Weekly Economic and Financial Commentary

U.S. Review

Pricing In A Deeper Recession

We had been assuming the November data would post a slight rebound following October's plunge. Those hopes appear to have been dashed, however, as economic conditions continue to deteriorate. Most of this week's reports came in worse than expected and it is now abundantly clear that fourth quarter real GDP will decline more than even our most recent forecast projected.

The financial markets are clearly pricing in a deeper recession. Thursday's stock market sell-off and dramatic decline in bond yields was driven by increased concerns about the financial system and the ongoing difficulties at domestic automakers. The problems in the financial markets and many old line industries are not likely to be fixed quickly and significantly increases the odds this recession will be longer and deeper than either of the past two downturns.

The only good news this week was the better than expected inflation figures. Plunging oil prices sent both the headline PPI and CPI down sharply in October. Even more surprising, the core CPI declined 0.1 percent.

Talk of Deflation is Way Too Premature

Even with these declines, the year-to-year change in the major price indices remains elevated. The overall Producer Price Index plunged 1.9 percent in October, following a 0.4 percent drop the prior month. Most of that drop was in energy costs, which plummeted 24.9 percent in October. Even with these declines, however, the overall PPI remains 5.2 percent above its year ago level. Excluding food and energy prices, the core PPI rose 0.4 percent in October and remains up 4.4 percent year-over-year.

The Consumer Price Index was also in negative territory, with the overall index falling 1.0 percent and prices excluding food and energy items declining 0.1 percent. The 0.1 drop in the core CPI marks the first monthly drop in this series since the early 1980s. That drop set off a great deal of discussion about deflation, and particularly a debt-deflation spiral. There is at least a grain of truth to these concerns. Debt laden car manufacturers, retailers and homebuilders are all slashing prices in order to clear out inventories in the face of incessantly weak consumer demand.

While consumer prices will likely post some modest declines in coming months, most of these drops are simply due to plunging commodity prices and oversupply issues. We do not believe a problematic deflation spiral is likely. Inflation will slow, however, and we expect the core CPI to return to levels well below the Fed's target zone and remain there for the next few years.

One other seemingly good bit of news was the 1.3 percent rebound in industrial production during October. The gain follows a 2.3 percent plunge in September and was largely due to disruptions in petroleum products and petrochemicals production surrounding Hurricane Ike. Excluding the rebound in energy output, the report was very weak. Output of motor vehicles plunged 3.5 percent in October and output declined sharply in most major components, including primary metals, wood products, apparel, and machinery.

The early data for November show conditions continue to deteriorate across a broad front. Early indications from auto dealers hint that November will be worse than October. In addition, the NAHB/Wells Fargo Housing Market Index fell to its lowest level ever in November, as buyer traffic has all but vanished amid the credit crunch. Manufacturing activity also appear to have weakened further, with both the New York and Philadelphia Fed reporting substantial drops in activity in November. And finally, weekly jobless claims rose much more that expected, surging by 26,000 to 542,000. With the jump, our estimate for November nonfarm employment now calls for a decline of 350,000 jobs.

U.S. Outlook

Existing Home Sales • Monday

Since the beginning of the year, existing home sales have shown some tentative signs of bottoming. Foreclosure sales have been a big reason for the recent boost to total sales, particularly in the hardest hit markets of California and Florida. High inventories, however, will continue to pressure home prices well into 2009 and possibly further.

Despite recent monthly volatility, the forward looking pending home sales index appears to suggest a relatively stable existing home sales pace over the next couple of months. Obtaining financing, however, is still a major hurdle for many would-be buyers. We are forecasting a modest 3.5 percent decline to an annualized pace of 5.00 million units in October.

Previous: 5.18M Wachovia: 5.00M Consensus: 5.02M

Real GDP • Tuesday

Finally registering what most consumers have been experiencing for some time, the advance reading of the GDP report fell at an annualized pace of -0.3 percent in third quarter. The decline was primarily attributable to sharp drops in personal consumption and business fixed investment.

While it appears no major revisions are expected in the preliminary report we are likely to see a haircut to personal consumption expenditures which could help knock a few percentage points off of real GDP in the third quarter. Adjustments to nonresidential structures investment and state & local government could also come into play.

Looking to the fourth quarter, we have forecasted as sharp decline of -3.6 percent. Given the weaker than anticipated start to the quarter, there is downside risk to that call.

Previous: -0.3% Wachovia: -0.6% Consensus: -0.5%

Consumer Confidence • Tuesday

After improving modestly in September, consumer confidence plunged 23 points to an all-time record low of 38.0 in October. Pessimism was broad based as both the Present Situation and Expectation indices recorded large declines.

The labor market deterioration has accelerated since the last report with the unemployment rate jumping to 6.5 percent. Stock prices have headed lower which should also weigh on consumers' confidence. Falling gasoline prices, however, will likely be the sole bright spot in this month's report. On net, we expect further deterioration in confidence in November.

With the unemployment rate expected to continue rising throughout 2009, consumer confidence will likely remain depressed for some time.

Previous: 38.0 Wachovia: 30.0 Consensus: 39.0

Global Review

Japan: Another One Bites the Dust

Data released this week showed that real GDP in Japan fell at an annualized rate of 0.4 percent in the third quarter (see chart at left). Coupled with the 3.7 percent drop that occurred in the second quarter, Japan has now experienced two consecutive quarters of negative GDP growth (technically a recession) for the first time since 2001. As we wrote in this report last week, the Euro-zone has also slipped into recession. With output in the United Kingdom dropping like a stone and with the U.S. economy likely to pull Canada under as well, every G-7 economy is already in or soon to slide into recession. Can you say “global downturn”?

Why is the Japanese economy contracting at present? After all, most Japanese banks did not have large exposure to U.S. subprime mortgages, and the credit crunch does not seem to have been as severe in Japan as in other major economies. Japan, however, does have exposure to the U.S. economy via exports, and shipments destined for the United States have clearly weakened over the past few months (see top chart). Although total exports of goods and services rose at an annualized rate of 2.8 percent in the third quarter, it was hardly enough to offset the 10.2 percent drop registered during the previous quarter.

In addition, non-residential investment spending, which helped to pace Japanese economic growth between 2002 and 2006, is also starting to fade. “Core” machinery orders, a good leading indicator of investment spending, fell more than 10 percent in the third quarter, which does not bode well for capex in the current quarter (see middle chart). Finally, growth in consumer spending, which was never very strong anyway, has slowed over the past few quarters (it not yet turned negative though), as the earlier rise in energy prices and deteriorating labor market conditions weighed on real disposable income growth.

Whither the Japanese economy? In our view, real GDP growth likely will remain negative for the next quarter or two, and the total contraction in the Japanese economy could approach 2 percent. Although certainly painful, this recession may not be quite as deep as the downturns in the late 1990s and the earlier years of this decade. For starters, the Japanese banking and corporate sectors are financially stronger today than they were during the previous downturns. Growth in important trading partners in Asia clearly will weaken, but a mass collapse in regional economic activity à la 1997-98 is not likely. Finally, Japanese authorities have announced plans to support the economy via a ¥5 trillion (about 1 percent of GDP) fiscal stimulus package.

The sharp run-up in energy prices earlier this year caused the overall CPI inflation rate to shoot up to an 11-year high this summer (see bottom chart). However, core inflation remained very low, and the overall rate should quickly recede to the core rate now that energy prices have collapsed. The Japanese yen, which rose to a 13-year high in early October as the global financial system tottered on the verge of collapse, remains the currency of choice among risk averse investors. Once risk aversion starts to subside, the value of the yen should start to trend lower.

Global Outlook

German Ifo Index • Monday

The Ifo index of German business confidence is a widely followed indicator because it is very current (the November outturn will be released next week) and is highly correlated with growth in industrial production. In that regard, the recent plunge in the index to it lowest level since 2003 does not bode well for German output.

Indeed, preliminary data show that the German economy contracted at an annualized rate of 2.1 percent in the third quarter. Data released on Tuesday will provide a breakdown of GDP into its underlying demand components. The unemployment rate has declined to 7.5 percent, the lowest rate since the heady days of reunification. However, labor market data that are on the docket on Thursday may show the rate starting to edge higher.

Previous: 90.2 Consensus: 88.7

Canadian Retail Sales • Tuesday

Unlike the United States, where growth in consumer spending has been on a weakening trend, growth in Canadian retail sales has held up fairly well this year. Indeed, overall GDP growth in Canada looks to have remained in positive territory in the third quarter, aided in part by decent growth in retail spending.

Data on Canadian retail sales in September are slated for release on Tuesday, and the market consensus forecast anticipates a 0.3 percent gain (month-on-month) following the 0.3 percent contraction registered in August. The outturn is likely to influence the Bank of Canada's decision on December 9, when it meets next to decide whether to cut its policy rate, which currently stands at 2.25 percent, further.

Previous: -0.3% (month-on-month change) Consensus: 0.3%

Japanese Industrial Production • Friday

Japanese real GDP contracted at an annualized rate of 0.4 percent in the third quarter, and next week's data barrage will give investors some sense of how the Japanese economy is faring thus far in the fourth quarter. An important indicator will be industrial production data for October, which will print on Friday. IP has been bouncing around on a month-by-month basis, but the underlying pace of growth clearly has slipped.

Other indicators for October that are on the docket on Friday include the labor market report, CPI inflation, retail sales and housing starts. Although upside surprises on anyone of these individual indicators is possible, we generally look for further weakness in the Japanese economy over the next few quarters.

Previous: 1.1% (month-on-month change) Consensus: -2.5%

Point of View

Interest Rate Watch

Secular Turn in the Credit Cycle?

Since 1982, credit expansion has supported the gains in both consumer spending and business investment. Financing the federal deficit has also been eased by capital inflows from abroad. Yet over the last year we have witnessed a change in the willingness of investors to supply credit at the narrow credit spreads experienced during the 2002-2006 period. The issue before us remains how much will credit spreads adjust to the new balance of risk and reward in this global economy? As a follow-on, the new risk/reward balance will also set the pace for credit-financed growth in the economic recovery ahead.

