Mounting US Consumer spending, good sign of trade mending

The U.S Dollar rose against the Euro and Yen yesterday on growth in U.S. manufacturing and doubts about Greece's ability to honor a pledge for further austerity measures in return for an aid package.

The Euro continued to fall against the U.S Dollar yesterday as longer term concern over the Euro-Zone sovereign debt contrasted with solid U.S economic data. The U.S data, which showed a strong reading in manufacturing and construction spending, illustrate a U.S economy that continues to drag itself out of the worst recession since the Great Depression. This compares with the Euro Zone where investors remain worried about the implementation of the unprecedented €110billion aid package for Greece. In the forex online market the EUR/USD closed at 1.31974 yesterday, after hitting a low of 1.31530.

The U.S. manufacturing sector grew in April at its fastest pace in almost six years and at a rate that was above expectations, according to an industry report released Monday. The Institute for Supply Management’s said its index of national factory activity rose to 60.4 in April from 59.6 a month earlier. The data represents a ninth straight month of gains, with the headline index at its highest since June 2004.

The U.S Dollar hit an 8-1/2 month high against the Yen as U.S. manufacturing data boosted optimism about the economic recovery. Following the release of the report, the USD/JPY struck a high of 94.774, up 0.82% from yesterday’s opening price. Strong U.S. data has increased expectations the Federal Reserve will raise interest rates later this year, while the Bank of Japan is seen keeping rates low indefinitely. The USD continued to appreciate against the Japanese currency this morning as signs the global economic recovery is gaining momentum damped demand for Yen as a refuge. The USD/JPY rose to a trading high of 94.970, up 0.30% from today’s opening price of 94.689.

Consumer spending in the U.S. rose in March by the most in six months, pointing to a recovery that may accelerate when the economy creates more jobs. Boosted by spending on autos and other durable goods, real U.S. consumer spending increased 0.6% to reach a record high level in March, at last surpassing the pre-recession peak set in November 2007, the Commerce Department reported yesterday. With spending growing much faster than incomes in March, the personal savings rate fell to 2.7%, the lowest since September 2008.

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Forex News: Greek Economy fallen into a vicious circle

Yesterday saw the U.S. Dollar gain against all of its major counterparts in the forex online market except for the Japanese Yen as German Chancellor Angela Merkel told investors they shouldn’t expect a European Union summit due to be held in Brussels on Thursday and Friday of this week to agree on assistance for Greece.

The US Dollar gained 0.40% against the Euro overall yesterday, with the Euro closing at $1.3566. Against the Pound the US Dollar rose by 0.76% with Sterling closing at $1.5109.

The US report on existing home sales is due to be announced later today. Economists are predicting that the figure will fall for the third month in a row as unemployment remains close to 10%. Existing homes account for almost 90% of the housing market. It is believed that the extension and expansion of a federal tax credit for housing has not yet had the desired effect as the labor market remains depressed.

Across the water in Europe European Central Bank President Jean-Claude Trichet said yesterday that aid should only be given to Greece if it will include an element of stabilization for the 16-country Euro Zone as a whole. He also said it was of the upmost importance for other Euro Zone members to maintain fiscal discipline.

The the Greek Central Bank said yesterday that Greece's economy is in a "vicious circle" and this year it will contract more severely than the government says. The Bank of Greece said economic output in 2010 will fall by 2%, worse than the government's prediction of between 1.2% and 1.7%. The bank says the recession will be worse due to planned public spending cuts. The bank said that it approves of the government's strategy to bring down the country's budget deficit, but that the impact will be worse than first thought.

"The Greek economy has fallen into a vicious circle with only one way out: the drastic reduction of the deficit and debt," the Bank's annual monetary policy report says. The report warned that the Euro Zone's economic recovery remains fragile, having relied to a large extent on fiscal stimulus, which must gradually be reversed as it is leading to large budget deficits.

Greece's budget deficit last year was 12.9% of GDP, more than four times greater than the EU allows. Germany has irritated some of its European partners with its opposition to a financial aid package to help Greece overcome its debt crisis, believing that Greece can solve the problem itself.

Elsewhere in the Euro Zone, Germany's coalition government is reportedly planning a banking levy to protect taxpayers from the costs of bank bail-outs. Leading conservative politician Volker Kauder said the money would stop banks from relying on state-funded rescues.

The levy would raise "billions of Euros" from the financial sector, he has predicted. The German government dug deep into its treasury coffers to provide a €500 billion ($679 billion) rescue package to shore up the banking system late in 2008. The new proposal seems to be designed to dissuade banks from taking risks in future which would see them begging for more government hand-outs.

The International Monetary Fund (IMF) has been asked by the G20 group of wealthiest countries to examine how banks can best contribute to the costs of insuring themselves against failure. But so far countries have adopted a piecemeal approach to the issue.

