US Dollar: Can the Greenback Hold On To Its Gains Next Week?

The US dollar and Treasuries surged on Friday as deleveraging led funds to flow away from stocks, commodities, and carry trades into safe-haven assets. Indeed, recession concerns weighed heavily on risk appetite, and the nearly 10 percent drop in Japan’s Nikkei 225 index triggered pronounced fears of similar declines in other markets. In fact, European shares plunged almost 10 percent themselves intraday, sending DJIA and S&P 500 futures to limit down. Fortunately, this did not translate to massive losses during the NY trading session, though we did see the DJIA test the October 16 lows before recovering slightly and ending the day down 3.59 percent. There were two fundamental factors coming in to play here, none of which were out of the US: UK GDP figures signaled recession while OPEC cut production by 1.5 million barrels. While a cut in production would normally lift oil prices, the deleveraging trend proved to be even stronger as crude ended the day down roughly 4.5 percent.

Looking ahead to next week, traders will continue to look for a stock market bottom and end to US dollar strength. Shifts in risk appetite have been extremely erratic, sending currencies straight through key support/resistance levels without even pausing, and as a result, it is very dangerous to try to catch turns. That said, the US economic calendar is chock full of market-moving data next week, and all of it has the potential to lead the greenback to finally decline. On Tuesday, the S&P/Case-Schiller index of home prices is likely to fall by 16.6 percent from a year earlier, marking yet another record decline. Later in the morning at 10:00 ET, the Conference Board’s consumer confidence index is forecasted to drop to 52.3 in October from 59.8. On Wednesday at 14:15 ET, the Federal Reserve is widely expected to announce a 50bp cut to the fed funds rate. In fact, as of Friday’s close fed fund futures were actually pricing in a 32 percent chance of a 75bp reduction, and while this is unlikely, it highlights just how dismal the outlook for the US has become. On Thursday, the advance reading of Q3 GDP is anticipated to fall to a 7-year low of -0.5 percent after surging 2.8 percent in Q2 on robust export growth. Indeed, with global growth slowing, foreign demand for US goods is simply not there and when you add to that the sharp pullback in consumption, the outlook for the US is not good. Finally, on Friday, personal income and personal spending numbers for the month of September should reflect something we’ve been saying for a while: slowing growth, a deterioration of the labor market, and tight credit conditions are bound to lead to a contraction in consumption.

British Pound Plunges Over 800 Points Intraday As UK GDP Signals Recession

The British pound plummeted over 800 points during the European trading session to a low of 1.5257 - its biggest intraday drop against the dollar in at least 37 years - as UK GDP for Q3 fell more than expected to -0.5 percent, confirming the market’s recession fears. This was the first contraction in 16 years and came on the tails a 0.0 percent reading in Q2 GDP. Looking at a breakdown of the report, nearly every component fell as the credit crunch took a toll on sectors ranging from finance to construction, and things are not likely to improve anytime soon as conditions have only worsened at the start of Q4. While the British pound subsequently bounced higher during the US trading session to consolidate just below 1.59, the GDP data has raised speculation that the Bank of England will cut rates by at least 50bp at their next meeting on November 6, if not by 100bps. With Credit Suisse overnight index swaps pricing in nearly 200bps worth of rate cuts over the next 12 months, an aggressive reduction next month doesn’t seem out of the question. Looking ahead to next week, there’s little in the way of UK event risk, but according to Technical Strategist Jamie Saettele, this week’s ATR reading for GBP/USD was one of the largest ever. With ATR’s of similar magnitude leading to significant turns in the 1990’s and earlier this decade, it may be time to start looking for indications of a bottom in the pair.

Euro Dives Amidst Evidence of Q3 Economic Contraction, ECB Rate Cuts

The euro fell roughly 300 points during the European trading session to an intraday low of 1.2494 on Friday as data from the region was broadly disappointing. In fact, the Purchasing Managers’ Index (PMI) for both the Euro-zone services and manufacturing sectors held below 50 for the fifth consecutive month, signaling a contraction in business activity and suggesting that the region will be one of the next to release negative Q3 GDP results. Furthermore, the composite index fell to the lowest level since record-keeping began in 1998. Keeping this in mind, Credit Suisse overnight index swaps are pricing in nearly 125bps worth of rate cuts by the European Central Bank over the next 12 months, and there is some speculation that the bank will enact a 25bp reduction as soon as next month. The potential for lower interest rates presents further downside risks for the euro, but with the Federal Reserve expected to cut US rates as soon as next week, EUR/USD could bounce higher in the near-term.

Japanese Yen Hits 10+ Year Highs as Deleveraging Continues

The Japanese yen was easily the strongest currency in the markets on Friday, as a lingering risk aversion, global recession fears, and a surge in volatility (as measured by the VIX Index) led to broad selloffs in the equity and commodity markets. However, the drop in crude oil was somewhat surprising given OPEC’s 1.5 million per day cut in oil production, but simply highlights the role of risk appetite throughout the markets. Indeed, the low-yielding yen rocketed more than 10 percent higher versus everything from the euro to the Australian dollar, and USD/JPY reached the lowest levels in more than 10 years. Is the Japanese yen ready to reverse yet? That will depend very much upon price action in the stock markets and the status of risk sentiment.

Terri Belkas is a Currency Strategist at FXCM.