With investors now focused on risk avoidance, the consequent deleveraging of the American financial system suggests that economic growth will remain sub-par next year and therefore we expect the Fed will keep the funds rate below one percent all year. Risk avoidance will also bias long Treasury rates to remain below what might be considered equilibrium as the flight to quality dominates investor thinking.

Global Interplay: Dollar and Deficits

One of the most interesting credit developments for 2009 will be the willingness of foreign investors to export financial capital to the U.S. in the face of changing politics and rising federal deficits. There are several factors at work here. In the short run, there is a strong flight to safety which has benefited both the dollar and the Treasury market. However, as the U.S. economy recovers we may see that the character of the recovery, inflation uncertainty and expected after-tax returns may alter foreign investor willingness to invest here. We enter an era of change with caution.

Topic of the Week

Tighter Lending Conditions Persist

To little surprise, conditions to acquire a business or consumer loan tightened even further in the three months ending in October according to the Federal Reserve's Senior Officer Loan Survey. Economic conditions since the last time this survey was taken (July), continued to deteriorate as the economy, while not officially named, is in recession.

For businesses, lending standards tightening significantly, from 60 percent to 85 percent, for commercial & industrial (C&I) loans to medium and large firms. That marked a record high for this series. While issues regarding the residential sector are more familiar, lending to commercial real estate has just recently started to tighten. A record 87 percent of banks reported higher standards over the past three months. Demand for both commercial real estate and C&I loans should remain sluggish in 2009.

As dire as banks are with businesses, lending to consumers has proved even worse. The net percentage of banks willing to lend to households has deteriorated to a record 50 percent. Banks are increasing minimum payments, charging higher spreads and requiring higher credit scores for credit cards and other consumer loan products.

Bank loan officers are becoming increasingly more cautious with their capital given that the current and future economic landscape remains treacherous. Until there are signs of some stability in home prices and a bottoming in business activity, lending conditions should remain restrictive. With two more quarters of forecasted negative GDP, business and households that rely on credit will remain under pressure as the credit crunch continues to play out in 2009.

Wachovia Corporation http://www.wachovia.com

Disclaimer: The information and opinions herein are for general information use only. Wachovia Corporation and its affiliates, including Wachovia Bank, N.A., do not guarantee their accuracy or completeness, nor does Wachovia Corporation or any of its affiliates, including Wachovia Bank, N.A., assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, are for general information only and are not intended as an offer or solicitation with respect to the purchase or sales of any security or any foreign exchange transaction, or as personalized investment advice. Securities and foreign exchange transactions are not FDIC-insured, are not bank-guaranteed, and may lose value.

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Weekly Market Commentary

Overview

More investors and different markets are reacting to the 'credit crunch' and are beginning to really understand the ramifications of unwinding the 'carry trade'. Central bankers are coming round to the fact that a 'zero interest rate policy' is probably warranted, maybe 'quantitative easing' as well, and in a surprise move Switzerland halved their target rate to 1.00% from 2.00%. The rush into Treasuries continues, the yield on three-month TBills dropping to just 1 basis point, forcing investors into longer maturities, causing a dramatic flattening of the US yield curve. Benchmark thirty-year TBonds dropped to a record low 3.43%, a massive 82 basis points in just four days, and probably the biggest ever percentage move. Similar if less extreme moves in other countries, although some emerging market bonds remain under pressure and Ecuador defaulted on what they call an 'illegal' issue. Treasury Inflation Protected Securities (US TIPS) are behaving in a most extraordinary manner, five-year yields up to a new record of 4.00%. Credit spreads widened as the interbank money markets continue very seized up, iTraxx Crossover a record 905 basis points and Moody's BAA over ten-year Treasuries 612. Hungary's sovereign rating was downgraded to BBB by Standard and Poors.

Most equity indices are close to or below October's low point, the S&P 500 losing a staggering 17% over the last 5 days to 750, lower than anything since April 1997 and worth half of what it did a year ago.

Commodities were sidelined or a bit lower, Nymex Crude Oil at $48.25 below anything since May 2005 when the 'boom' in raw materials started. Currencies also sidelined although some Yen crosses dipped below October's low.

Political and Economic Developments

Inflation is coming down quite sharply, UK October CPI running at 4.5% instead of September's 5.2%; US CPI 3.7% versus 4.9%; US Producer Prices rising 5.2% instead of 8.7% a month ago; German PPI a mere 7.8% against 8.3%. All well and good but still way higher than their maximum targets. Several sentiment measures are also lower, the Philadelphia Fed Survey close to its lowest in twenty years. The US National Association of Home Builders Index almost a record low at 9.00 (from an average of roughly 66 from 1998 to 2005). Japan and Singapore are now also officially in recession.

On the 'positive' side, UK M4 Money Supply has ballooned by 15.1% over the last year, a rate of expansion last seen in August 1990. Government Budget deficits are also expected to expand significantly this year and next.

Underlying Themes

Echoes of previous market peaks with yesterday's lavish inaugural bash for The Atlantis Hotel, Palm Jumeirah, Dubai. Kylie Minogue was allegedly paid £1.3 million for a one hour show for 2,000 of the world's elite; a firework display six times bigger than Beijing's this year could be seen from space; total cost of the do: about $20 million. Hard to credit it but the heads of the big three US carmakers travelled to Washington in their private jets begging, as they threatened widespread unemployment if they weren't bailed out (again!). President elect Obama is looking increasingly like the 'great white hope' with the US National Intelligence Council saying political decisions of the next 4-8 years are critical as the US moves towards being just one of several superpowers.

A recent poll showed 33% of Icelanders want to emigrate.

What to watch for next week

A holiday-shortened week with Thanksgiving in Japan Monday and in the UAE and US Thursday. From Monday German October Import Prices and UK November Nationwide House Prices, IFO Survey, EZ15 September Industrial New Orders and Current Account, plus US October Existing Home Sales. Tuesday Japan October Corporate Service Prices, Supermarket Sales, German and US final Q3 GDP; then German December GfK Confidence, UK October BBA Mortgages, September CaseShiller House Prices and November Consumer Confidence. From Wednesday CPI for the different German states, UK final Q3 GDP, US October Durable Goods Orders, Personal Income, Core PCE, New Home Sales, November Chicago Purchasing Managers and final Michigan Confidence. Thursday Minutes of the Bank of Japan's meeting, Eurozone Money Supply, November Business Climate and German Unemployment. Friday Japanese October Jobless, Household Spending, Housing Starts, Industrial Production, Retail Trade, National CPI, Tokyo November CPI and Small Business Confidence. Then UK GfK Consumer Confidence, CBI Distributive Trades Report, EZ15 CPI and October Unemployment.

Positioning and Technical Analysis

We have shifted up a gear in the rush to try and sort out things by year-end. The reality is that many will find it impossible to do as they would like, forced into salvaging what they can, and hoping things will improve next year. Job cuts are also likely to accelerate as part of this process, avoiding Christmas and other bonuses in a desperate bid to scrimp. Shops will find this Christmas' spirit mean, conspicuous consumption the ghost of Christmas past, and enforced belt-tightening the ghost of Christmas future. Family, friends and foes will all understand the need to preserve capital and cut debt. Next year many will come to learn how, and how much, needs to be done to repair their savings.

Mizuho Corporate Bank

Disclaimer

The information contained in this paper is based on or derived from information generally available to the public from sources believed to be reliable. No representation or warranty is made or implied that it is accurate or complete. Any opinions expressed in this paper are subject to change without notice. This paper has been prepared solely for information purposes and if so decided, for private circulation and does not constitute any solicitation to buy or sell any instrument, or to engage in any trading strategy.

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Weekly Focus : Time for Another Rescue Package

The financial crisis continued to escalate in the past week. US equity markets have fallen to their lowest levels since 1997, credit spreads are widening and Emerging Markets are under renewed pressure. The latest problems started on 12 November, when US Treasury Secretary Hank Paulson announced a change in how the remaining money from the USD 700bn TARP rescue package would be spent. Paulson stated that the Treasury would use the rest of the money (USD 400bn) to support the ailing Asset Backed Security (ABS) market. This is the market where car loans, student loans and credit card loans are sold to investors. The initial chunk of rescue finance was used to pump capital directly into the banking system. However, the latest decision means the US Treasury has totally abandoned the original purpose of the rescue package, which was to buy "troubled assets" (sub-prime related mortgage assets) from the banks in order to remove the risk of further write-downs stemming from these assets.

Paulsen's decision led to a major sell-off in the US mortgage market - not least the sub-prime CDO tranches (see ABX indices). The ABX indices have previously provided a good guide to future write-downs in the banking sector. Hence the recent declines will likely lead to more write-downs and thus a need for further capital injections into the banking system. With private investor interest still very muted, this capital will most likely have to come from the government. Hence there is much to suggest the need for another rescue package with additional money from the US Treasury if panic is to be avoided. Grabbing the headlines in the past week was Citigroup - once the largest bank in the world - which suffered the biggest ever one-day drop in its share price on Thursday on fears that current measures are not enough to stop the downward spiral. A solution for the US auto industry, which is fast running out of money, is also much needed if some sort of calm is to return to the markets.

Euroland: Weak PMI to be reflected in sharp fall in Ifo

PMI for Euroland again surprised negatively, as our below-consensus estimate proved all too positive, unfortunately. We had expected composite PMI to fall to 42.2, but the actual outcome was 39.2. Euroland is now in a deep recession that will stretch very far into 2009. Meanwhile, the significant falls in commodity prices will bring inflation considerably below the ECB target of close to but below 2% in the medium term. Given the above, we have revised our ECB forecast, now expecting that the ECB will cut its policy rate by 75bp in December and by a further 50bp in January 2009. In both February and March, we expect the ECB to cut by another 25bp, bringing the key rate down to 1.50% by the end of Q1.

The German Ifo index, which is due on Monday, will reflect the weak PMI numbers - we expect a fall to 87.0 from 90.2 in October. This would be the lowest level since 1993, and would signal - just like PMI - that Germany will again experience a drop in GDP in Q4, for the third quarter in a row. The fall will be driven by a further decline in the assessment of the current economic situation from 99.9 to 96.5, which would be the lowest since September 2005. The expectations index is also anticipated to drop further to 80.5 from 81.4 in October. This would mark a new low-point for expectations since German re-unification in 1990.

