DailyFX Fundamentals 01-15-08
By Kathy Lien, Chief Strategist of DailyFX.com
Retail Sales and PPI Turn Negative, Triggering Sharp Moves in the Currency Market
Retail sales and producer prices both contracted in the month of December, leading many traders to wonder whether the US economy will fall into recession. Spending on cars, electronics, furniture, gas station receipts, building materials, clothing and sporting goods all declined, reflecting a broad based slowdown in consumer demand. According to Bloomberg News, this is the worst year for US retailers since 2002. Interestingly enough, despite the softer numbers, the dollar did not weaken across the board today. In fact, it strengthened against the Euro, Australian and New Zealand dollars while selling off only against the Japanese Yen, British Pound and Canadian Dollars. The main reason for this divergent price action is because the weak data has caused a sharp rise in risk aversion. The Dow dropped as much as 275 points, triggering massive carry trade liquidation. Does this mean that the US economy will fall into a recession? Not as long as the Fed steps up to the plate. The futures market has completely priced in a 50bp rate cut, but this may only be a band-aid for a growing problem. Long term yields have remained stubbornly high and even though they will fall on a half point rate cut, the relief to borrowers may be minimal. The Federal Reserve really needs to act aggressively to restore confidence in the financial markets and to stabilize the economy. This means either an interest rates cut now (yes, that would be an inter-meeting rate cut) or 75bp of easing at the end of the month. The goal is to send let the markets know that the Fed is not playing around and will do everything in their power to prevent a recession from happening. With producer prices falling, the Federal Reserve actually has the flexibility to make a larger move. Tomorrow we are expecting another laundry list of US economic data that includes consumer prices, the Treasury International Capital flow report, Industrial production NAHB housing market index and the Fed’s Beige Book report. Most of the data should be dollar bearish, which would trigger more losses for the US dollar.
Why Did the Euro Fall on Weak US Data?
To the surprise of the market, the drop in US retail sales and producer prices failed to trigger a meaningful rally in the EUR/USD. Although part of the currency pair’s weakness could be attributed to the drop in the ZEW survey, we believe that that the main reason why the currency failed to rally was EUR/JPY selling. German investor confidence dropped to a 15 year low in January, but analysts have been bearish on the German economy for months and the deterioration was hardly a surprise. Instead, what was surprising is the fact that EUR/JPY fell over 100 pips minutes after the US data release. Eurozone consumer prices are due for release tomorrow. Even though German consumer prices weakened, price growth in France accelerated. Strong numbers could help the Euro recover. We are still bullish Euros over the medium term, especially against the US and Canadian dollars. Once the stock market stabilizes, allowing carry trades to recover their losses, traders will realize that the US economy is far more vulnerable than the Eurozone economy and US rates will fall faster than Eurozone rates. If the Federal Reserve cuts interest rates by 50bp at the end of the month, the US interest rate would actually be lower than the Eurozone rate.
USDJPY Falls to Two Year Low, More Weakness Ahead
The currencies that were punished the most by the weak US data was the Yen crosses. Fear that a slowdown would hit the global economy caused the Dow to drop 277 points to a new 9 month low. This pushed the dollar to a 2.5 year low against the Japanese Yen and the British pound to a 1.5 year low. Risk aversion is rising around the world not only because of the ripple effects of slower US growth, but also because the leading banks on Wall Street are continuing to issue bearish news. Citigroup announced the biggest loss in the bank’s 196 year history, days after Merrill Lynch announced a significant write down. Earnings season has just begun and the fear is that more bad news will surface. Even continual investments by Sovereign Wealth funds fail to help the stem US equity market losses. It is too early to pick a bottom. If anything, carry trades are prime for further losses. There are a number of Japanese economic releases due for release this evening. Although they are important, their market moving potential at this point is minimal.
British Pound: Still Struggling
The British pound was one of the few currencies to actually rally against the US dollar on the belief that US rates will fall much faster than UK rates this year. Economic data from the UK this morning was stronger than expected with consumer prices rising at a faster pace than the market expected last month. Despite stronger economic data, we still believe that the British pound will continue to sell off. Employment numbers are due for release tomorrow. The employment components of service, manufacturing and construction PMI all increased in the month of December suggesting that the number of jobless claims will fall more than the -5k forecast. However the number to focus on is average earnings. Softer wage growth can easily offset a larger drop in jobless claims.
Commodity Currencies Hit by Falling Prices and Carry Trade Liquidation
The Australian, New Zealand and Canadian dollars sold off on a combination of falling commodity prices and carry trade liquidation. Gold prices continue to remain at high levels, which is why we believe that if high yielding currencies bounce tomorrow, the AUD/USD may benefit the most. There is no data from any of the commodity producing countries until Thursday evening.