will continue to drive the price action of the EUR/USD. We would not be surprised if the European Central Bank followed in the Swedish National Bank’s footsteps. The market expected the central bank to cut interest rates by 25bp but instead they lowered rates by a half-point for the second time this month to provide support for the economy on the expectation that the worst has yet to come for Sweden. With the market pricing in another 100bp of easing over the next 12 months, another half point cut by the ECB could be possible. Service and manufacturing PMI numbers are due for release tomorrow we do not expect the data to help the Euro.

BRITISH POUND TESTS 1.60

It is almost hard to believe that the GBP/USD was trading at 1.85 one month ago as the currency pair came within an arm’s length of the 1.60 level this morning. Consumer spending dropped by 0.4 percent last month, driving the annualized pace of growth to the slowest level in more than 2 years. As Bank of England Governor King indicated earlier this week, the UK economy is in trouble and recent economic data certainly confirms that. The advance release of third quarter GDP is due on Friday. The market is calling for a contraction in growth, but consumer spending improved in the third quarter. However as we have seen today, even if the data is better than expected, the British pound could still weaken with growth predicted to slow further in the coming months. There is a very strong chance that the UK economy will contract next year and in order to avert a sharp contraction, the Bank of England will be compelled to cut interest rates once again.

USD/CAD CLIMBS TO 4 YEAR HIGH

The US dollar climbed to a four year high of 1.2742 against the Canadian dollar. Although picking a top in trends as strong as USD/CAD can be dangerous, the fact that the currency pair closed near its daily low suggests that the currency’s strength may be fleeting. Consumer prices are due for release tomorrow and even though industrial and raw material product prices decreased, the price component of IVEY PMI increased and it tends to be a strong leading indicator for CPI. Meanwhile weakness in commodity currencies continues to be one of predominant themes in the foreign exchange market with the Aussie and Kiwi also slipping against the greenback.

JAPANESE TRADE TAKES A BIT HIT FROM GLOBAL SLOWDOWN

The volatility in the equity market has weighed on all of the Japanese Yen crosses. However even though the Yen has been the one of best performing currencies of 2008, Japan is not without its own problems. The country actually reported a material decline in their trade surplus last month with the balance falling from JPY574B to JPY 95B. Slower growth in the US and China has taken a big toll on Japanese exports. We expect this trend to continue with the strength of the Yen adding to the export sector’s woes. However in a world where every major country is slowing, Japan may prove to be the outlier simply because their banks are healthier.

EUR/USD: Currency in Play Over the Next 24 Hours

The EUR/USD is the currency in play over the next 24 hours with the OPEC meeting, Eurozone PMI data and US housing market numbers due for release on Friday. The manufacturing and service sector PMI reports are due between 3:30 am and 4:00 am ET or 7:30 and 8:00 GMT. US existing home sales will be released at 10:00am ET or 14:00 GMT.

The EUR/USD is trading in our sell zone, which we establish using Bollinger Bands, but there is scope for a bounce to the first standard deviation band which sits at approximately 1.3160. As long as the currency pair does not break above that price level, the downtrend remains intact. If however it does break and close above 1.3330, which is the Fibo resistance from the 2006 to 2008 rally then there is scope for a rally back towards resistance at 1.35.