Inflation has fallen sharply in recent months, and we believe this tend will intensify in November. We expect Friday's flash inflation number will show a decline from 3.2% y/y in October to 2.4% y/y in November. This is a greater fall than consensus expects (2.5%), but given the recent tumble in oil and food prices, there is in fact a chance that the fall will be somewhat greater than we anticipate. In light of the pronounced movements in commodity prices seen in recent weeks and months, there is great uncertainty regarding the impact on consumer prices. A foretaste of the impact will be provided by Wednesday's inflation numbers for Germany. In any case, the recent falls in commodity prices highlight the need for the ECB to revise down its inflation estimate for 2009 in its upcoming forecast.

Among the other important economic data in the coming week, we would mention M3, which we expect will ease further in the wake of the financial crisis. Unemployment figures for Germany are due on Thursday.

Key events of the week ahead

• Monday: German Ifo. We expect a fall to 87.0 from 90.2 in October. Expectations index expected to fall from 81.4 to 80.5.
• Friday: Flash HICP expected to show a fall from 3.2% y/y in October to 2.4% in November.
• German national accounts and unemployment plus M3 for Euroland during the week.

Switzerland: SNB cuts to 1.00% from 2.00%

The Swiss National Bank (SNB) cut its interest rate on Thursday by one percentage point to 1.00%. Hence, the target range for the 3M LIBOR is now 0.50-1.50%. The cut came between the planned quarterly meetings, but after the 3M LIBOR fixed on Tuesday below the SNB target - for the first time since September. This latest move means the SNB has now cut its policy rate by 1.75pp in the past one and a half months.

In the accompanying press statement, the SNB said the cut resulted from the inflation outlook having improved significantly while the prospects for growth had deteriorated - not least due to lower global economic activity. Inflation is now expected to fall below the 2% target before the current year-end on the back of the recent falls in food and energy prices. At the same time, the economic data have generally been weak, and a number of the leading Swiss economic research institutions now expect an actual recession in Switzerland and average real GDP growth of below or just around zero in 2009. The latest sharp rate cut indicates that the SNB has probably also calculated on a recession or at least something close to recession in their economic growth forecast.

Looking ahead, we see a not insignificant chance that the SNB will ease monetary policy further, though focus will initially - as was also the case with the previous cuts - be on ensuring that the 3M LIBOR fixes at the SNB target. While the SNB has been particularly successful in the past month at bringing the 3M LIBOR down, this will presumably prove considerably more difficult going forward. In order to bring the 3M LIBOR down to target, the SNB has provided extremely generous short-term liquidity by, for instance, keeping the 1-week repo rate at just 0.5% since 7 November, and the Bank will have to continue providing extensive short-term liquidity if it is to reach its new target. This may prove difficult, however, as there is a natural limit as to how much lower short-term rates can be set and, furthermore, a high spread can still be observed in global money markets.

Key events of the week ahead

• Tuesday 10.00: Consumption indicator for October.
• Thursday 09.15: Employment for Q3.
• Thursday 17.00: SNB's Roth speaks in Bern.
• Thursday: Extraordinary AGM for UBS shareholders.
• Friday 11.30: KOF leading indicator for November.

USA: Spectre of deflation moves closer

The prospect of a significant downturn in global economic growth has prompted sharp falls in commodity prices, which are now feeding through into consumer prices. The October inflation numbers published in the past week showed a fall of 1.0 % m/m, the largest monthly decline ever, driven by a large drop in energy prices. More interestingly, though, core inflation, ie, consumer prices net of food and energy, also declined, down by 0.1% on the month. Deflation does not occur in an economy just because the price of a single group of goods, such as energy, declines. For deflation to be present, the price of a broad selection of goods needs to decline. In other words, core inflation and inflation expectations have to come down too. Although we expect inflation to continue declining in 2009, we do not expect to see a sustained period of deflation. That said, the concern about deflation is understandable, since the economic consequences of a deflationary environment are very negative. As falling prices increase the cost of debt, households and businesses will have an incentive to reduce debt levels, which in turn will weigh on consumer and corporate spending. Saving, on the other hand, becomes more attractive in a deflationary environment, and businesses and consumers will be tempted to put off investment or purchases of consumer goods. Hence, we could end up in a deflationary-recessionary spiral, which historically has proven difficult to stop.

However, the FOMC of the Federal Reserve and, not least, Bernanke are no doubt conscious of this risk. This concern has been one of the drivers of the massive liquidity injections into money markets and was reflected in the minutes of the October 28-29 policy meeting of the FOMC released in the past week. All committee members agreed that developments in the financial markets and the growth outlook were a cause of major concern, and the minutes indicated growing concern about deflation among FOMC members. Hence, there is nothing to indicate that the Fed will stay on hold, and we expect it to cut rates by another 50bp at the December policy meeting. This would take the effective fed funds rate down to close on zero. But this does not mean the Fed is running out of ammo, but rather that the central bank will use other instruments, such as quantitative easing of monetary policy, to counter any further deterioration in the growth outlook and hence avoid inflation running significantly below the Fed's comfort zone.

Key events of the week ahead

• Monday: Existing home sales set to continue trending down; look for a fall of 1.1% to 5.12 million.
• Tuesday: First revision of Q3 GDP numbers expected to show downward revision to -0.6 % q/q AR from -0.3%.
• Tuesday: We expect the Conference Board's consumer confidence indicator to rise to 40. However, the most important part will be the sub-section relating to the job situation.
• Wednesday: We expect income to have increased by 0.2%, while personal spending probably declined by 1.2% in October.
• Wednesday: New home sales set to come out weak. We expect a fall of 5.2% in October to 440K.

Asia: Japan now in recession

In Asia, Japan will once again be in the limelight in the week ahead. The third-quarter GDP data released during the past week officially sent Japan into recession - assuming that recession means two consecutive quarters of negative GDP growth (see Flash Comment - Japan: It will get worse before it gets better). On Thursday of the coming week the Bank of Japan will publish the minutes of the October 31 policy meeting, at which the BoJ cut its benchmark interest rate by 0.2 percentage points to 0.3%. Four committee members voted against the decision. Three of the no-voters favoured a larger rate hike, while one voted for unchanged rates. Hence, it will be interesting to get a clearer picture of the internal discussions at the BoJ, including not least the arguments for the view that money market rates too close to zero could hamper the functionality of money markets. Committee chairman Shirakawa in particular has lately argued along these lines. Based on inflation and growth developments alone, the BoJ could easily justify a return to a zero rate policy. As such, the likelihood of the BoJ resuming its zero rate policy depends, not least, on committee members' assessment of the costs of running zero interest rates. The minutes of the October 31 policy meeting will give us an idea about committee members' thoughts on this issue. The coming week will also see the release of consumer prices and industrial production data for Japan (due out Friday). The market has begun pricing in some likelihood of the benchmark Japanese interest rate being cut further. Twelve-month O/N forward is trading at around 0.25% at the moment.

Otherwise, the main focus in the week ahead will be on the release of Q3 GDP data for a number of Asian countries (India, the Philippines, Thailand and Malaysia). To nobody's surprise the Q3 GDP numbers reported so far have pointed towards weaker growth, and the preliminary data for Q4 suggest a significant slowdown in the last quarter of 2008.

Key events of the week ahead

• In Japan the minutes of the October 31 monetary policy meeting of the BoJ will be released Thursday. Consumer prices and industrial production data for October are due out Friday.
• No key releases expected for China in the coming week.
• Thailand (Monday), Philippines (Thursday), India (Friday) and Malaysia (Friday) are all set to publish Q3 GDP numbers.

Fixed Income: Deflation will be the next fear in line

The steep falls in yields in both Europe and the US continued unabated in the past week. The sour mood in the financial markets and the still swift and very synchronous deterioration of the economic numbers have further boosted expectations of rate cuts. The markets now expect that the policy rate will fall to 0.50% in the US by December and 1.75% in Euroland by next summer.

However, what is interesting is that the falls in yields in the past couple of days have not led to a steeper curve. On the contrary, 10-year yields have fallen more than 2-year yields. This has been particularly true in the US, and is due to an increasing expectation that it may be a long time before central banks again begin to raise rates. Underpinning the markets' expectation is a growing fear that the economic downturn could be so deep and long-lasting that the credit crisis might cause a deflationary spiral in the world's economies. That deflationary fears are not unfounded was confirmed in the minutes of the Fed's latest meeting, where several members mentioned deflation as a real risk (see Flash Comment - FOMC: Deflation fears looming).

In the US, where the policy rate is close to zero, making it difficult for short rates to fall further, growing deflation fears will primarily push down yields at the long end of the curve. In other words, a flatter US yield curve is increasingly likely if expectations grow of the fed funds rate remaining low for an extended period. Pulling in the other direction is the massive budget deficit, which has to be financed via the government debt market. Concerns about the increasing issuance of government bonds have so far been the prime reason why 10-year yields have had difficulty in falling further. However, it now seems that fears of deflation have begun to negate issuance worries.

The week ahead will see minor activity data in the US. In Europe, the German Ifo will be released along with final GDP numbers. We are not looking for any major positive surprises, meaning the downward momentum in the fixed income market will be maintained.

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Danske Bank http://www.danskebank.com/danskeresearch

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READ MORE - Weekly Focus : Time for Another Rescue Package

The Weekly Bottom Line

HIGHLIGHTS

• U.S. inflation rapidly decelerating
• Fed begins new policy of quantitative arming
• Canadian core inflation constant while headline eases from 3.4% to 2.6% y/y

Central banks slashed interest rates and all I got was this lousy economy. That could be the slogan for the hottest selling t-shirt this holiday season, or the refrain phrase for the next Top 40 hit on the radio. But as bad as financial markets have been to date, the worst is still yet to come for the economic news.

Elegantly Wasted

U.S. inflation figures for October reported the first month-over-month decline in core consumer prices (- 0.10%) since the early 1980s, and the 1.0% m/m decline in headline inflation (to 3.7% y/y) is the largest monthly fall in U.S. consumer prices in the 60 year history of the series. The drop in headline inflation is being driven by the almost $100 decline in oil prices since the summer, while the fall in core inflation is a sign of the growing slack building in the labour market. The weekly jobless numbers released this week show the pace of job losses in the U.S. is now past the peaks in either the 2001 or 1990 recession. More job losses mean more slack in the economy and even lower inflation.