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Forex Market News

GBP collapses on dour BoE report and prospect for lower rates. Will EURUSD break to new lows after ugly German GDP number?

Risk aversion back on the front burner again as US equity indices eye the lows for the cycle. JPY crosses seem a bit less panicky this time around.

MAJOR HEADLINES – PREVIOUS SESSION

• New Zealand Oct. Business PMI out at 43.5 vs. 46.7 in Sep.
• New Zealand Sep. Retail Sales out at +0.1% vs. +0.4% expected and ex Autos at -0.5% vs. +0.4% expected.
• Japan Oct. Domestic CGPI out at -1.6% vs. -0.9% expected
• New Zealand Oct. REINZ House Sales fell -34.8% YoY vs. -23.7% in Sep.
• China Oct. Industrial Production out at 8.2% vs. 11.1% expected
• Germany Q3 GDP out at -% QoQ vs. -0.2% expected

Market Comment:

The BoE was out yesterday with its quarterly inflation report, and Mr. King's turned in an ultra-bearish performance, forecasting that national income would drop by almost 2% on year on year comparisons by Q2 of next year and that the overall economy would shrink as much as 1.3% in 2009. This would mean that BOE rates are likely to eventually fall below 2.00%, meaning a multi-century lows. Yesterday also saw the release of unemployment data that shows the employment situation reaching its worst levels in 11 years. The combination of a very low interest rate outlook on accelerating negative economic indications and renewed trouble in the financial sector has the pound experiencing the most pain in this environment. GBP is now scraping along at a 12-year low on a trade-weighted basis. EURGBP blasted through 0.8200 and posted new highs above 0.8400 before finding resistance. There may have been barrier options involved in some of that action.

US Treasury Secretary Paulson announced yesterday that the US government is abandoning the plan to lift toxic assets off bank balance sheets by buying them in the open market, and will instead focus more on bank recapitalization, propping up debt markets related to consumer credit and trying to prevent mortgage foreclosures. This announcement added to the uncertainty already plaguing the market as it is increasingly clear that the fiscal response to the ongoing crisis just balloons larger and large with no end in sight. Financials were especially hard hit by the news and some of the risk indices are widening again (credit, emerging market and mortgage spreads).

Still, there are a few divergences in this cycle of risk aversion relative to the last big liquidation move that ran for the balance of the month of October. Namely, while US equity indices are close to their lows, the JPY crosses still have a way to go before they reach the lowest levels in late October, and EURCHF is one of the more glaring divergences, as it is still well north of the 1.4300 low. For the latter cross, this may have something to do with the market factoring in financial/banking troubles as a CHF negative that wasn't added to the calculation in earlier cycles when the market simply sold EURCHF as a knee-jerk trade on any sign of risk aversion. (Specifically, UBS is in the spotlight due to the US indictment of one of its top executives)

There are three ways to read the divergences more broadly: first, that previous moves were simply overdone and that nibbling at some of the risk appetite trades (AUD crosses and perhaps EURCHF) on dips is one trade tactic worth pursuing. Second, the action may simply be suggesting that risk aversion could continue, just in a choppier and slower fashion as momentum comes out of the market. We may get an answer to this question in the coming few trading days before and after the G20 meeting this weekend as the market decides how it wants to play the riskiest end of the market: the emerging market currencies. Third, the divergences could be a sign of CB intervention (at least for JPY and AUD pairs), as Japan explicitly sought a G7 statement that gave it a green light to intervene, and it is heavily rumored that the RBA has been intervening - more on this below. The intervention may be looking to avoid huge volatility rather than targeting specific levels over a sustained period of time.

It appears that EURUSD and the S&P500 are the two major instruments tracking each other most closely at the moment and at this inflection point (close to recent lows), we are likely either faced with a sizeable new leg down or support that leads to a more rangebound outlook in the coming weeks. EUR was perhaps artificially propped up by all of the EURGBP flow going through yesterday and would seem vulnerable to further downside this morning for at least a retest of the 1.2330 lows after the ugly German GDP announcement this morning as this was going to press.

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MAJOR HEADLINES

Market updates by Finexo

China gets serious on stimulation China announced a massive CNY 4 trillion stimulus package over the weekend as the global economic growth deceleration is finally hitting the Chinese growth miracle with full force. This enormous package represents some 20% of Chinese GDP, making the puny 1-2% stimulus package ideas being bandied about by US lawmakers look puny in comparison. Some have suggested that growth rates of 5-6% would represent a truly hard landing for the China due to its historic shift to an industrial economy that creates massive pressures to increase the numbers of jobs as the population migrates from the countryside to the city. China will be sorely pressed to avoid this hard landing due to the imbalances in its economy that focus so heavily on production rather than consumption. For now, markets have decided that this is good news, but the rally in risk it has brought on is unlikely to last beyond the shortest term.

