US Dollar Bounces From Technical Support Despite Worst US GDP Reading Since Q3 2001

The US dollar gained throughout most of the day on Thursday as the currency rebounded from critical support and despite the release of US economic data that added to evidence that the nation is facing recession. The advance annualized reading of US Q3 GDP fell by the most since Q3 2001 at a pace of 0.3 percent, after jumping 2.8 percent in Q2. This was slightly better than the -0.5 percent estimate projected by economists, but this was really the sole “positive” aspect of the report as a breakdown of the shows that conditions may only get worse. Indeed, export growth cooled to a 5.9 percent pace during the quarter, down from 12.3 percent, and with many of the world’s developed economies slowing at the same time, foreign demand for US goods is bound to deteriorate further. In addition, personal consumption plunged 3.1 percent, marking the first contraction since 1991 and the worst decline since 1980. This isn’t entirely surprising as consumer credit growth during the month of August fell for the first time in over 10 years and by the most since record-keeping began in 1943. It has become very clear that the credit crunch has taken its toll on consumers that are accustomed to living off of debt via credit cards and home equity loans, which has been to the detriment of retailers as advance retail sales fell negative in September for the third consecutive month.

Overall, this news leaves the Federal Reserve all the more likely to cut rates down to record lows before year-end, as indicated by fed fund futures which are fully pricing in a 25bp cut on December 16 and a 65 percent chance of a 50bp cut. Data due to be released on Friday may exacerbate this sentiment, as personal income and personal spending numbers for the month of September are likely to disappoint amidst slowing growth, a deterioration of the labor market, and tight credit conditions. In fact, personal income is forecasted to rise a tepid 0.1 percent while personal spending is anticipated to fall 0.2 percent, marking the first negative reading in two years.

Euro Plunges as European Consumer, Industrial Sentiment Turns Increasingly Pessimistic

After running in to resistance at 1.3250, EUR/USD pulled back sharply throughout the day to test support at the 50 percent fib of 1.2328-1.3296 at 1.2813. The pair managed to recover above 1.2900 later in the day, but the fundamentals of the Euro-zone remain resoundingly bearish. The European Commission reported this morning that their index of consumer confidence plummeted to a nearly 15-year low of -24 while industrial confidence dropped to match the lowest level in more than 12 years at -18. Nearly every sector in the region is suffering in the wake of restrictive monetary policy, rising unemployment, tight credit conditions, and the global economic slowdown. As a result, Friday’s Eurostat estimate for Euro-zone CPI will be very important. Indeed, the figure is projected to show at 6:00 ET that inflation growth eased to a 3.2 percent pace in October from 3.6 percent. Given European Central Bank President Jean-Claude Trichet’s more bearish stance on economic growth and the bank’s participation in the October 8 coordinated rate cuts, a weaker-than-expected CPI reading could exacerbate the market’s speculation that the ECB will cut rates next week on November 6. We also have to consider that the Euro-zone unemployment rate will also be released at the same time and is forecasted to hold steady at 7.5 percent. Considering the dismal conditions plaguing the region’s economies, there is a risk that the unemployment rate will tick higher, and combined with a drop in CPI, the euro could plunge.

British Pound Slumps as UK Nationwide Home Prices Fall By the Most on Record

The British pound slumped through most of the day as the 61.8 percent fib of 1.7516-1.5257 at 1.6653 provided ample resistance for GBP/USD. UK data didn’t bode well for the pair either, as UK Nationwide home prices dropped 14.6 percent in October from a year earlier, the worst reading since records began in 1992. Given the extremely dovish comments issued by Bank of England Monetary Policy Committee member David Blanchflower yesterday, in which he noted that UK interest rates must be lowered significantly and quickly, it is becoming increasingly likely that the BOE will cut rates aggressively on November 6 from 4.50 percent by at least 50bps. Seeing as though Credit Suisse overnight index swaps are pricing in nearly 200bps worth of cuts in the next 12 months, significant downside risks remain for the British pound in the long-term.

Japanese Yen: Will the Bank of Japan Actually Cut Rates?

Forex carry trades continued to rally on Thursday, as the Japanese yen tumbled more than 3 percent versus high-yielding currencies like the New Zealand dollar and Australian dollar, while falling over 1 percent against the US dollar and British pound This had mostly to do with a further improvement in risk appetite, as the DJIA and S&P 500 rose over 2 percent. However, risks remain for the low-yielding yen as some are speculating that the Bank of Japan may actually cut rates tonight. According to an updated Bloomberg News poll, 15 of the 17 economists surveyed think the BOJ will do so and Credit Suisse overnight index swaps are pricing in 17bps worth of rate cuts over the next 12 months. However, I’m with the minority on this one, and I would be absolutely floored if the BOJ did anything but leave rates unchanged at 0.50 percent. It was just in the summer of 2006 that the central bank finally moved away from ZIRP, or Zero Interest Rate Policy, which they implemented in 2001. With interest rates already so low, a reduction is highly unlikely to have a significant impact on Japanese growth, so I don’t think the BOJ will believe it’s worth their while to cut. While BOJ rate decisions don’t usually have a big impact on the Japanese yen, the speculation surrounding this news could lead the low-yielding currency to gain if they do indeed leave rates unchanged. On the other hand, a rate cut could provide a good opportunity for the Japanese government to intervene in the markets and capitalize on the potential drop in the yen.

Terri Belkas is a Currency Strategist at FXCM.