US Dollar: Next Week’s ISM Manufacturing, ISM Services, and NFP Releases Likely to Reiterate US Recession Risk

US economic data may have been broadly disappointing, but that didn’t prevent the US dollar from gaining across the majors as relative fundamentals continue to benefit the greenback. Indeed, the bulk of the dollar’s gains came during the European trading session, as the New York trading data proved to be fairly boring compared to the significant volatility we’ve seen in recent weeks. Looking at the indicators on hand, US personal spending tumbled 0.3 percent in September – matching the sharpest drop in four years – and followed two consecutive months of stagnation, which only highlights how poor consumption growth in the US currently is. In fact, we saw clear evidence of this in the advance reading of Q3 GDP, as personal consumption plummeted 3.1 percent, marking the first contraction since 1991 and the worst decline since 1980.

Meanwhile, JPMorgan Chase is taking steps to try to stop the housing market collapse as they announced that they would not begin foreclosure proceedings for at least 90 days while the firm modifies $110 billion of troubled mortgages. Bank of America took similar steps this year as they reportedly helped more than 117,000 homeowners avoid foreclosure between January through June. It will be interesting to see if these efforts have a real impact, or if the deterioration in the labor markets and impending recession will prove to provide even greater pressures on the housing sector, preventing a recovery.

Overall, the Federal Reserve remains 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 55 percent chance of a 50bp cut. Data due to be released next week may exacerbate this sentiment, as the ISM manufacturing and services indexes are forecasted to reflect a contraction in business activity during October. Furthermore, US non-farm payrolls (NFPs), are anticipated to contract for the 10th consecutive month, by 180K, while the unemployment rate is expected to jump to a more than 5-year high of 6.3 percent from 6.1 percent. Nevertheless, if economic data from other regions like the UK and Euro-zone prove to be more fundamentally bearish or if risk aversion strikes again, the US dollar could gain on safe-haven flow.

Euro Consolidates Above 1.37 - Will the European Central Bank (ECB) Cut Rates Next Week?

After plunging at the start of the European trading session, EUR/USD did little but consolidate above support at 1.2682/90. While the pair may eventually recovery from these levels at the start of next week, one thing is clear: there is still significant bearish potential for the euro. Economic conditions have deteriorated rapidly throughout the region, with the October PMI readings showing that business activity in the Euro-zone’s manufacturing and services sectors has been contracting for five consecutive months. Furthermore, this morning’s Eurostat estimate of Euro-zone CPI showed that price 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 the economy and the bank’s participation in the October 8 coordinated rate cuts, the indications of cooler inflation pressures gives the ECB even more room to cut rates. As a result, a Bloomberg News poll of 50 economists shows that the European Central Bank is very likely to cut rates by 50bps to a nearly 2-year low of 3.25 percent on Thursday, November 6, at 7:45 ET. The reaction of the euro, however, may depend more on Mr. Trichet’s post-meeting press conference at 8:30 ET as his speeches tend to be very straightforward and biased. If Mr. Trichet suggests that the ECB will cut rates further, the euro is likely to take a hit but if he signals a more neutral stance going forward, the currency could actually rebound.

British Pound Faces Gloomy Outlook, Bank of England (BOE) Almost Guaranteed to Cut Rates

The British pound continues to slump toward 1.60 amidst demand for dollars and in anticipation of the Bank of England’s monetary policy decision next week. The BOE is widely expected to follow up their October 8 rate cut with yet another 50bp cut to 4.00 percent on November 6 at 7:00 ET, as the UK economy tips into recession and the financial markets remain unstable. While UK CPI remains well above the BOE’s 2 percent target and 3 percent ceiling at 5.2 percent, weaker commodity prices have led inflation outlooks around the world to drop rapidly. Furthermore, BOE Monetary Policy Committee member David Blanchflower, who has long been the most dovish of all the members since joining the MPC in mid-2006, was as staunch in his bias as ever when he noted that he thought deflation was a bigger concern than inflation, and that CPI may fall from the September reading of 5.2 percent down to 1 percent or could even go negative. Mr. Blanchflower also said that UK interest rates must be lowered significantly and quickly. If the BOE does indeed cut rates, especially if they enact something even more aggressive than forecasts like a 75-100bp cut, the news will weigh heavily on the British pound.

Japanese Yen Shrugs Off Rate Cut – Intervention Risk?

Forex carry trades slumped on Friday, as the Japanese yen ultimately ignored the Bank of Japan’s 20bp rate cut as the currency rallied over 2 [percent against the Australian dollar and British pound while rising more than 1 percent versus the Canadian dollar, euro, and New Zealand dollar. According to comments from BOJ Governor Shirakawa, three dissenters actually wanted a 25bp rate cut while one member of the rate-setting committee wanted to leave rates unchanged. Mr. Shirakawa also said that there has been a clear change in export and production trends due to the Japanese yen’s strength, and that the rate cut was meant to keep conditions “accommodative.” However, if Japan really wants to make an impact and weaken the yen, intervention may be the only option. The government has not done so since 2004, but they have a long history of doing so successfully since they hold the second largest amount of foreign currency reserves in the world (China holds the most). As a result, Japanese yen traders should be alert in coming weeks, as another sharp rally in the currency could persuade Japan to take action.

Terri Belkas is a Currency Strategist at FXCM.