And unfortunately, the problems in the credit markets suggest the pace of job losses will continue to worsen. When businesses have problems borrowing, they have problems investing in factories, machinery, and employees. In fact, the Fed's survey of tightening standards in commercial and industrial lending, which continued to worsen to a new high in the fourth quarter of 2008, tends to lead the peak in U.S. job losses by 6-9 months, which implies weaker consumer spending, business investment, and economic growth in general. Early trade figures out of Asia suggest we may see a significant contraction in U.S. exports in the fourth quarter. Coupled with consumer retrenchment, business investment pull back, and new home construction falling to the slowest pace in the 50 year history of that series, the contraction in U.S. GDP in the fourth quarter could be twice as large as the 3% contraction earlier data were tracking.

Manic Depression

In this environment, the Fed knows what they want but they just don't know how to go about getting it. Inflation worries are out the window, and in fact, the Fed now appears to be turning its attention to creating inflation. While the Fed's target for the fed funds rate remains at 1.00%, the effective fed funds rate has actually been trading at below 0.50% since late October. On top of that, the Fed has quietly increased the size of their balance sheet by almost $1.3 trillion over the last two months. The Fed now has over $2 trillion to deploy into financial markets as needed. At the same time, with short-term market interest rates so low and the Federal Reserve paying 1% on reserves that the banks choose to park with the Fed, excess reserves in the banking sector have increased by $600 billion over the last two months - more than they hold in deposits - and almost $300 billion in just the last two weeks. This increase in bank reserves is a double-edged sword. On the one hand, it means there is a lot of cash sitting with banks that could be quickly deployed at a moments notice, rapidly increasing inflation and lending. Unfortunately, holding all these excess reserves means they are not currently lending it, implying credit markets are still too rough for banks to comfortably enter.

Now some of this discussion may sound as nerdy as overhearing a debate at a Star Trek convention on who was the greatest starship captain. But make no mistake. The Fed is gearing up for battle. Lowering interest rates closer and closer to zero has less and less impact on the economy. And all that slack building in the economy so quickly raises the risk of the dreaded “d” word - deflation. In fact, the magnitude and duration of job losses implied by the Fed's commercial lending survey suggests that even if credit markets were to improve right now, the economic lags discussed above would result in the unemployment rate breaching 8%. And that level of the unemployment rate tends to see core PCE inflation (the Fed's preferred measure) fall by 1 percentage point each year, running the risk U.S. core inflation could hit 0.0% by 2010.

While the Fed has been fairly mum on these balance sheet moves, it appears they are getting fairly close to the quantitative easing policies followed by Japan - but used there only after deflation had begun. We think the Fed is trying to increase their arsenal so that should a massive intervention be necessary, they have the firepower to back it up. Announcing this policy too early might risk spooking the markets before the Fed's monetary army is big enough. Right now, the Fed is following a policy of quantitative arming. The easing will come when the Fed starts using that new capital they have to buy new financial instruments to get credit markets moving again. (For more, see http:// www.td.com/economics/special/rk1108_fed.pdf).

Tainted Love

Unfortunately, as hard as it tries, the global economy cannot run away. The Bank of England has now cut interest rates to the lowest level in over 50 years, while inflation has only just started to ease off a nearly two decade high. Headline inflation in Canada fell by 1.0 percentage point in October, the biggest monthly decline since 1959, bringing inflation down to 2.6%. While core inflation remained constant at 1.7% y/y, inflation is not a concern for the Bank of Canada either. It seems highly likely they will cut rates by 50 basis points in December, a week before the Fed likely delivers its next cut. But unlike the Fed, the BoC still has plenty of interest rates cuts they could deliver should the domestic economy worsen, and fortunately, the Canadian economy remains less bad - which is what passes for optimism these days - than its U.S. cousin.

We do think the concerns over the Canadian housing industry have been overblown in making comparisons with the U.S., and even the national average Canadian home price aggregate measure seems distorted, which is why we have started publishing our own series (for more, see http://www.td.com/economics/special/pg1108_hpi.pdf). But Canada and the rest of the world simply cannot escape the clutches of the American economy. And the rapid declines in commodity prices feed into less spending power of Canadian consumers and businesses. We continue to wait for that Bobby McFerrin moment, when financial markets start to think “don't worry, be happy.” But unfortunately, the economic data continues to confirm our belief that the global economy, U.S. and Canada included, will not start to see a serious recovery until 2010.

UPCOMING KEY ECONOMIC RELEASES

Canadian Retail Sales - September

Release Date: November 25/08 August Result: total -0.3%% M/M; ex-autos -0.3% M/M TD Forecast: total 0.7% M/M; ex-autos 0.4% M/M Consensus: total 0.3% M/M; ex-autos 0.2% M/M

After slipping last month for the first time since February, Canadian retail sales are expected to post a recovery of sorts in September with a modest 0.7% M/M advance. Much of the improvement in sales should come from the rebound in motor vehicle sales, while the whopping 106K jobs added to Canadian payrolls during the month should also have a favourable impact on consumer spending. Excluding autos, sales are expected to rise by a more modest 0.4% M/M. This pace of advance, however, is unlikely to be sustained as we expect Canadian consumer spending to moderate in the coming months.

U.S. Durable Goods Orders - October

Release Date: November 26/08 September Result: total 0.8% M/M; ex-transportation -1.1% M/M TD Forecast: total -3.0% M/M; ex-transportation -2.0% M/M Consensus: total -2.5% M/M; ex-transportation -1.5% M/M

Most indicators of U.S. economic activity have been on a downward trajectory, and the pace of decline in October for a number of these economic indicators has been particularly pronounced. As such, with overall U.S. business activity continuing to weaken at a fairly brisk rate, we expect U.S. durable goods orders to post a rather significant 3.0% M/M drop in October, reflecting the growing unwillingness of U.S. businesses to embark on major capital investments during a time of economic recession. Much of the weakness is expected to come from orders for machinery and transportation equipment. Excluding transportation, however, durable goods orders are expected to fall by a smaller 2.0% M/M.

U.S. Personal Income & Spending - October

Release Date: November 26/08 September Result: income 0.2% M/M, spending -0.3% M/M; core PCE deflator 0.2% M/M, 2.4% Y/Y TD Forecast: income 0.0% M/M; spending -0.9% M/M; core PCE deflator 0.0% M/M, 2.2% Y/Y Consensus: income 0.1% M/M; spending -0.9% M/M; core PCE deflator 0.S1% M/M, 2.3% Y/Y

It is now clear that with a rapidly deteriorating labour market, declining home prices and slumping equity markets sapping household wealth, U.S. consumers are beginning to reduce their spending at a fairly dramatic pace. For October, we expect personal income to remain flat, while personal consumption expenditures should post its second consecutive monthly decline, falling by a massive 0.9% M/M - which will be the largest decline in this indicator in seven years. On the inflation front, the core PCE deflator is expected to remain unchanged on a monthly basis, bringing the core PCE deflator to 2.2% Y/Y. In the coming months, we expect to see further weakness in consumer spending, while the core PCE deflator is expected to moderate even further on account of the growing U.S. economic slack and falling commodity prices.

TD Bank Financial Group

The information contained in this report has been prepared for the information of our customers by TD Bank Financial Group. The information has been drawn from sources believed to be reliable, but the accuracy or completeness of the information is not guaranteed, nor in providing it does TD Bank Financial Group assume any responsibility or liability.

READ MORE - The Weekly Bottom Line

Financial Markets Review : Credit Market Tensions Intensified This Week

Financial market review - foreign exchange

Rising fears saw risk appetite retrench this week, pushing equities and benchmark bond yields to multi-year lows. The bearish sentiment was reflected in currency markets by another solid week for the yen, which rose to a 3-week high against the US$ (93.57), in spite of data showing the Japanese economy in recession for the first time since 2001. In contrast, the biggest G10 fallers were the high yielding Australian and NZ dollars, prompting the RBA to intervene and purchase its own currency as it tested recent lows. Overall, the US$ had another solid week, with the dollar index - its average value against six major world currencies, rising to the highest since April 2006 (88.46). Within this, £/$ eased 0.3% on the week to 1.4784, while €/$ fell 1.4% to 1.2519. The SNB surprisingly cut its target rate by a record 1% this week, reducing it to just 1%, from 2.75% at the start of October. The franc fell to its lowest against the US$ since August 2007 (1.2298), while €/CHF briefly rallied through 1.54. However, the biggest falls this week were again in emerging market currencies, led by the Brazilian real and Mexican peso, as risk aversion spiked up. It may in part have also reflected further selling pressure on commodities, with crude oil falling below $50 for the first time since May 2005. However, gold prices rose for a third straight week.

Economic news in the UK this week confirmed the prospect of further interest rate cuts, however its impact on sterling was relatively limited. Inflation data showed consumer prices rose by 4.5% in the year to October, down sharply from 5.2% in September, with a large fall also in retail price inflation. We now believe that headline retail price inflation may be negative for 2009 as a whole, from 4.5% in October. The minutes of the Bank of England MPC meeting earlier this month provided another surprise, as they revealed that the committee considered cutting rates by more than the 1.5% sanctioned. This was based on projections in the Q4 Inflation Report that implied that a cut in excess of 2% might be required in order to meet the inflation target in the medium-term.

The comments raise the risk of a further cut next month, possibly by as much as 1%. Other UK data published this week showed retail sales were more resilient than expected in October, falling by just 0.1% during the month. Ahead of the Pre-Budget Report next week, public finances data showed borrowing already at £37bn in the first seven months of the fiscal year, compared with £20bn last October and the full year Budget 2008 target of £43bn. A surprisingly sharp 1% fall in US consumer prices in October saw the $ spike to its intra-week lows against the £ and € on Wednesday, at 1.5250 and 1.2814, respectively. However, the rallies proved short lived, as rising risk aversion saw the $ strengthen at the close of the week. The $ remained bid in spite of other data showing a sharp rise in initial jobless claims and some very disappointing housebuilding figures in October.

