Highlights
- USD strengthens across the board; looking for more to come
- EUR/USD & USD/JPY price levels to watch
- Outlook continues to stabilize in US while deteriorating elsewhere
- Key data and events to watch next week
USD strengthens across the board; looking for more to come
The USD recovered broadly against other major currencies this week as the GSE panic subsided further and oil and other commodity prices continued their sharp retreat. US 2Q bank earnings reports also came in generally better than expected, though many firms still reported significant losses and write downs, but left the impression that financial sector hemorrhaging is nearing an end. Non-financial firms' 2Q earnings reports were also generally better than expected, reinforcing the notion that US firms are well-positioned to weather the current economic storm, with attendant positive implications for the US economic outlook.
In short, the US outlook continues to stabilize while fresh signs of deterioration are appearing in other major economies' outlooks, particularly in Europe and the UK. (We look at some key recent data points to support this view in the next section.) Hawkish Fed rhetoric (FOMC minutes, Stern and Plosser) has increased expectations of a Fed rate hike in the fall-Fed Fund futures now reflect a nearly 50% likelihood of at least a 1/4% increase in US rates at the September 16 or October 29 meetings. Increased US rate hike expectations, coupled with the sharp declines in commodity prices (stemming from overall slower global growth and demand, e.g. China's 1st half 2008 steel exports fell sharply), are dovetailing to support the USD. I am now more optimistic than in many months that the US will avoid a recession and that in a few months time we'll look back at July 2008 as the significant low point for the USD.
While I am significantly more optimistic that the worst-case scenario in the US and for the USD will be avoided, I would remind traders of the highly uncertain outlook both here in the US and globally, as well as recent range-bound trading conditions that have dominated FX markets this summer. Take it one step at a time. At the same time, I am very encouraged by the persistence of the USD's recovery this week-pullbacks were minimal and the USD is closing nearer to its highs for the week. I view such persistent price moves as an indication that markets were are not positioned for a USD rebound, and consequently had to chase the buck higher, limiting any pullbacks. That also suggests additional flows are likely to come into the USD in the weeks ahead, as shorts continue to unwind and long positions are established. The inverse relationship between commodities (oil still the key) and the USD (commodities down/USD up) continues to be the most visible trading correlation at the moment and will remain a key driver of USD. A WTI oil price drop below the $119-122/bbl support zone is the trigger for further steep losses, likely to the $100/105 area.
EUR/USD & USD/JPY price levels to watch
EUR/USD: Trendline support for the recent upmove since June 13 was broken on the drop below 1.5830, and is now resistance at 1.5900/10. A 'double top' looms above at 1.6020/40. More immediate resistance is at the 1.5750/55 level, which is marked by the Kijun line and the 38.2% retracement of the decline from 1.6038 to 1.5625. Only a daily close above the Tenkan line at 1.5833 signals further upside potential. The Tenkan Line is falling and looks set to cross down below the Kijun line next week, generating a sell signal should it occur. To the downside, the Ichimoku cloud is below between 1.5652 and 1.5572, and a drop through there will confirm fresh weakness ahead. The 100 and 55-day moving averages are also at the 1.5655 level. Also, there was talk this week of institutional buying orders between 1.5570/1.5620, highlighting that area as the key to further weakness. I look for 1.5450 next on a daily close below 1.5570.
USD/JPY: Broke and closed above the 200-day moving average, now at 106.93, and trend line resistance from recent highs, now support at 106.60/70, highlighting the potential for further gains. 108.00 is immediate resistance from a trend line drawn off the 6/16 and 6/25 intra-day highs, and above there is the recent high at 108.65/70 as the next target. Overall, the shift above the 200-day moving average suggests potential to 109.50/110.00 area. USD/JPY is currently above the Tenkan and Kijun lines at 105.88 and 106.10, respectively.
Outlook continues to stabilize in US while deteriorating elsewhere
The relative strength of the US economy versus its counterparts across the pond seems to be shifting in earnest. While no one can say that US growth has rebounded and is now on the verge of turning higher, it can be said that the data of late suggest signs of stabilization and that the worst of the declines are very likely behind us. Consumer confidence is improving, business activity looks resilient, and housing seems pretty darn close to putting in a bottom. In contrast, the European economies are witnessing renewed deterioration in these areas. We believe that the market has not yet priced in these developments and that the potential for a firming in the USD is very real, from a fundamental standpoint. We highlight some of the key economic developments here.