G-20 meeting

The G20 meeting over the weekend talked up coordinated action of various stripes and heavier involvement from the developing nations in stimulating its way out of weakening economic conditions. The UK's Gordon Brown is calling for coordinated action and is showing off to the world how willing he and Chancellor Darling are to pump up the UK budget deficit to an estimated 7% next year and in 2010. Things are not looking well for the pound, which is teetering on the precipice of new lows vs. the EUR (or DEM, really, since we are closing in on the weakest level since the mid-1990's here). We are a bit doubtful going forward of the developed world's commitment to developing countries as long as economic woes are keeping domestic pressures. Politicians are acutely aware that the voting public becomes very selfish in hard times.

US employment report

The US employment report was even worse than expected, with not only the nonfarm payrolls number coming in 40k worse than expected, but with the previous month's number also adjusted down a huge -125k. This sent the unemployment rate 0.4% higher to 6.5%, the highest level since 1994. We fear that the crunch in US consumption, which is such a large part of the US economy at over 70% and which hasn't seen a recession since a brief dip in the early 1990's, could send the unemployment rate far higher for the cycle as droves of service sector jobs are eliminated.

Heavy supply in new US treasuries this week

This week will be an interesting one for measuring the demand for US Treasuries, as the US treasury will auction some $55 billion of securities this week, the most in one week since 2004. The amount of issuance arriving in the coming year is mind-boggling and one wonders where the buyers will come from. If yields begin to rise due to insufficient treasury demand while economic data remains weak, this could add to pressure on the markets. Keep an eye on the US 10-year note futures, therefore. Signs of strong demand would be USD bullish.

CAD: still on borrowed time

The Canadian employment data for October released on Friday was far better than expected, but as we discussed, the Canadian economy has historically been closely coupled with the US economy and will not escape its growing negative drag. USDCAD should eventually try back toward the 1.3000 area and we would expect the pair to find support in the 1.1500-1.1800 area.

Key data on the way

This week's economic calendar is relatively quiet, with focus likely on the German GDP data out on Thursday and the US Retail Sales report for October, released on Friday and could show the weakest retail sales environment in the 16-year history of the survey.

Trading stance

We see the rally in risk appetite as an eventual opportunity to look for new entry levels to play the predominant trend/theme of global deleveraging. Keep an eye out for reversal patterns that suggest new entry points for going long the USD, JPY and CHF against the EUR and virtually any other currency.

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Today's Forex Market Comments and Updates

Key Risk Events (All times in GMT)

• Switzerland Oct. ZEW Survey (0900)
• UK BOE to publish money market reform proposals (1000)
• Switzerland SNB to hold briefing on Financial System (1200)
• US Sep. CPI (1230)
• US Weekly Initial Jobless Claims (1230)
• US Aug. Net TIC Flows (1300)
• US Sep. Industrial Production and Capacity Utilization (1315)
• US Fed's Bullard to Speak on US Growth Potential (1330)
• US Oct. Philadelphia Fed (1400)
• US Weekly US Crude Oil Inventories (1500)
• US Fed's Stern to Speak (1600)
• US Oct. NAHB Housing Market Index (1700)
• Us Fed's Rosengren to Speak (0000)
• Australia Q3 Import Price Index (0030)
• Japan Sep. Department Store Sales (0530)
• Japan BoJ's Shirakawa to Speak (0635)

Market Comments

Another round of selling swept through the equity markets. Recent news of mutual fund and hedge fund redemptions raises worries of further liquidation pressures when liquidity is thin. (An article in FT out overnight says that $45 Billion was redeemed in September alone for hedge funds and the previous day we read of a record in mutual fund redemptions by a similar amount). So, while this may simply be a "retest of the lows" scenario for equities - and the related FX crosses that follow the "axis of risk", as long as these very large market entities face liquidation pressures the indices can go anywhere. The abovementioned FT article also points out the risk of end of year liquidation pressures from hedge funds, and this may continue as a theme or worry as Jan. 1 approaches. The only market participants that could step in here are governments who are already trying to prop up the entire financial world and those with the biggest money bags - the likes of the sovereign wealth funds. Unfortunately for them, some of their initial forays into markets saw them burned badly, so they may be unwilling to step in even at these levels.

Yesterday we talked about the shifting focus to Main Street fall-out from the banking crisis. This proved justified as the US registered the worst Retail Sales drop in 16 years (measured as three consecutive monthly drops). The falls in some discretionary categories like clothing show that the consumer has quickly begun to yank in their spending. We should worry about the October numbers as well and the general sentiment going into the Christmas shopping season in a month's time. After all, during September, the S&P500 was mostly trading between 1150 and 1250 rather than October's 850-1050.