It was a relatively quiet week for data in the euro zone, however a busy one for ECB speakers. Their comments supported market speculation that further deep cuts in interest rates were likely in coming months. The main data highlight was the 'flash' services and manufacturing PMI estimates, which fell to record lows in October.

Interest rate market review - bonds, cash and swaps

A worsening backdrop for the global economy and the associated falls in equity markets kept intact the downward trend for G7 benchmark bond yields this week. Measures of credit risk widened appreciably as equities accumulated losses in the wake of negative business updates and announcements of job cuts by some of the world's leading companies. The grim outlook for the world economy and the fall in crude oil prices below $50pb also caused deflation fears to intensify. This led to a generalised decline in yields in the US, the UK and the euro zone to historical lows. Yields on the US 10 and 30 yr bonds fell to a record low of 3.06% and 3.61%, respectively. The FTSE-100 closed the week down nearly 11%.

UK economic data was dominated this week by the report of a bigger than forecast drop in inflation in October. Both CPI and RPI inflation fell more than expected last month led by to sharp falls in oil prices and the cost of transport. Annual CPI fell to 4.5% from 5.2% in September and annual RPI fell to 4.2% from 5.0%. Core inflation slowed to 1.9% from 2.2%, the lowest since July. Sharp cuts in interest rates and falling house prices mean that we now expect RPI inflation to fall into negative territory next year. The rapid unwinding of inflation pressures and fears of outright deflation are putting downward pressure on long-dated yields, despite concerns that the Chancellor will announce a steep rise in government borrowing next week. The yield on the 10yr gilt fell to 3.85% this week, a drop of 22bps. The yield on the 30yr gilt fell 35bps to 4.06%. 5yr swaps ended the week down 24bps at 3.73%.

Speculation that the BoE will cut interest rates by 100bps to 2.0% in December was buttressed by the MPC minutes of the November meeting. These revealed that the BoE voted unanimously for the rate cut to 3.0% this month. We now expect the cost of borrowing will be trimmed next month to 2% as the BoE guards against inflation undershooting its 2% target next year. Retail sales figures for October were published on Thursday and showed a smaller than expected decline of 0.1% m/m. UK 3-month Libor fell 14bps this week to 4.04%, reducing the spread over Bank rate to 104bps, a 2-month low.

The biggest falls in bond yields this week were concentrated in the US where worries about the financial system and the solvency of the three largest car manufacturers sparked strong demand for the safe haven of government bonds. The Dow fell below 8,000 and the S&P 500 fell below 750, putting losses so far this year close to 50%. Moreover, US economic data is still not stabilising and this is compounding fears that the recession could be deeper than previously thought, causing ripples across the world economy. The Fed this week revised down its 2009 forecasts for growth and inflation, and turned more pessimistic about the labour market. Initial claims continued their ominous rise this week, climbing to 542,000. At the same time, October inflation data showed the first monthly fall in core CPI since 1982. The 0.1% fall led to a drop in annual core inflation to 2.2% from 2.5% in September. The combination of shrinking output growth and falling inflation led to a steep decline in treasury yields across the curve. 5yr swaps fell to an intra-week low of 2.81%, but closed the week at 2.97%, down an extraordinary 42bps from last week.

New all-time lows for the euro zone manufacturing and services PMI's in November underlined the threat of a more protracted period of negative gdp growth in the region. The resulting rise in spare capacity and expectations of a sharp fall in inflation pulled 10yr bund yields and 5yr swaps below 3.50%. The weak data will inevitably add pressure on the ECB to cut rates decisively when it meets in two weeks time. We expect rates to be cut in December by at least 0.50%.

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READ MORE - Financial Markets Review : Credit Market Tensions Intensified This Week

Weekly Foreign Exchange Insights

With one notable exception, this past week in foreign exchange was pretty much a carbon copy of the prior week. The yen continued its advance against just about all other currencies including the dollar. The U.S. currency posted sharp further gains against many emerging market currencies and commodity-sensitive currencies. Chinese officials kept the yuan steady as they have done since midyear. The main exception involved sterling, which at 16:00 GMT was showing net gains of 0.75-1.0% against the dollar and euro after plunging nearly 6% against the dollar in the week to November 14th. The economic and financial backdrop was also similar during each of the past two weeks. Equities crumbled everywhere, bonds rallied strongly, and oil (but not gold) continued to drop. Very few advanced economies have escaped a recession that promises to be among the worst, if not the most severe, since World War Two. The stimulus of low interest rates, cheaper energy, and more deficit spending will continue over coming quarters to be overwhelmed by difficult credit conditions, rising joblessness, deflating housing and financial asset prices, and major adjustments by consumers to a substantial loss of wealth and reduction in income. Housing markets must stabilize before economic rebirth can begin, but that development is no longer a sufficient condition for recovery. It is doubtful that Europe, Japan, or Canada will be able to secure upward traction until the United States is doing so, and a huge risk for other advanced economies is that the United States experiences an L-shaped business cycle. The new leadership taking power in the U.S. Federal government in 60 days faces daunting challenges. Success may hinge more critically upon how clearly change and hope is communicated to markets and voters than the specific actions that will be taken.

Equities in the United States and Europe have tumbled about 20% in the very brief time since the election. The Nikkei lost somewhat less, but many Asian markets did worse. The bear market was already long in the tooth by the start of this month, and recent data, although grim, do not reflect this latest shock to wealth. Resolution of the GM bailout request has become a lightning rod for the markets if one believes the chatter. But most likely, markets and economic data will continue to accentuate the negative whatever is decided about GM. Interestingly, as the chart below indicates, the period since the U.S. election has been one of those rare times when the dollar, euro, and yen all moved in the same direction on a trade-weighted basis. Such has happened because of steep declines in many non-G-7 currencies.

Trade-Weighted Chg	Since Nov 04	Since Sept 12	Since one year ago
U.S. Dollar	+3.8%	+10.0%	+15.8%
Euro	+1.4%	-2.9%	-4.2%
Yen	+7.6%	+20.9%	+37.1%
Sterling	-5.2%	-9.2%	-18.6%

Japanese intervention to reduce yen appreciation is a mounting risk. Economic prospects in Japan have darkened as a result of escalating global financial turbulence. The recession is getting worse. A softer yen would be appropriate, and the sharp appreciation depicted above will inflict substantial incremental damage. The tightening impact on domestic monetary conditions needs to be offset with much easier domestic monetary policy. However, short-term interest rates are below 0.5%, and BOJ officials still refuse to bring them to zero and resume quantitative easing. Given those constraints, officials might as well sell yen in the market, a policy tool that the G-7 has given Tokyo permission to try.

The stabilization of sterling in recent days probably will prove brief. Britain is likely to experience a deeper recession than most advanced economies. It's chronic current account deficit and weak factory sector point to a need for a more competitive exchange rate. With domestic inflation subsiding faster than expected, the path is clear for the Bank of England to continue cutting interest rates aggressively. The pound has fallen over the past year about as much as the dollar rose. The rally in the dollar is welcome, because holders of big dollar portfolios were expressing impatience about a year ago with the U.S. currency's persistent loss of value and threatening to diversify into the euro. Aside from that situational consideration, sterling has moved more appropriately than the dollar in a deleveraging world where both the United States and Britain will be required afterward to become more reliant on net exports for growth.

The euro continues to be an object of stability in contrast to the three other currencies featured in the above table. Flexible exchange rates have been embraced for the past 35 years because they give policymakers and economies an extra option when adjustments are unavoidable. However, currency movements will not promote appropriate adjustments in the case of the dollar and yen, and exchange rate stability would be a more desirable outcome in those instances. More broadly, G-7 leaders introduced new language earlier this year in their shared foreign exchange policy, which declared that "sharp fluctuations in major currencies" could have adverse "possible implications for economic and financial stability." Their point is that currency volatility per se can undermine economic growth especially if conditions in the marketplace are borderline disorderly. A debate has indeed broken out in Europe's financial press regarding whether the question of Britain joining the common currency system is an idea who's time may have come. Not to get into the pros and cons of joining, I will simply say that the British and world recessions will be completely in the rearview mirror before this possibility will be even taken seriously.

A more interesting test posed by the recession is whether capitalist or planned economies handle it better in the sense of emerging sooner with restored trend growth. Advanced capitalist economies like the United States have already made huge concessions to the other side, pouring taxpayer money into the financial sector and considering the same into other areas deemed by some as too important to fail. China stands at the top of the planned economy food chain. China has adopted a many elements of capitalism, but the central government retains immense powers that can be used for managing a crisis like what the world faces now. The yuan's appreciation was halted in July, for instance, and a fiscal stimulus equal to 15% of GDP over two years was announced recently. China was not spared from the global slowdown. Growth has slowed already by nearly 3 percentage points from 11.9% in full-2007 to 9.0% in the year to 3Q08. That's a bigger percentage point slowdown than in many advanced capitalist regimes, and the social consequences of not getting over this hump quickly could be huge. China may slow appreciably further in 2009. The real test will be if it resumes double-digit expansion faster than Europe, the United States, or Japan take to recapture trend rates of growth.

Larry Greenberg CurrencyThoughts

READ MORE - Weekly Foreign Exchange Insights

This Week's Market Outlook

Highlights

• Risk appetite dictating the pace in a very emotional market
• Treasury auctions and auto bailout key for the buck's direction
• Key data and events to watch next week

Risk appetite dictating the pace in a very emotional market

Risk appetite continued to dictate the pace in very emotional markets this week. US stocks got decimated nearly -14% as a supposed deal to bring relief to the US automakers and speculation that a large US bank would be split up and sold never materialized. The S&P 500 took out the 2002 intraday low and made a fresh 11 year nadir just above the 741 mark as we write. The buck was once again the beneficiary of this flight to safety and the USD index jumped 2% on the week.

The price action in FX was in line with the move back into risk aversion as well. JPY crosses followed global equity marts lower. USD/JPY shed about -230 pips for the week and was sitting near 94.80/90 while EUR/JPY saw more dramatic selling and sank about -350 points towards the 118.90/95 zone. The downside is likely to persist while below 96.50 and 123.00 respectively. EUR/USD was down a modest -70 pips on the week towards 1.2530/40 as the action in the JPY crosses kept the volatility here relatively mild. We would expect the trend lower to persist while below 1.2650/1.2700 here.

