Philly Sinks the Dollar
The aftereffects of the extremely poor results from the Philly Fed survey reverberated throughout the currency markets taking the EUR/USD above the 1.2800 by the end of the week. The shockingly low number which printed at -0.4 versus 14 expected fueled fears thatUS economy was headed for a recession rather than just a soft landing and prompted a spate of short covering in the pair. While hardly representative of the whole US industrial sector, the Philly Fed nevertheless carries weight with the market because of its â,"canary in the coal mineâ, nature. It tends to be extremely sensitive to economic demand. More than the negative value â,“ the first such reading since April of 2003 â,“ was the sheer size of the drop in the survey which spooked traders and spurred speculation that the slowdown in the housing market may now depress consumption in the overall US economy.
Whether this hand wringing is justified remains to be seen. Already by end of day Friday the pair had come off its highs as traders reconsidered their panicked response. For now the jury is still out on what will have the greater impact on US economic demand â,“ the simulative nature of lower oil and gasoline prices or the depressive effect of slumping housing market Next week the market will have plenty of opportunity to consider the possibilities as both Housing and Consumer confidence surveys all hit the tape. Finally, in the midst of all the hoopla about Philly, most players had already forgotten the woeful TICS report form last Monday which printed at $32.9 Billion vs. $70.0 Billion expected. While some analysts shrugged off the massive shortfall as a non-event, we are not one of them. If this is a start of a nasty new trend the repercussions for the dollar will not be benign as a toxic combination of slow growth and lack of financing could hurt the greenback as we approach 2007. For the time being however, range continues to dominate with 1.3000 serving as massive resistance.
Quiet Week for Europe
The euro continued to chug along dented slightly by the negative news flow from the start of the week only to recover its footing as data became considerably more supportive as the week wore on. On Tuesday the ZEW printed at -22 â,“ considerably lower than -8 expected as investors continued to fret about the familiar litany of problems of high oil high exchange rates and high taxes. Additionally Industrial Production contracted unexpectedly to -0.4% from 0.2% projected. Neither report however, had much legs, as ZEW showed a sharp dichotomy between current and future expectations that made the indicator a far less reliable source that the much more watched IFO due next week and the negative IP results were offset by news that New Industrial Orders jumped a healthy 9.4%.
Next week the aforementioned IFO will be the marquee event of the week with most analyst looking for slight dip to 104.3. German unemployment is expected to show further improvement and Friday will round off the week with CPI numbers and Retail Sales. Both of those reports could prove crucial to trade especially if CPI prints â,"coldâ, below the 2% barrier and Retail Sales surprise to the downside. In that case euro could well come under pressure as the present certainty of ECB rate hikes may be put into question. Should the data be supportive however, euro may be able to build on the momentum built this week as the prospect of decoupling between EZ and US growth rates could become a reality.
Yen Bounces Back
After a horrid several weeks of trade when seemingly all economic news surprised to the downside, the yen finally found some buyers at the 118.00 level as the combination of post G-7 reaction and massively skewed positioning help spark a bounce. On G-7 we wrote last week,â, the carry seeking speculators may be a tad too complacent in their view of G-7â,"s true intent. While the tone of communiquƒ© was relatively restrained it sent a clear warning signal to any trader thinking that the yen is a one way bet to the downside. For now G-7 officials appear to tolerate the present level of yen weakness, but should it cross the critical 120 USD/JPY and 150 EUR/JPY barriers the rhetoric of disapproval is likely to become far more aggressive and the jawboning from fiscal and monetary authorities will no doubt be far more explicit. Thus, we believe those who hold long USD/JPY positions should tread lightly. For the time being fundamentals are on their side but positioning is not. Yen shorts reached a record high of more than 99K contracts in the latest Commitment of Traders data on the CME and the market will need only a small catalyst to trigger a short covering rally in this massive positional skew."
The calendar for the upcoming week carries a fare busier release schedule with Retail Trade, Industrial Production and employment data all due to hit the tape. With the data generally expected to be positive, the yen may see a further rally, but its true strength will only come if the market becomes convinced that global monetary policy will soon turn to neutral from hawkish. In that case, the hunt for yield will lose its allure triggering tremendous carry trade liquidation orders with of course would be of greatest help to the low-yielders like the yen.
Another Solid Week for Cable
Signs that the housing sector continues to hold its own and further growth in industrial sector figures helped Cable break last weekâ,"s resistance at the 1.8900 figure to close out Friday at 1.9002. On Wednesday, BBA mortgage lending posted a record high of 6.2B, but the BOE minutes tempered major GBP/USD gains as the release revealed that the September vote to keep rates steady was a unanimous 8-0. As we said last week, â,"UK central bankers are still trying to asses the extent of inflationary pressures in the UK economy and as of now, odds of yet another 25bp hike before year end appear to be 50%-50%â,¦With housing prices enjoying a rebound and wage growth steady the UK consumer appears to be in relatively good health ahead of the critical Christmas season. Nevertheless, high debt levels and slowdown in US growth which may dampen both UK export demand and further growth in its booming finance sector, could all serve to contain any inflationary impulses and keep the BOE on the sidelines for the rest of the year.â, Other economic news reiterated our claims, as CBI Industrial Trends, whose headline figure posted its best reading since 2004 at â,“5 from â,“8, also showed price expectations have moderated markedly since last month, dropping to 8 from 13. The rapid decline in energy costs accelerated the fall and, should oil prices remain at these levels or fall lower, the need for additional rate hikes may decrease.
Next weekâ,"s economic data could give Pound bulls something to smile about as improvements in the housing sector, as well as consumer confidence, are expected to be released. Additionally, the third reading of Q2 GDP is not anticipated to show any revisions, but the posting of CBI Distributive Trends could make or break the GBP/USD rally, as a gain in the indicator of retail sales will be necessary to prove that the UK consumer is resilient.
M&A Saves the Swissie
The long suffering Swissie finally strengthened this week following months of stellar economic data. With interest rates still at a relatively low 1.50%, the currency has been a prime candidate as a carry trade vehicle. However, M&A news gave the Swiss franc a boost, as it was announced that European-based Merck would buy Swiss-based Serono for $13 billion. Word of the deal resulted in a 100 point gain against the greenback and a 60 point rise versus the euro. Meanwhile, SNB Vice Chairman Blattner commented hawkishly on Wednesday that rates had not yet reached normal levels, indicating the need for policy tightening. However, he also noted that the central bank did not need to accelerate its monetary policy, effectively negating the possibility of a 50bp hike in December and leaving traders to price in one more 25bp hike to 2.00% in December. Economic data released during the week highlights the 25bp hike bias, as the trade balance narrowed due to weaker export growth to the Euro-zone, along with slower retail sales growth of 2.1% from 4.8%.
Economic data in the week going forward could further Swissie gains, as the most import gauge on the agenda, the KOF Swiss Leading Indicator, is anticipated to hold at 2.42 in the month of September, well above average and near a 6 ,½ year high. The economy has shown extremely solid growth throughout Q2 and into Q3, as GDP has posted a strong 3.2%, the labor market has tightened, and producers have seen accelerating prices. Meanwhile, the UBS Consumption Indicator is estimated to rise to 1.900 in August from 1.881, as household spending has been encouraged by low unemployment numbers and mounting consumer sentiment. Wrapping up the week will be the SECO September Economic Forecasts, in which USD/CHF shorts will be looking for higher revisions and an optimistic outlook.
Boris Schlossberg is a Senior Currency Strategist at FXCM.
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