US Dollar Reclaims Lost Ground Despite New Lows In Consumer Spending, Housing Sales And Durable Goods

Traditional fundamentals were painting a dour picture of the US economy; but the greenback was nonetheless rising into the holiday liquidity drain. Notably, the euro’s tentative trend reversal was cut short by a pull back towards 1.2825 while the pound pulled back from 1.55 in a 300 point plus intraday dip. Setting the scene for recession speculation, personal spending in the US contracted by the most since September 2001 at a rate of 1.0 percent, despite a 0.3 percent rise in personal income, as consumers opt to save or pay off debt. Meanwhile, US durable goods orders dropped a whopping 6.2 percent during October, marking the third consecutive contraction and worst decline in two years, and even excluding transportation, orders fell by the most since 2002. Furthermore, non-defense orders excluding aircraft also tumbled for the third straight month at a rate of 4 percent, suggesting that business investment is slowing dramatically. Finally, the Commerce Department reported that new home sales dropped 5.3 percent through October to a 433,000 annual pace, the lowest since January 1991. A breakdown shows that inventories rose to 11.1 months’ supply while median prices fell 7 percent from a year earlier to $218,000. Overall, the data suggests that consumption is falling rapidly, as we’ve already seen reflected in the Q3 GDP figures, and with the labor markets and housing sector still deteriorating and credit conditions remaining tight, consumer spending could easily take a toll on Q4 GDP figures as well. In light of this, businesses are cutting back on spending and investments as well, since both domestic and foreign demand are sure to slow further in coming months. This leaves the Federal Reserve very likely to cut rates again when they meet on December 15-16, especially as fed fund futures are fully pricing in a 50bp cut to 0.50 percent and a 32 percent chance of a 75bp reduction.

There is no US data scheduled to be released through the end of the week due to the Thanksgiving holiday on Thursday. As a result, US markets will be closed tomorrow and will stop trading early today and on Friday. Nevertheless, the forex markets and foreign stock and bond markets will be open as usual and we tend to see one of two things happen during these times of lower volumes: extremely quiet price action or a pick up in volatility. Considering the sustained levels of high volatility in the market, we would expect the latter; however, the tentative trend breaks from Monday may have mitigated the breakout potential that could have been.

Euro: European Commission Announces €200 Billion Fiscal Stimulus Proposal; Consumer Confidence, CPI Likely to Fall Further

The European Commission announced a sweeping package of proposals this morning, worth approximately €200 billion and nearly equivalent to 1.5 percent of the Union’s GDP. European Commission President José Manuel Barroso also urged member countries to implement policies to boost growth, even if it pushed budget deficits beyond normally acceptable limits. Mr. Barroso also noted that while measures shouldn’t be identical, they do need to be “coordinated.” This comes just a day after the US government pledged another $800 billion to improve lending conditions for homeowners and small businesses, and two days after the UK’s announcement of a £20bn fiscal stimulus plan. Looking ahead to Thursday, Germany unemployment is actually forecasted to fall slightly while consumer and business confidence in the Euro-zone is expected to have deteriorated further in November. Bigger event risk looms on Friday, though, as Eurostat estimates for Euro-zone CPI are projected to show at 5:00 ET that inflation growth eased to a 2.4 percent pace in November from 3.2 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 and their November 6 reduction during a scheduled meeting, a weaker-than-expected CPI reading could exacerbate the market’s speculation that the central bank will cut rates again soon. We also have to consider that the Euro-zone unemployment rate will also be released at the same time and is forecasted to edge up to 7.6 percent. Considering the dismal conditions plaguing the region’s economies, there is a risk that the unemployment rate will climb even higher, and combined with a drop in CPI, the euro could plunge.

British Pound Sees Mixed Session As Fundamental Traders Weigh In On Dour GDP Revision

It was a mixed session for the pound, as growth revisions and Prime Minister Gordon Brown’s calls for UK banks to free up credit reminded the market of the nation’s economic and financial bind. From the docket, the second reading of third quarter UK GDP fell in line with expectations at a rate of -0.5 percent, coming one step closer to confirming that the economy is experiencing its worst slowdown since 1990-1991 (the final results will not be available until December 23). This contraction comes on the tails of a complete stagnation during the second quarter, and was 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. In fact, a breakdown of the GDP report shows that private consumption fell 0.2 percent (the biggest slump contraction since 1995) while exports slumped 0.3 percent. And, in light of this data, Credit Suisse overnight index swaps are fully pricing in a 75bp cut by the Bank of England next week. Upcoming economic indicators may add to this sentiment with Thursday’s 2:00 ET release of Nationwide home price index anticipated to fall for the 13th consecutive month and drag the annual rate down to at least a 16-year low of -15.1, as records began in 1992. With the Governor King and his fellow MPC members scheduled to deliberate on monetary policy next Thursday, we will likely see interest rate speculation have a leveraged influence over the sterling’s price action.

Japanese Yen Congestion May Turn Into Breakouts As Low Liquidity Leverages Volatility

Considering the short-order reversal potential won by many of the yen crosses earlier this week; the single currency was back on the trail of risk aversion trends through Wednesday’s session. One of the few places the popular funding currency was in the USDJPY pair (where the dollar makes for a more attractive save haven). These moves reflect the broader consolidation that has suppressed the revival or reversal of risk trends that have been side-lined since the October panic. 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.