Treasury auctions and auto bailout key for the buck's direction

In terms of gauging the direction of the USD going forward, upcoming Treasury auctions and the outcome of the US automakers' problems should be closely watched. The recent rally in US Treasuries is testament to the allure of US assets in an uncertain global landscape. The 2-year note fell below 1% this week for the first time ever while the shorter term 3-month bill plunged to 0.01% and the lowest since 1940. This flight to US paper has helped keep the buck supported and thus a positive outcome in the upcoming auctions should continue this trend.

The automakers' problems look more and more likely to be resolved prior to the Obama administration taking office. Congress continues to push for some sort of plan while Obama's transition team has drawn up a prepackaged bankruptcy plan for the Big Three. Failure of the automakers would likely be devastating to the US economy at least in the short run and would likely push forecasts for 2009 unemployment and growth to gloomier levels. While a plan towards viability would initially see the USD lower as risk appetite increases, we would look for an improvement in US economic fundamentals to give the buck a nudge higher on the follow.

Key data and events to watch next week

The US economic calendar is busy in the upcoming holiday shortened week and Monday kicks things off with existing home sales. Tuesday sees 3Q preliminary GDP, the Case-Shiller home price index and consumer confidence on deck. Wednesday rounds out the week and is ultra busy with durable goods, personal income/spending, core PCE price index, initial jobless claims, the Chicago PMI, University of Michigan confidence and new home sales. US equity marts are closed for Thanksgiving on Thursday and Friday has nothing on the agenda.

The Euro-zone is jam-packed with economic events. Monday starts it off with EZ current account, German IFO and EZ industrial new orders. Tuesday sees German GDP, German GfK consumer confidence, French business confidence and French housing starts. Wednesday has German import prices, French consumer confidence and German consumer prices on tap. On Thursday we get German employment and EZ business/consumer confidence while Friday closes out the week with French producer prices, EZ consumer price estimate and EZ unemployment.

Japan sees a pretty busy calendar as well but the action on the data front doesn't start until Thursday. That day sees employment, consumer prices, industrial production and retail trade. Friday follows up with small business confidence and housing starts. Also look out for the BOJ monthly report on Tuesday and the minutes to the monetary policy meeting on Wednesday.

It is a rather slow week in the UK and it kicks off with business investment on Tuesday. Wednesday has GDP and the index of services lined up. Friday rounds out the week with GfK consumer confidence and the CBI distributive trades report. On the policy front, watch for BOE members (King, Gieve, Bean, Barker, Sentence) testifying on Tuesday.

Canada also sees a characteristically slow week ahead. Tuesday sees the all-important retail sales report while Friday closes out the action with the current account and industrial product prices.

The action down under is on the light side. New Zealand trade balance kicks it off on Wednesday. Thursday sees Australian private capital expenditures, New Zealand business confidence and New Zealand building permits. Friday closes it out with Australian new home sales.

Brian Dolan, Chief Currency Strategist Jacob Oubina, Currency Strategist Forex.com http://www.forex.com

DISCLAIMER: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase of sale of any currency. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.

READ MORE - This Week's Market Outlook

Market Week Wrap-up

Fear of the three D's - deleveraging, deflation and Depression - has gripped markets this week, with myriad problems faced by the economy weighing heavily on investors. The non-event that was last weekend's G20 meeting destroyed hope for coordinated economic rescue plans from the major industrial countries. Then early in the week Treasury Secretary Paulson said that he would not draw the second $350B tranche of TARP funding, electing to leave the funds in reserve until the new administration takes over next January. By Thursday GM was trading well below $2, Citigroup sank below $5 and the VIX volatility index, a widely followed measure of fear in the stock market, headed back above 80 for the first time since the October panic. Word that President Elect Obama had chosen New York Fed's Timothy Geithner as his treasury secretary sparked a late rally on Friday, making up a significant portion of the week's losses while eliminating one more chance for capitulation. For the week, the DJIA fell 5.3%, the Nasdaq composite dropped 8.8%, and the S&P 500 slumped 8.4%, hitting an 11 year low.

The fragile state of the US auto industry was on full display this week as Congress held two days of hearings on a potential auto industry bailout and then failed to even bring a rescue bill up for a vote. On Monday the White House foreclosed on any chance of drawing funds from TARP the auto industry turning the package into a political football as Democrats spurned any deal that would not be carved out of the TARP. Senators Levin, Bond and Voinovich made a last ditch attempt to work out a bipartisan aid bill on Wednesday and that would redirect the already authorized $25B in funding as financial support, but ultimately the effort failed. The Democratic Congressional leadership indicated that they were prepared to hold a legislative session in the first week of December on automakers aid, but insisted that the industry had to bring them a viable plan for reorganizing themselves before any package would be passed.

Shares in Citigroup have been declining steadily all year, but things took a dramatic turn this week after CEO Vikram Pandit announced substantial job cuts at a company-wide “town hall meeting” on Monday morning. Then on Wednesday Citi said it would bring $80B worth of assets from its SIVs back onto the balance sheet. The move unnerved shareholders, given that the holdings involved aren't garden-variety securities but rather tricky, potentially toxic assets like CDOs. Saudi Prince Alwaleed made a vote of confidence in the company's restructuring plans, pledging to boost his stake back up to 5% from about 4.3% prior, noting that he believes Citi is taking "all the right steps," and that its banking model is a "long-term winner," but things were looking dire on Thursday and Friday. Citi's shares broke $5.00 an hour after the open on Thursday and broke $4.00 not long after the open on Friday. The sharp declines fired up the rumor mongers, led by CNBC's Charlie Gasparino, who insisted that Citi was possibly looking for merger partners, including Goldman, Morgan Stanley and State Street. Nothing came of the rumors on Friday, but there's no doubt we will be hearing a lot more about Citi this weekend and through next week.

Yahoo co-founder and CEO Jerry Yang finally threw in the towel and announced on Monday that he is stepping down from the helm. Investors responded enthusiastically to the news at first, sending Yahoo's shares up around 16%, although the shares were making fresh five-year lows later in the week. Analysts and observers immediately began speculating on the probability that a Microsoft deal is back in play, although Microsoft CEO Steve Ballmer told investors at a shareholder meeting that talks with YHOO over an acquisition are finished and that MSFT has no active talks with Yahoo, although a search deal could be interesting.

Dow component Hewlett-Packard offered preliminary fourth-quarter data showing that earnings and revenue will be more or less in line with expectations. But other tech news was less reassuring. The Semiconductor Industry Association (SIA) projected that 2009 semiconductor sales will fall by 5.6% y/y, making for the first decline since 2001, while flash memory titan Sandisk cut its 2009 CAPEX guidance to $900M from $1.3B prior.

On Wednesday BASF, the world's largest chemical company, said it was slashing output, shutting plants and laying off workers due to massive declines in demand among key industries. The company plans to shut down 50% of its production capacity, shuttering nearly 80 plants worldwide and reducing production at another 100 plants. BASF said that customers in the automotive industry have canceled orders at short notice and noted that volumes are being negatively impacted by increased reduction of inventory due to a lack of credit in customer industries.

Most of the leading companies in the retail sector reported third quarter results this week. Generally speaking firms disclosed results that held up fairly well in the quarter, although this reporting period ended before the crisis in credit markets had fully spilled over into the “real” economy. Home improvement giants Home Depot and Lowe's came in ahead of earnings and revenue estimates, although both firms cut their full-year outlook slightly. Target met EPS targets, missed revenue estimates by a hair and suspended its stock buyback program. The Gap held things together, reporting in line with estimates, and even managed to maintain its outlook for the year.

The positive correlation between stocks and commodities has held good as investors around the world look to or are forced to sell a variety of assets as part of the dreaded deleveraging process. The woes continue in the energy complex as demand destruction and severe recession concerns hobble prices. Front-month crude closed the week below $50 for the first time since May 2005. Average gasoline prices in the US fell below $2/gallon for the first time since March 2005. Natural gas remains near multi-year lows despite a brief uptick early in the week upon the arrival of winter temperatures in the Northeast. Metals futures also remain under pressure led by the industrials. Front-month copper touched fresh three-year lows while aluminum traded at levels not seen since 2004. Gold futures rallied hard on Friday sending the December back above $800 for the first time in nearly a month. Speculation swirled that it was likely the Chinese in the market driving up prices after earlier in the week the Hong Kong Standard reported the PBoC was considering diversifying its currency reserves, and that it could result in the purchase of up to 4K tons of gold.

Trading in fixed income markets was dominated by what can best be described as a stampede to safety. Worries about the deteriorating economy and in particular the functioning of major financial institutions sent US Treasury yields to historic lows. Interbank lending rates remain well off the highs seen at the height of the credit crisis last month, but little if any improvement in actual lending activity was seen this week, enabling the US three-month TED spread gain traction above 210 basis points. Rumors of pending defaults in the commercial mortgage-backed securities market amplified risk aversion as the spreads spiked. The insatiable desire for cash and cash equivalents helped slash the yield on the three-month T-bill to 0.01%, a level last seen way back in 1940. On Thursday, the two-year cash yield moved below 1% for the first time and along with the long bond yield reached record lows before rebounding on Friday.

The surprise 100 basis-point cut by the Swiss National Bank spurred speculation that coordinated rate intervention was possible before next week's Thanksgiving Day holiday. Subsequent commentary from both Fed and ECB officials indicated they were likely to continue down the path of quantitative easing even as we move towards zero in the US. Midweek the Jan fed fund future priced in as much as a 40% chance the Fed cuts 75 basis points by year end before backing off, though that contract continues to fully price in a 50 basis point cut a next month's FOMC meeting. Trading is likely to remain thin next week with focus finding its way to Monday's existing home sales data and the 2 and 5-year note auctions.