Consumer Confidence
Falling oil prices are translating into a more upbeat US consumer as evidenced by the latest University of Michigan sentiment numbers. The headline index jumped to 61.2 in July from 56.6 in June, and the first time above 60 since April. More importantly, the economic outlook component rose to 53.5, which is the highest result since March. This highlights US consumers' obvious sensitivity to gasoline prices and suggests that if oil continues to crumble, consumer spending looks to hold up even after the tax stimulus dissipates. On the flipside, the data in the UK this week showed a consumer on the brink. Retail sales for June plummeted -3.9% on the month and the annual growth rate sank to just 2.2%, the weakest since early 2006. This is why despite the hawkish inflation talk recently from the BOE we are still sellers of GBP/USD on rallies and especially into the 2.00 area.
Business Activity
Business confidence took a turn for the worse in the Eurozone this week as pretty well every indicator measuring sentiment fell. French business confidence slipped to 98 from 101, German IFO business climate plunged to 97.5 from 101.2, and the Eurozone PMI composite fell to 47.8 from 49.3 just to illustrate a few. Meanwhile, business spending in the US was running on nearly all cylinders in June. The latest report on capital spending showed that non-defense capital goods ex-aircraft orders -- which feed directly into GDP -- rose a strong 1.4%, while core shipments were up a healthy 0.7%. This suggests an increase in US 2Q GDP of more than 2.0% (the current consensus) and the robust orders provide a good handoff to 3Q to boot.
Housing
Housing has been a thorn in the side of the US economy for some time now and it looks from the last few months of data that stabilization is finally in the works. Existing US home sales seem to have found a bottom near 4.9 million units, as the pickup in foreclosures continues to create bargains for market entrants that were once hesitant about falling home prices. The new home sales data also showed signs of improvement, especially on the very worrisome inventory front as the latest release showed months' supply falling to 10.0 on higher sales, even as median prices rose. The same cannot be said about Western Europe where the UK saw mortgage approvals plunge to the lowest level since 1997 just this week and an inventory glut of new homes in Spain threatens to plunge that economy into recession.
Key data and events to watch next week
Next week marks month end and traders should be aware of reduced liquidity and heightened volatility, especially around key economic data releases. We believe the ramped up volatility bodes well for a USD break higher as lower volumes will see more explosive trading. Also keep in mind that the Senate is expected to sign the GSE legislation this Saturday (July 26), a measure already passed by the House. President Bush has announced his intention to sign the bill into law and this will remove another cloud hanging over the US markets.
The US economic calendar is bustling with top-tier events next week. It kicks off with the Case Shiller home price index and the Conference Board consumer confidence measure on Tuesday. Wednesday sees the ADP employment report, which has been pretty unreliable as a gauge for the government's measure of employment change. Thursday we have the advance release of 2Q GDP and the Chicago PMI index. Friday is the big day with the July NFP employment report release, ISM manufacturing, and construction spending all on tap.
The Euro-zone will also be pretty hectic, and it starts the week off with German GfK consumer confidence on Monday. Tuesday is jam-packed with French producer prices, French housing starts, German consumer prices, and the German Trade Chambers' company export survey -- this should give us some color on how the high priced euro is impacting European trade sentiment. (Our hunch is negatively.) On Wednesday we'll see Euro-zone business climate indicator, Euro-zone consumer confidence, and German retail sales. Thursday rounds out the key data with Euro-zone CPI estimate and German unemployment data.
The data week in Japan is pretty light and starts the off with the employment numbers and retail trade on Monday. Tuesday we have industrial production on tap and Thursday closes out the week with housing starts.
The UK is also relatively on the modest side. Tuesday starts it all off with consumer credit, mortgage approvals, and CBI distributive trades report (a private retail sales report) all on deck. Wednesday sees the all important GfK consumer confidence report while Thursday has nationwide home price numbers out. Friday rounds out the week with the release of the PMI manufacturing report.
Canada is very light but important nonetheless. Wednesday has the industrial and raw materials price indices while Thursday sees the important May GDP numbers. The reports will be key to assessing the Canadian inflation-to-growth balance and should provide guidance as to the BOC's next move on rates.
It is modestly busy down under and the week kicks off with New Zealand trade data on Sunday evening. Monday sees Australian leading indicators along with New Zealand building permits. Tuesday we'll see the Australian NAB business confidence while Wednesday brings Australian building approvals. Thursday has the all important Australian trade balance and Australian retail sales data on deck. Last but not least, the AiG manufacturing index is on tap for Friday.
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