Trade or Fade: Weekly Analysis of Major Currencies

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By Boris Schlossberg | Published 01/8/2007 | Currency | Unrated

Trade or Fade: Weekly Analysis of Major Currencies

Greenback Goldilocks
As the New Year started, the biggest surprise in FX land was the remarkable buoyancy of the US economy. Both ISMs (Manufacturing and Non) printed above consensus, with the former climbing back above the 50 boom/bust level of the month prior as it registered a reading of 51.4. And while housing continued to limp into a recession as Pending Home sales contracted another -0.5% in December, the biggest boost for dollar bulls turned out to be the NFPs. Employment data shocked the market with its strength as payrolls gained 165K against expectations of 110K. The news was even more positive in light of the fact that ADP and Hudson surveys at the beginning of the week were decidedly downcast with ADP actually predicting a loss of -40K jobs. The news reignited the whole goldilocks argument for the US economy as jobs growth has clearly offset the depressive effects of housing contraction and reduced the chances of a Fed rate cut in Q1 to virtually nil

Nest week the calendar is considerably lighter with only Trade Balance and Retail Sales as key event risks on the docket. The Trade Balance is expected to remain below $60 Billion as lower oil costs and lower exchanger rates should keep the gap contained. In either case, with TICs data printing far in excess of $80 Billion last month the Trade deficit issue isnâ�,��"�t likely to cause the dollar much trouble. Of far greater interest to the market will be Decemberâ�,��"�s Retail Sales. The latest Christmas Sales data has been tepid at best as the US consumer appears to be tapped out despite relatively tight labor markets. Can the dollar rally continue? Only if the Retail numbers surprise to the upside. Otherwise the focus will turn right back to the weakening US consumer and this weeks power move may fizzle into range bound trading.

Euro Runs Our of Steam
The EUR/USD dropped 200 points for the week losing half that number in just 5 minutes post NFP. Although the week was clearly owned by the dollar bulls, Euro-zone data did little to buoy the currency. While German unemployment continued to shrink dropping below 10% for the first time in 4 years, providing further evidence of economic rebound, manufacturing, services and consumption surveys all missed their mark suggesting that the EZ recovery may be hitting a wall. While business activity certainly remains expansionary the trifecta of downward surprises offered little reason for euro bulls to defend the unit and therefore the currency crumbled in the process.

Next week the market will zero in on German Retail Sales. Despite the pick up in business demand EZ consumers and specifically those in Germany have been wary of spending and if the recovery is to maintain momentum they will need to open up their purse strings as the production end of the economy most likely has already hit its peak . End of the week also brings the ECB rate announcement and while the market expects no action from the central bank, Mr. Trichetâ�,��"�s comments will be heavily scrutinized. If the ECB chief continues to sound hawkish traders may begin to price in another rate hike in February. However, if Mr. Trichet appears non-committal the unit may see further selling as trader will begin to price in the possibility that Decemberâ�,��"�s move was the last for the foreseeable future.

Yen- Is Carry Trade Liquidation Here?
Yen was the biggest gainer against the dollar for the week, rising nearly 50 basis points while all other currencies crumbled. It was even more impressive on the crosses gaining more that 200 points against the Kiwi and the Aussie. The theme of the week was carry trade liquidation as speculation built that BoJ would raise rates at its January 18th central bank meeting. Some analysts even speculated that the move would involve a 50 rather than a 25 basis point hike. The country itself was on holiday for most of the week, so the economic data was virtually non existent as trade flows keyed off official commentary rather than fundamental news.

Whether carry trade liquidation has started in earnest remains to be seen as next week the market will begin to see the first trickle of economic data. Most important in our view will be Eco-Watchers survey. This man in the street poll takes most sensitive reading of latest consumer sentiment and ever since it dipped below the 50 boom/bust level the yen has suffered as much anticipated recovery of the Japanese consumer failed to materialize, forcing the BOJ to remain sidelined. Therefore, if Fridayâ�,��"�s Eco Watchers survey could surprise to the upside printing above the 50 for the first time in 3 months then it would provide the fundamental support for the long awaited unwind of the carry trade.

Cooling Housing Leads Cable Lower
While greenback strength dominated trade last week, generating more than 500 points of losses for Cable, economic data out of the UK provided little help for the British pound. HBOS house prices declined for the first time since June at 1.0 percent on a monthly basis, potentially marking a turn for the housing sector. However, the less-volatile three month moving average was still the highest since February 2005 at 9.9 percent and has steadily risen over the course of 2006. Meanwhile, the final release of M4 money supply slipped to 13.0 percent â�,�“ a far cry from the record of 14.5 percent just a few months ago â�,�“ and a signal that rampant borrowing may be easing. Last weekâ�,��"�s data will help assuage BOE fears of ballooning credit and a housing bubble, and with consumer confidence taking a hit, the broader picture hinted of a more dovish tone. Nevertheless, the BOE will likely maintain their tightening bias as price pressures persist and the housing market continues to boom, albeit at a slower pace.

The marquee economic event for the UK next week lies on Thursday, when the BOE announces their interest rate decision. Since they are likely to keep rates steady at 5.00 percent, the monetary policy committee will not be releasing a statement for a few weeks. However, hawks will remain focused on wage price growth, while doves may note the inherent tightening effects of a stronger British pound. With expansion in the UK starting to cool, rate hike expectations have been pushed much further back into 2007, which will only be to the detriment of Cable as interest rate differentials continue to favor the US dollar.