The global recession inducted another member this week as Japan officially dipped into recession for the first time since 2001, with its Q3 GDP dropping to -0.1%, the second straight quarterly contraction. A monthly Japanese government report showed that the deepening financial crisis was spreading to Asia, lowering forecasts for the economy and export sector again. Global recession concerns are also highlighted by recent steel production statistics, which showed a decline of 12.4% in Oct from year-earlier levels with Chinese output dropping 17%. y/y. Meanwhile, a Goldman Sachs analyst revised his forecast for Q4 real US GDP to -5.0% from prior view of -3.5% and projected that the US unemployment rate would rise to 9% by the end of 2009 against its prior view of 8.5%. Warren Buffett also chimed in on unemployment, stating he expects the jobless rate to rise considerably higher than the Fed estimate of 7.1%-7.6% in 2009.

In Forex, the overall theme for the USD as the week commenced was the prospect for a trading range with EUR/USD pair seen between 1.24 to 1.28. European currencies moved higher as the week began on chatter that a Far Eastern central bank was covering its recent GBP short position. The USD exhibited some weakness mid-week but maintained its recent overall consolidation range. Looking at the big picture, the EUR/USD continued a broader consolidation after hitting lows back on Oct 27 at 1.2330 with 1.24 to 1.2850 seen continuing. Dealers noted that the five-week euro downtrend line was broken above the 1.2690 level on Wednesday

In regards to suspicions of intervention, one dealer noted that the USD weakness was complemented by good demand from “supra nationals,” prompting speculation that the moves could be some kind of stealth action to calm recent extreme FX moves. By Thursday the theme of risk aversion returned in a big way as multinationals continued to announce plans to reduce output and employment. The USD encountered some week-ending profit taking aided by comments from ECB's Mersch who noted that large rate cut would be counterproductive. Other ECB members, however, signaled they are still open to further rate cuts with Paramo stating that it is “not improbable” that the ECB will cut at its December meeting.

Trade The News Staff Trade The News, Inc.

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READ MORE - Market Week Wrap-up

US Dollar Strength May Be Tempered By Near-Term Resistance

Forex Trading Weekly Forecast

• US Dollar Strength May Be Tempered By Near-Term Resistance
• Euro Forecast Dims on Euro Zone Recession Fears, Dow Tumbles
• Japanese Yen May Rally Through GDP Numbers On Carry Flows
• British Pound Could Forge New Lows As Rate And Growth Outlook Fail
• The Swiss Franc At Major Support Levels, Is A Retrace In Store?
• Canadian Dollar Sinks Further Against US Dollar on S&P Tumbles
• Australian Dollar Looks to G-20 Summit, Risk Trends for Direction Cues
• New Zealand Dollar To Test October Lows As Carry Demand Stalls

US Dollar Strength May Be Tempered By Near-Term Resistance

Fundamental Outlook for US Dollar: Bullish

• Treasury Secretary Paulson announces that Troubled Asset Relief Program (TARP) will not buy troubled assets
• US continuing jobless claims rise to most since December 1982, suggesting unemployment rate will climb even higher
• US retail sales, import prices fall by the most on record during October

For weeks we've been discussing how risk appetite, or the lack of it, has been driving price action throughout the forex markets to the benefit of the lowest yielding major currencies: the US dollar and Japanese yen. The strength of the greenback has been all the more surprising given the dismal status of the US economy, but since the currency has managed to hold on to its status as a "safe haven” asset, fundamentals frankly do not matter at this juncture. Nevertheless, economic indicators are still worth watching since they have been impacting the US stock markets and will likely play into future rate decisions by the Federal Reserve.

Following comments from Fed Chairman Ben Bernanke, who said on Friday that "monetary policy actions have not resolved the ongoing strains in financial markets, including interbank funding markets…Central bankers and other policymakers around the world must continue to work together to address disruptions in credit markets and to promote a vibrant global economy,” Credit Suisse overnight index swaps are fully pricing in a 50bp reduction on December 16. News on November 19 may shake up these forecasts, though, as US CPI and the Federal Open Market Committee (FOMC) meeting minutes from October 29 will both hit the wires. At 8:30 ET, CPI is anticipated to plunge 0.8 percent during the month of October, which would mark the sharpest drop since 1949, while the annual measure is projected to slip to a 5-month low of 4.1 percent. However, the FOMC meeting minutes at 14:00 ET could draw more attention, especially if they highlight the downside risks to growth and declining inflation expectations. Since risk trends have been the primary driver of price action lately, it will likely be best to watch for the stock market's reaction as pessimistic turn in sentiment could lead equities lower, and thus lead the US dollar higher given their negative correlation.

From a technical perspective, the US dollar's trade-weighted index faces heavy resistance at 87.90/88.00, where the 78.6 percent fib of 92.63-70.67 looms. Meanwhile, EUR/USD has had difficultly breaking below 1.2400, suggesting that the US dollar may not be able to make significant headway in the near-term.

Euro Forecast Remains Dim on Euro Zone Recession Concerns

Fundamental Outlook for Euro: Bearish

• US Dollar is Safe Haven of Choice, Rallies against Euro Despite Dismal US Data
• Forex Positioning Proves Prescient in Predicting Euro Recovery, but What's Next?
• View our monthly Euro-US Dollar Exchange Rate Forecast

Euro forecasts against the US Dollar took a turn for the worse on the week, as generally dismal European economic data and further losses in the US Dow Jones Industrials Average led to similar Euro/US Dollar weakness. Official confirmation that the German economy entered a technical recession through the third quarter suggested that the broader Euro Zone finds itself in a similarly weak position - forcing further deterioration in euro fundamental forecasts. Whether or not the Euro may recover against the stubbornly resurgent US Dollar will largely depend on whether global financial market conditions will improve through upcoming trade. The Euro and US Dollar find themselves inextricably linked to broader developments in risky asset classes.

Recent price swings in the Euro/US Dollar exchange rate have been almost purely a function of price action in global equity indices, and we expect that this will continue to be the case in the week ahead. Indeed, forex market reaction to historically market moving economic data has been anything but intuitive; currencies move according to equity market reactions to event risk. It is very difficult to predict how stocks may react to upcoming economic data, and overall bearish momentum suggests we can expect to see the Dow Jones and other major indices drop further through subsequent trade. Further equity market losses could easily lead to further losses in the Euro/US Dollar pair - leaving an overall bearish forecast for the Euro until we see sustained improvement in global risk sentiment.

The Euro may likewise react to any developments out of the much-anticipated G20 meeting over the weekend. Though markets are somewhat unsure of what to expect from the global economic summit, some alarmist forecasters have gone as far to suggest that global leaders could reinstate the Gold standard for currencies for the first time since 1971. Such suggestions seem outlandish to say the least, but we must nonetheless watch for key shifts in global economic policy following the meeting - especially as it relates to exchange rates. We will listen for noteworthy rhetoric from global leaders and take cues from equity market reactions to guide expectations for the Euro/US dollar price action. - DR

Japanese Yen May Rally Through GDP Numbers On Carry Flows

Fundamental Outlook for Japanese Yen: Bullish

• Market Threatens To Revive Carry Unwinding As Recession Fears And Deleveraging Efforts Loom
• Word Of A Chinese Bailout And The US Shifting Focus To The Consumers Can't Quell Fears
• What Should We Expect From The Dollar - Japanese Yen Pair Over The Coming Month?

The vacillation in risk appetite has been constrained for most of November; but the steady rise in volatility and refocus on larger fundamental themes in the currency market promise breakouts and revived trends. Considering its sensitivity to fear and greed in the currency market, the Japanese yen will act as a barometer to market conditions in the week ahead. To start the week off, risk trends will look for any accelerants in the G20 meeting. Over the previous weekend, the group issued a statement that announced they were prepared to act "urgently” to fortify financial markets and global growth. As compelling as this may sound, verbal warnings have little sway over traders who know the market responds to unwavering economic and speculative trends. To turn such a prevalent force - even temporarily - officials will need to offer the market policy steps that show a global effort is genuinely being made to stabilize the worst recession and credit crisis since the Great Depression. Confidence in this event however is low as political barriers are significant while substantial efforts made so far (individual bailout plans, massive liquidity injections and sharp rate cuts) have yielded little so far. Expect promises for fiscal stimulus from all members, collaboration on international regulation and warnings that lending rates will be lowered further.

Should the G20 fall short in their efforts to revive lender and investor confidence, market conditions and the primary fundamental drivers underlying the market will swell. Though carry interest, equity markets and other risk-sensitive assets have stalled since the turn of the month, volatility has moved back towards record highs. Like a breakout in price action, one side of the market must give: congestion or volatility. The better probability is for breakouts to revive the dominate bear trend in yen crosses. The odds are clear when we consider the factors that brought us to this point: forecasts of an economic slump and a surge in risk aversion. Even conservative market regulators forecast a global recession; and data already suggests it will be far worse than a short-lived slump. As for risk trends, returns are naturally depressed when growth stalls and fear will be driven by the knowledge that far too much credit and leverage is still floating around the market.

Also, we should not ignore the top-tier event risk on the economic docket this week - even if it does have little impact on immediate price action. The first reading of 3Q GDP is scheduled for release early Monday morning in Tokyo. While risk aversion naturally diverts capital to the Japanese yen, eventually fear will abate; and when it does, investors will look to reallocate their capital into those economies that have ultimately recovered from the global economic recession first and with the least damage. If economists' expectations prove correct, Japan will be in good form. However, considering the country's dependence on foreign consumers and its long history as a net saver, these is little doubt, Japan will trail the inevitable rebound. The other event to watch will be the BoJ rate decision. There is little chance that the central bank will lower its rates again; but it will be interesting to see any comments made after the event. Unless they come up with a unique policy plan, the market will no doubt label the group effectively impotent in the ongoing crisis. - JK

British Pound Could Forge New Lows As Rate And Growth Outlook Fail

Fundamental Outlook for British Pound: Bearish

• Pound Pushes To A Six Year Low Against Dollar After BoE's King Says He Won't Discount Bringing Rates To Zero
• European Central Banks Face Tumbling Inflation Rates And Recessions By Readying The Markets For Further Rate Cuts
• Read The DailyFX Monthly Forecast For GBPUSD For A Fundamental And Technical Outlook

While most of the currency market was consolidating this past week, the high volatility underlying the market led the fundamentally weak British pound to push new lows. And, considering the outlook for growth and interest rates, the immediate future looks bleak for this once high-flying currency. The first concern for traders as the economic winds pick up next week will be the outlook the interest rates. Up until a few weeks ago, one of the few things the sterling had going for it was the expectations that the global recession would be short-lived and the return of risk appetite to the market would find a relatively high benchmark lending rate in the UK. However, interest rate expectations have quickly turned from boon to burden for this European economy. After the Bank of England surprised the market with a massive 150 basis point rate cut two weeks ago, any hopes that the currency would benefit from a reversal in yield appetite quickly diminished. After BoE Governor Mervyn King acknowledged he would not rule out lowering interest rates to zero to restore order to the economy and markets, speculators recognized the full scope for policy easing going forward.

