US Dollar Tumbles as Q3 GDP Falls 0.5% Amidst Sharpest Contraction in Consumption Since 1980

The US dollar fell sharply across the majors as US data was broadly disappointing, adding to the pile of evidence suggesting that the nation is in the midst of recession. It seems that the announcement of yet another Federal Reserve lending facility - this time to support consumer and small business loans - and additional bailout measures for Fannie Mae, Freddie Mac, and Ginnie Mae totaling $800 billion didn’t encourage investors. Instead, traders focused on the revision of US GDP for the third quarter down to -0.5 percent compared to the advance reading of -0.3 percent, which signals the worst US economic slowdown in seven years. The decline was led by a 3.7 percent drop in personal consumption, which marks the sharpest contraction since 1980, as the major deterioration of the US labor markets, stagnant wage growth, and a reduction in the availability of credit takes its toll. Meanwhile, the S&P/Case-Shiller Home Price Index tumbled 16.55 percent during the third quarter, which is the worst decline since recordkeeping began in 1988. On the other hand, the Conference Board’s consumer confidence index climbed to 44.9 in November from a record low of 38.8. However, since this latest result is still the second-lowest since 1974, the rise didn’t inspire too much confidence of a rebound in consumer sentiment.

There was something encouraging about today’s dollar decline: the moves suggested that fundamentals are starting to play a role in forex market price action once again. Indeed, there are signs emerging that the financial markets are stabilizing a bit since risk trends have lost some influence on the greenback. Previously, any sort of losses in equities would trigger gains for the US dollar amidst flight-to-quality, but with the Dow Jones Industrial Average barely ending the day higher and the greenback gaining 0.85 percent versus the euro and 1.98 percent against the British pound, it is clear that this relationship has faded a bit. It remains to be seen if this trend will hold, but with upcoming US economic data likely to be disappointing, downside risks may linger for the US dollar.

US Durable Goods Orders are forecasted to have dropped 2.7 percent in October and excluding transportation is anticipated to fall negative for the second consecutive month. Indeed, Boeing orders - a good leading indicator of this headline reading - slumped in October to 14, down from 41 in September. Meanwhile, Personal Income growth during the month of October is anticipated to rise a tepid 0.1 percent while Personal Spending is expected to fall by the most since September 2001 at a rate of 1 percent. Such results would only create additional potential for fourth quarter GDP to be just as disappointing as the third quarter readings, and will likewise lead to increased speculation that the Federal Reserve will cut rates by as many as 50 basis points during their next meeting on December 15-16.

Euro, British Pound Break Higher - Further Gains Likely

The euro and British pound surged higher on Tuesday, breaking above key resistance points. More specifically, EUR/USD managed to push above 1.30, a level that has prevented previous recovery attempts in recent weeks. Meanwhile, GBP/USD rallied above the 38.2% fib of 1.6671-1.4557 at 1.5361, which also provided support in the past on October 24, October 27, and November 11. The gains in the euro came despite the fact the final reading of German GDP for the third quarter fell in line with expectations at a rate of 0.5 percent, confirming that Europe’s largest economy is experiencing its worst recession in at least 12 years. Looking ahead to the next 24 hours, the second reading of third quarter UK GDP is anticipated to confirm that the economy is experiencing its worst slowdown since 1990-1991. Indeed, the advanced results showed that GDP fell 0.5 percent in the third quarter from the previous quarter, following a complete stagnation. This deterioration comes as the result of a combination of restrictive monetary policy in the UK through mid-2008 along with the collapse of the housing sector and weakening domestic and foreign demand. If GDP happens to fall more than forecasted, the news could weigh on the British pound as it would add to speculation that the Bank of England will cut rates aggressively next week. However, if the data meets expectations, there may be little reaction in the forex markets, allowing the British pound to continue its ascent toward 1.5850.

Australian, New Zealand Dollars Gain, Outpaced by the Canadian Dollar on Surprisingly Strong Canadian Retail Sales

The Australian dollar and New Zealand dollar both rocketed higher at the start of the US trading session amidst broad declines in the greenback, though these commodity currencies finished the day essentially unchanged from Monday. Moves in the Canadian dollar were a bit more dramatic, though, as the release of Canadian spending figures proved to be much stronger than expected. Indeed, retail sales jumped 1.1 percent in September, nearly three times as much as economists had forecasted. This is something we noted potential for yesterday, given the solid employment numbers we’ve seen over the past three months and 1.5 percent gain in wholesale sales. While this does bode well for Q3 GDP results, the Bank of Canada is still anticipated to cut rates by 25 basis points during their next meeting on December 9, as the financial crisis and economic slowdown in the US threatens to weigh on growth in Canada as well.

Japanese Yen Gains Amidst Consolidation, Low Holiday Trading Volumes Present Breakout Risk

While the inverse correlation between the US dollar and stocks didn’t hold up today, the Japanese yen did manage to hold up on Tuesday, gaining roughly 1.5 percent versus the euro and over 2 percent against the US dollar. However, the moves reflected more of a consolidation of Monday’s plunge rather than a clear turn as the Japanese yen remains within its latest trading ranges. While volatility is down from its October records, it is still historically high and suggests potential for breakouts. The big risks for the Japanese yen crosses and other carry trades this week are associated with the closure of US markets on Thursday for the Thanksgiving holiday. We tend to see lower trading volumes around this time, which leaves price action likely to either quiet down substantially or become very choppy.

Terri Belkas is a Currency Strategist at FXCM.