Signs of Slowdown Takes Out Swissie
A humdrum set of data in Switzerland last week brought the USD/CHF pair to surge 200 points higher by Friday, though the 1.2400 level continued to hold as formidable resistance. Meanwhile, EUR/CHF fell back after making a fresh seven-year high on Wednesday on rumors that the Swiss National Bank was not happy about the franc's weakness weighing on the cross. Economic releases hit the tape exactly in line with analyst expectations, and reaffirming SNBâ�,��"�s 2007 outlook. Inflation was essentially non-existent in December, as the monthly rate went unchanged while the annual rate managed to edge higher to 0.6 percent from 0.5 percent. Furthermore, SVME PMI dropped to 65.0 in December from 67.0 the month prior. The figure has remained relatively buoyant over the past few months, in contrast to the KOF leading indicator, which has slipped. Thus, the correction did not come as a large surprise by any means and merely adds to the number of indicators pointing to a slowdown to Swiss growth in 2007. Regardless, the SNB is still widely anticipated to pursue a further normalization of rates from the current 2.00 percent, as long as reports out of Switzerland continue to fall in line with estimates.

This week looks to be extremely light on data with the sole release, the unemployment rate, estimated to slip to 3.0 percent. The labor market has proven to be the most resilient aspect of the Swiss economy, and its continued tightening has helped to underpin the consumer spending engine to drive expansion. Additionally, if the unwinding of carry trades extends into Swissie price action, the franc could get a boost throughout the week.

Labor Gives Loonie Last Minute Boost
As the cherry blossoms bloomed in Washington DC amidst record high temperatures, sending February NYMEX crude to trade in reach of nearly 18-month lows of $54.86. The drop sent the oil-driven USD/CAD pair to edge towards the 1.1800 level, but an unexpected surge in Canadian employment gave Loonie a boost on Friday. The number of employed persons jumped 61.6K - far higher than 15K projected - and significantly better than 22.4k gain the month prior. This sent the unemployment rate to plummet to a 30-year low of 6.1 percent from 6.3 percent. The recent weakness in the Canadian dollar helped spur growth the export-dependent country. Furthermore, the most impressive aspect of December's labor numbers was the fact that a large percentage of jobs were full time rather than part time, as Canadian businesses made room for 36,000 new full time positions. Similar to Switzerland, the rosy employment picture should keep consumption humming along as the manufacturing sector flounders.

Housing growth may start to lose steam, as next week is anticipated to find data out of the sector slowing. Housing starts are estimated to ease back, while building permits â�,�“ a leading indicator for starts â�,�“ are expected to plunge 1.0 percent after jumping 6.1 percent the month prior. Traders will also focus on the international merchandise trade balance due out on Wednesday. While consumer spending has certainly come to the aid of Canadian growth, the export-dependent country will need to see continued trade surpluses to ensure the health of the economy. As a result, any weakness in the figure could lead Loonie to lose further strength next week.

Aussie Strength Hit From Data, Commodity Slump
The Australian dollar was hit hard in the opening week of 2007. Initially, in the first few days of liquid trade, Aussie bulls seemed to have a firm handle on the yolk. However, a number of disappointments from second tier economic indicators and sharp contractions in key commodity prices sabotaged the run and left 0.80 in AUDUSD an elusive figure. The week started off on shaky footing with AIGâ�,��"�s manufacturing survey for December. The index slipped 2 points as the worst drought in a century forced producers of food, beverage and paper products to cut production forecasts. A little later in the week, the same group released its services figure with much of the same feeling. Though the report was better than Novemberâ�,��"�s print, it marked the second consecutive month the sector has contracted. Finally, the CashCard Retail Index, which measures sales made with electronic cards, slipped 0.1 percent in December as consumers responded to the previous monthâ�,��"�s rate hike.

Though last weekâ�,��"�s data was wearing on the bullish advance, a catalyst was required for the sharp trend change. Consequently, this trigger was the broad plunge in commodities that began on Wednesday. Mining and exports of natural resources accounts for 13.5 percent of total GDP, so the sizable correction in a number of key commodities took its toll on the currency. A three day drop in gold prices was capped by the biggest one day drop in three months, while copper suffered its biggest weekly decline in ten years. In fact, the Reuters/Jefferies CRB Commodity Index fell to its lowest level in 20 months.

Looking ahead, volatility looks as if it will be well stocked, but direction is still up in the air. Currency traders will look across the markets to commodity to determine whether a retracement in industrial and precious metal contracts will encourage the same for the Aussie dollar. Furthermore, the newswires will be glowing red. Building permits and retail sales will measure the temperament of the Australian consumer, while the trade and employment reports will reveal whether two of the economyâ�,��"�s stalwart pillars will survive the nationâ�,��"�s severe drought and the dour growth projections issued by the government.

Kiwi Sees Weakness on Greenback and Yen Rallies
The Kiwi was considerably weaker in the past week, as a firm Trade Balance report was not enough to counteract sharp US Dollar and Yen rallies. An improvement in the headline Trade Deficit provided a miniscule short-term bounce, but traders seemed relatively unmoved by the monthly change. Instead, speculators focused on the broader commodity market tumble and carry trade liquidation to leave the Kiwi worse against its lower-yielding counterparts. This carry trade-linked tumble was especially pronounced against the JPY, with the NZDJPY falling over 300 points off of its yearly highs in a mere 3 days of trade.

With such strong momentum to the downside, the Kiwi dollar may look to continue weaker through the coming week devoid of economic data. As the sole fundamental news release, New Zealand Building Permits is unlikely to provide support for the Pacific currency. Indeed, the figure itself may follow recent monthly trends of falling new construction projects. Otherwise, the New Zealand dollar will continue to stay sensitive to developments in other global markets, with a barrage of Australian fundamental data to add event risks to the closely-linked economies. The New Zealand dollar will likely require a pickup in carry trade interest and/or improvement in Aussie figures to post any reasonable retracement in the coming week of trade.

Boris Schlossberg is a Senior Currency Strategist at FXCM.

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