Highlights
- The panic lifts and the USD survives
- Oil weakens and a top is evident
- Euro strength pinching Eurozone growth
- Key data and events to watch next week
The panic lifts and the USD survives
This time last week the world as we knew it seemed to be on the verge of collapse. The GSE's were under assault, the US financial system was looking into the abyss and the USD was being punished as a result. As I suggested last week, however, US officials stepped up to the plate and organized a backstop for the GSE's, raising the implicit Federal guarantee to its most explicit level yet. The SEC also imposed restrictions on short-selling of GSE shares and their rebound has been almost as spectacular as their sell-off. Overall financial sector stocks have also had a stunning rebound as balance sheet woes finally appear to be coming to an end. While losses were still registered for the 2Q, the key take-away is that there is not much left for many of these firms to keep writing down. The US Congress still needs to act on the GSE plans put forward by the Fed and Treasury, and while the devil may be in the details, I am confident that the Congress will pass the essential core of Treasury's plan sometime next week and I look for markets to breathe another sigh of relief.
The USD came under pressure last week as the US financial sector appeared on the brink of imploding, but with many of those risks now receding the USD appears set to do better. While US data continues to point to a weak economy, the rate of deterioration appears to be slowing and may even be stabilizing. With all the negativity priced into the USD and US assets in general, it would seem the only way forward is higher. At the same time, slowdowns in other economies, Europe, Japan and the UK in particular, continue to accelerate. Current FX levels do not reflect this reality and I anticipate further USD gains in the weeks ahead. Technically, EUR/USD was rejected again from above the 1.60 level and looks to be in the process of reversing lower. The 1.5750/80 area in EUR/USD is acting as the key support zone and I look for eventual declines below to trigger a drop back to the lower end of recent ranges in the 1.53-54 area in coming weeks. USD/JPY and the JPY-crosses have also rebounded as yield-chasing resumes and risk appetites improve on the brighter financial sector outlook. USD/JPY continues to have difficulty surmounting the 200-day moving average, currently at 107.17, but the sharp recovery from below 103.70 (the base of the Ichimoku cloud) suggests a greater likelihood of gains toward the 109-110 area in the weeks ahead. I continue to pursue a 'buy the USD on dips' strategy in the current environment.
Oil weakens and a top is evident
As the USD came under pressure over the financial sector panic last week, oil prices surged to new all time highs. As oil prices moved higher, USD selling pressure increased. Since the GSE backstop was announced and the panic subsided, oil prices have retreated sharply and the USD has recovered, though not nearly as much as the decline in oil prices would suggest, giving additional reason to expect that further USD gains are likely. A downbeat economic outlook by Fed Chair Bernanke reminded markets that US growth was weak and likely to remain so, and many analysts cited this as the catalyst for the oil price sell-off. Demand destruction has been taking place and oil prices were not reflecting that reality. Today the API (American Petroleum Institute) reported that 1H 2008 US fuel demand fell the most in 17 years, down 3% in the first half. Global growth is also slowing, with Chinese exports falling and 2Q GDP slowing to 10.4% from the 1Q's 10.6% and down from 2007 GDP of 11.9% (yes, growth is still high in China, but relatively less so.)
Geo-political tensions between the US and Iran are also easing in dramatic fashion after a complete volte-face by the Bush administration on engaging Iran. Developments in Iraq are also contributing to an easing of mid-East tension, with JCS Chairman Mullen suggesting further troop reductions are likely before the end of the year. I ball-park the geo-political risk premium in oil at around $20-30/bbl, and that is probably a conservative estimate. Between slowing global growth and easing mid-East tensions, the oil price reversal this time looks to be for real. Plus when we consider the potential outcomes from these talks - Iran suspending uranium enrichment, the US abandoning the Central European missile shield, US-Russia relations improving - the downside for oil looks even more pronounced.
Technically speaking, all the signs point to lower prices as well. First of all, crude oil has formed a double-top near the $145.25 mark. Moreover, the moves lower over the last three days have formed what's called a "three black crows" pattern. The pattern is three long down candlesticks, where the opening price of each day is higher than the previous day's close. It is typically indicative of a market that has been at a high price for too long. Looking at the Ichimoku chart we get even more confirmation that a move lower is in store. The Tenkan and Kijun lines are currently both sitting at the $137.91 level. If the Tenkan manages to cross below the Kijun (which looks very likely right now) this would be yet another bearish signal. Also, the commodity is currently trading within the Ichimoku cloud which extends from a top of $130.10 to a bottom of $119.34. So it looks like even with fundamental headwinds aside, the price of oil looks poised for a correction from a technical level.
Euro strength pinching Eurozone growth
Eurozone trade data this week highlighted once again something we have been harping on for some time now - that the higher euro is crimping European competitiveness abroad and hurting domestic economic growth. The May Eurozone trade balance plunged to a -4.5B euro deficit from a surplus of 2.5B euro. Looking at the year-to-date balance, the result looks even worse. For 2008 thus far the Eurozone has incurred a trade deficit of -2.6B euro, compared with a surplus of 0.4B euro in the same span last year.
This week we heard from French Finance Minister Christine Lagarde who said flat out that the euro is "very high". If we had to wager a bet, we'd say that she isn't the only one reflecting this sentiment and that although the ECB prides itself on being an independent body, the political pressure to leave rates on hold is palpable. So despite the tough talk on inflation and the heightened bets that the ECB will hike another 25 bps by the end of the year, we still believe that the Eurozone would rather see EUR/USD 1.50 before it sees 1.60 again. Thus, we would still look for USD buying on dips going forward.
Key data and events to watch next week
The US calendar is pretty busy next week and kicks off with the index of leading economic indicators on Monday. Wednesday sees the all important Fed Beige Book release, which will give us an anecdotal account of the goings on in the US economy. Thursday sees the usual weekly jobless claims and also the latest existing home sales report. Friday closes out the week with the always volatile durable goods report, University of Michigan consumer sentiment and the latest data on new home sales. On the speaking circuit we will hear from Treasury Secretary Paulson and the Fed's Plosser on Tuesday, the Fed's Mishkin and Kohn on Wednesday and the Fed's Geithner on Thursday. These events should provide USD price action abound.
The Eurozone theme next week is surveys and they are all jam-packed into one day. France, Germany, and the Eurozone will release PMI manufacturing and services indices on Thursday. The German IFO business climate survey and Eurozone current account are due up that day as well. Nothing scheduled on the speaking docket thus far.
Japan sees a relatively light week, though most of the releases are top tier. Monday sees the all industry activity index and this is followed by the merchandise trade balance on Wednesday. Thursday is the big day with consumer price data on deck. We will also hear from the BOJ's Mizuno who is scheduled to speak on Thursday.
The UK sees some pretty significant data next week as well, starting with the Rightmove home price data on Sunday evening. On Wednesday we'll get a look at the Bank of England minutes from their recent interest rate decision. It will be interesting to see if and how the balance of risk between growth and inflation has shifted. Thursday will see another key data point with the retail sales report, while Friday closes out the week with 2Q GDP.
The calendar is light in Canada but key nonetheless. Tuesday sees the retail sales report while Wednesday has consumer prices on tap. These top tier data points should elicit some price action in CAD.
Down under is light but important as well, with Australian producer prices and New Zealand credit card spending on Monday. Wednesday sees Aussie consumer prices and the all important RBNZ rate decision. The market expects the central bank to keep rates steady at 8.25%, but given the very real deterioration in New Zealand's economic growth, the risk here is that they take rates lower. Stay tuned for some major moves in Kiwi (NZD/USD) if the bank surprises.
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