The big news this morning in Europe was the generous Swiss rescue of UBS, with a plan to inject capital and offload $60 billion of toxic assets - this is a sweetheart deal for the bank and looks like the best of all worlds - the combination of the US and UK rescue plans - at least for the bank, if not taxpayers. The banking sector is extraordinarily important to Switzerland, so it's not surprising to see this kind of deal - the surprise is perhaps the fact that it took so long for this kind of intervention. There seem to be few implications for CHF at the moment, caught up as it is in the whole risk aversion theme, but it is nominally bullish for the franc.

In Europe, the German regional governments are complaining about being doubly exposed to the bank bailout plan - which could require some fine-tuning of the original €500 Billion plan advanced recently. In the UK, some of the banks are complaining about the harshness of the terms of Brown's plan, saying that it will cut too deeply into future earnings (have some cake and eat it, too, please....). EURGBP sways back and forth as these issues come to light - it looks like GBP could gain the upper hand if EURGBP drops below 0.7700. Watch the 200-day moving average at 0.7830 as a key resistance level.

The Scandies were waylaid by the risk aversion yesterday, and EURSEK squeezed well through 10.000 in thin evening markets. EURNOK also smashed to a new, near 10-year high just below 9.000. These have retraced sharply this morning as bargain hunters are bidding up equities on the European open.


In general, while some of the risk spreads have come in, a few of them stalled yesterday (like Libor) and over in credit-swap land, the bank credit spreads are falling, but non-financial companies' credit spreads are rocketing higher - so this is far from an across the board green light in the risk department. This and the potential liquidation issues are the most pressing themes at the moment.

Also keep an eye on the equity situation once again and tread lightly in these markets until this volatility begins to ease somewhat. The pattern of stronger USD, JPY, CHF and weaker everything else on risk aversion and vice versa on stronger risk appetite is likely to continue until this volatility fades somewhat and some more nuanced themes can develop.

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Themes To Watch – Upcoming Session Recommended by Finexo.com

Key Risk Events (All times in GMT)

• Sweden Aug. Industrial Production and Orders (0730)
• UK Sep. BRC Shop Price Index (0930)
• Germany Aug. Industrial Production (1000)
• US Fed's Plosser to Speak (1145)
• Canada Sep. Housing Starts (1215)
• US Aug. Pending Home Sales (1400)
• US Weekly Crude Oil and Product Inventories (1435)
• Japan Aug. Machine Orders (2350)
• Australia Sep. Unemployment Rate (0030)

Finexo Market Analysis

• UK getting ready to put tax payers' money into banks (aka nationalization), according to Chancellor of the Exchequer, Alistair Darling.
  
  
• US Fed/Treasury considering to get into the unsecured lending market (i.e.commercial paper). This has never happened in the history of the Fed and the legal basis and ramifications are unclear.
  
  
• The RBA cut interest rates to 6.00% (i.e. -100 bps.). The expectation was 6.50%. ASX200 saw some support after the move (only stock index, which ended higher yesterday). AUD plummeting.
  
  
• Iceland's Prime Minister says that it cannot be ruled out that they will go bankrupt.
  
  
• Commodities are plummeting. Several of them were limit down in Shanghai trading. Only exception is precious metals, which are still holding the ground.
  
  
• DOW dropped to (and closed) below 10,000 for the first time since 2004.

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EUR/USD – Dollar's 8-month high continues to slip away

Yesterday, the dollar lost its 8-month peak against major currencies as investors continued to sell their positions in order to profit from the dollars latest rally. In addition, many of the investors like me are not taking any risks with the dollar in sight of the indebted mortgage giants Fannie Mae and Freddie Mac's apparent need for governmental assistance.

A combination of these factors as well as the recent rise in gold and oil prices has brought the dollar's rally to a halt. On the other hand, the rise of oil to above $116 a barrel was not as helpful to the euro and the sterling as expected, reflecting the bearish sentiment towards these currencies.

Nevertheless, the losses in the dollar were minimal in sight of a slowed growth around the world which might prompt cuts in interest rates in the world's largest economies besides the U.S.
Traders are expecting key European data later in the day in order to estimate the state of economic health of this region.


According to the Finexo currency trading room euro dropped 0.2% and stabilized at $1.4776, remaining above the 6-month low of $1.4630 hit on Tuesday. This adds up to a total of 8% fall from its July record peak of $1.6040.

EUR/USD recovers further today but still fails to take out 1.4830 resistance. Outlook remains neutral for the moment. On the upside, break of 1.4830 will confirm that a short term bottom is in place and bring stronger rebound, probably to test 1.5284 double top neckline resistance before staging another fall. On the downside, below 1.4672 minor support will flip intraday bias back to the downside and break of 1.4629 will indicate that recent decline from 1.6038 has resumed for next target of key medium term support at 1.4309.

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