However, looking to Credit Suisse overnight index swaps, we can see that only 100 basis points of additional easing are priced in over the coming 12 months. This highlights a significant imbalance between what the market is projecting and how aggressive the MPC may actually be should conditions worsen with time. A fundamental divergence of this magnitude opens the pound to significant moves as these split expectations converge into one reality. The minutes scheduled for release on Wednesday will be instrumental in driving forecasts one way or the other. The vote will be of upmost importance. Lowering the benchmark lending rate as aggressively as the BoE did to a 53-year low could not have been made easily and debate over this move's efficacy is expected. Noting the extreme: if all nine MPC members voted for the massive rate cut, it would clear the way for further, aggressive rate cuts going forward.

Aside from the vagaries of rate speculation, the economic calendar will give a more definite read on the factors that policy officials will consider when voting in future meetings. Inflation will take a play a key role in defining the scope for further cuts. Before the BoE was set its recent pace of loosening monetary policy, Governor King ironically quipped that he expected to write a number of letters to Chancellor of the Exchequer Darling explaining why inflation was so high and what would be do to tame it. While statements made by central bankers suggest they have moved on expectations of a collapse in price growth (their primary mandate for policy), they have yet to see confirmation of this yet. Should, CPI (the primary gauge for inflation) drop more sharply than expected in its October reading, it would open the door wide open to further gouges in the benchmark lending rate. The longer-term concern, however, will be in the eventual rebound in economic activity. A drop in the cost of living will help to offset the sharp decline in employment and wages expected for the coming months. And, the rest of the economic calendar will make sure to concentrate fears over growth. Housing, industrial trends, consumer spending and public borrowing readings promise nothing more provide additional confirmation that this evolving recession will be far worse than the slump of 1992. - JK

The Swiss Franc At Major Support Levels, Is A Retrace In Store?

Fundamental Outlook for Swiss Franc: Bearish

• Consumer confidence in Switzerland fell to its lowest level since 2003 at -27 from -17 in July, According to the SECO
• ZEW survey rose to -88.5 from -91.1 as investor confidence rose as central banks stepped in to help the economy.

The Swiss Franc resembled its traditional form to end the week as a bullish spike in equity markets sent the typically safe haven currency lower against the dollar. The move would sent the USD/CHF above the 1.2000 price level for the first time since September, 2007, its high of 1.2002 would have it break the 200-Day SMA. This would be the first time it breached this significant technical level since October 20,2006 and may prove to be a formidable obstacle. Swiss fundamental data typically doesn't impact price action, yet the slight improvement in investor confidence could be a sign of improving global confidence, which could add to Franc weakness, and the historic drop I consume confidence will lower the outlook fro domestic growth.

Swiss retail sales and the trade balance will dot the economic calendar during the week and may provide some event risk as they may give traders a clue to the possible interest rate direction for the SNB. Given that the BoE has begun aggressively cutting interest rates and the ECB is expected to continue easing, we may see the Swiss central bank follow their lead as they did when they surprised markets with their coordinated effort. A decline in consumer consumption and exports would leave the country without any avenues of growth. The export driven nation has seen the impact of the credit crisis weigh on demand for its products which has sent it into a recession along with its European counterparts. Therefore, another rate cut is very likely at their December policy meeting which could extend the Franc's losses against the dollar. If we see a clean break above the technical levels of the 200-Day SMA at 1.1964 and 1.200, that would leave the June 22, 2007 high of 1.2430 as the next level of resistance. -JR

Canadian Dollar Sinks Further Against US Dollar on S&P Tumbles

Fundamental Outlook for Canadian Dollar: Bearish

• Canadian Dollar Loses Luster Despite Jump in Commodities - Why?
• US Dollar/Canadian Dollar Technical Outlook Points Towards 1.3025
• View our monthly US Dollar - Canadian Dollar Exchange Rate Forecast

Subsequent forecasts for the future of the US Dollar/Canadian Dollar exchange rate will largely depend on outlook for commodity prices and global equity indices. Given that oil and other key commodity costs have been trading off of broader financial market risk sentiment, it is perhaps unsurprising to note that the Loonie has remained especially sensitive to equity market declines. As such, we will watch for stock market reactions to key US economic event risk in the week ahead. Wednesday will bring a combination of US housing, inflation, and Federal Reserve Open Market meeting minutes - likely to force noteworthy reactions out of US and Canadian equity indices. Forex traders will likewise watch for noteworthy developments out of the weekend's G20 summit and subsequent reactions out of global risky asset classes.

It remains especially difficult to predict USD/CAD price action through shorter time frames, but overall momentum continues to support US Dollar Strength and Canadian Dollar weakness through longer-term trade. - DR

Australian Dollar Looks to G-20 Summit, Risk Trends for Direction Cues

Fundamental Outlook for Australian Dollar: Bearish

• Business Confidence fell to the lowest in 11 years, says National Australia Bank
• Westpac Consumer Confidence rebounds in November on rate cuts, fiscal boost
• RBA slashes GDP growth forecasts, signals more interest rate cuts

The Australian Dollar will again find itself at the mercy of risk sentiment as a light economic calendar is unlikely to produce a catalyst to derail the priced-in fundamental outlook familiar to forex traders. The Retail Sales reading is expected to see receipts correct a bit to grow 0.4% in the third quarter versus a -0.6% contraction in the three months through June. Still, traders are likely to take the improvement with a grain of salt with the pace of sales growth slower by close to 80% from a year before. Economic slowdown is likely to be equally on display in September's Westpac Leading Index figure. The release matched a 5-year low in August, suggesting the economy was growing at an annualized rate of just 2.5% (as compared to the trend average at 4%). Economists' forecasts suggest the pace of annual growth slowed to a near-standstill reading at 0.4% by the end of the third quarter. Motor Vehicle Sales too is likely to extend loses in October as the shaky economy and limited credit access steers consumers away from big-ticket purchases. On balance, these releases collectively point to substantially more monetary easing ahead for the larger antipodean country (as is sure to be telegraphed in the release of the minutes from the last RBA policy meeting). Looking at overnight index swaps, the markets are pricing in a 0.75 to 1.0 percent rate cut at the RBA's next meeting in December with a total of 150-175 basis points in easing over the next 12 months.

All told, the data docket is set up to add to but not meaningfully alter the established outlook for the Australian economy. The upcoming G-20 summit holds far more market-moving potential. The heads of state from the world's top 20 economies are set to meet in Washington, DC over the weekend to hash out a joint plan for dealing with what the International Monetary Fund is forecasting to be a global recession of a magnitude unseen since the Second World War. A preliminary meeting of the G-20 finance ministers in San Paolo, Brazil last week issued a statement urging countries to use "all their policy flexibility, [including] monetary and fiscal policy.” The action plan (or lack thereof) that will emerge at the beginning of next week will be instrumental in shaping risk appetite going forward: if the markets find the outcome favorable, the Australian Dollar will have room to rise as traders re-establish exposure to risky assets; otherwise, the Aussie will again fall victim to the US Dollar and the Japanese Yen. The technical outlook cautiously favors the former scenario, with AUDUSD showing an inverted Head and Shoulders chart formation and positive divergence with the RSI oscillator.

New Zealand Dollar To Test October Lows As Carry Demand Stalls

Fundamental Outlook For New Zealand Dollar: Bearish

• Retail spending in New Zealand Contracts for Third Consecutive Quarter
• Dour Fundamentals Forecasts Ongoing Weakness in Carry Trades

The New Zealand dollar fell against the greenback for three consecutive sessions this week, and may fall back towards the October lows next week as investors continue to curb their appetite for risk. Tightening demands for carry trades paired with lower commodity prices favors a bearish outlook for the New Zealand dollar, and the kiwi is likely to face increased selling pressures over the coming week as fears of a global recession intensify. Falling commodity prices dragged the Jefferies/Reuters CRB index to its lowest level since 2003, and slowing demands from the global economy suggests that prices will continue to fall lower, which would only stoke increased selling pressures for the commodity bloc over the near-term.

The event risks scheduled for the following week will also play an key role in driving price action for the high-yielding currency as deteriorating fundamentals continues to spur bets that the Reserve Bank of New Zealand will aggressively cut borrowing costs well into the next year in order to avoid a deep and severe recession. RBNZ Governor Alan Bollard reiterated this week that New Zealand is in a 'period of slow growth,' and went on to say that household consumption is likely to deteriorate over the coming months as growth prospects deteriorate. Dr. Bollard noted that the government may establish a fiscal stimulus package in order to 'stabilize the economy throughout the downturn,' which suggests that policymakers are looking to increase their efforts as the downside risks to growth intensify. Moreover, Credit Suisse overnight index swaps continues to reflect a bearish outlook for the New Zealand dollar as market participants raised bets that the RBNZ will lower the benchmark interest rate by at least 175bp over the next 12 months amid expectations for 150bp worth of projected cuts last week.

Meanwhile, the G20 Summit in Washington D.C. scheduled for the weakened could stoke increased volatility in the currency market next week as global leaders meet to respond to the financial crisis, and may help to ease fears of a global meltdown. However, the absence of President-elect Barack Obama suggests that the group is less likely to agree on any long-term commitments at the meeting, and may not reach a sound solution until Senator Obama comes into office next year. As a result, the event may fail to spark volatility in the currency market as the fundamental outlook for the global economy turns increasingly bleak. - DS

DailyFX

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READ MORE - US Dollar Strength May Be Tempered By Near-Term Resistance