Weekly Review and Outlook

Euro May Tumble in an Eventful Week on Speculations of Deep ECB Cut

Improvement of risk appetite was the main theme in the forex markets early last week as reflected with AUD/USD and AUD/JPY being the top gainers. Nevertheless, momentum in yen crosses receded as the holiday shortened week went on and upside of yen crosses are still limited by some near term resistance levels. The outlook of investors sentiments remained shaky despite the boost by announcement of various stimulus and rescue plans.

The most important development of the week was, indeed, the deterioration in Euro towards the end with Euro felling sharply across the board after sharper than moderation in consumer inflation. Weakness of Euro was most apparent in EUR/GBP as the correction from 0.8660 record high resumed and dived to as low as 0.8234. EUR/USD was sharply lower from 1.3080 to as low as 1.2464 while EUR/JPY was back pressing 121 level. Note that Nov HICP flash was at 2.1% yoy, just inch above ECB's target of 2%, thus giving ECB the much room to catch up with other major central banks around the world on cutting interest rates.

Dollar index dived to as low as 84.78 early last week but subsequent strong rebound and break of 86.43 resistance argues that such correction from 88.46 has completed. Some more strength in the greenback is in favor, probably led by weakness in EUR/USD. Also, note that Gold's rebound lost momentum after hitting 833 level. OPEC also said that they will delay cutting production this year. Any short term reversal in Gold and Crude Oil will provide further support to the greenback.

The coming week will be extremely eventful, featuring rate decisions of four major central banks, ECB, BoE, RBA and RBNZ. In addition, we'll have both ISM indices as well as Non-Farm Payrolls. Let's prepare for a roller-coaster ride in the markets.

Currency Heat Map Weekly View

US President-elect Obama unveiled the economic team which includes New York Fed President Timothy Geithner as Treasury Secretary and former Treasury Secretary Larry Summers as head of the National Economic Council. He also urged Congress to pass a costly, job-creating stimulus bill as quickly as possible.

Fed announced a plan to unfreeze credit for home buyers, consumers and small businesses including purchase of as much as $600b in debt issued or backed by GSEs as well as setting up a $200b program to support consumer and small-business loans.

US Q3 GDP contraction was revised deeper from -0.3% to -0.5% annualized. Price index was unchanged at 4.1%. PCE growth was revised lower to 5.2% while core PCE growth was revised lower to 2.6%.

Personal spending dropped sharply by -1.0% in Oct, worst since 2001. Though, income rose more than expected by 0.3%. Headline PCE slowed sharply from 4.2% to 3.2% while core PCE slowed from 2.4% to 2.1%. Headline durable goods orders dropped much more than expected by -6.2% in Oct, largest drop in 2 years. Ex-transport orders contracted -4.4%, biggest fall since 2002.

Jobless claims improved mildly to 529k but remains elevated above 500k level. Continuing claims unexpectedly dropped to 3.962m. Conference board consumer confidence improved more than expected to 44.9 in Nov. U of michigan consumer sentiment was revised lower to 55.3. Chicago PMI dropped more than expected to 33.8 in Nov.

Existing home sales dropped more than expected by -3.1% to 4.98m annualized rate in Oct but was slightly above Aug's low of 4.91m. Median price fell -11.3% yoy to $183.3k, largest annual drop since record began in 1968. New home sales dropped -5.3% to 0.433m annualized rate. S&P/CS compite-20 house price index dropped more than expected by -17.4% yoy in Sep.

ECB Trichet said that chance for negative growth in 2009 is "gradually appearing" even though the forecasts still point to positive growth in 2010. He noted again that ECB is prepared to take any measures necessary to improve short term liquidity while maintaining price stability.

Germany Ifo Business Climate dropped to new 16 year low of 85.8 in Nov, much worse than expectation of 88.7. The fall was driven by deterioration in both Current Situation Component, which dropped from 99.9 to 94.8 and Business Expectations Component, which fell from 81.4 to 77.6. All industry components, trade & industry, manufacturing, construction, wholesaling, retailing deteriorated deeper into negative region. Inline with market expectation, final Q3 Germany GDP fell -0.5% in 3Q08 when adjusted for seasonal and calendar effects, after contracting -0.4% in Q2. Gfk consumer confidence index rose to 2.2 in Dec. Import price dropped -3.6% MoM and 2.9% YoY. This was the biggest drop since records began in 1962 because of declines in commodity prices. Unemployment rate was also unchanged at 7.5% in Nov.

Eurozone inflation posted a record drop in November with HICP flash estimate sank further to 2.1% from 3.2% in October. After being above ECB's target of 2% since Sep 07, inflation is now very close to such target. Unemployment rate came in at 7.7% for October, the highest level in 2 years (consensus: 7.6%). Current account deficit came in at EUR 10.6B in September, down from a deficit of EUR 5.3B in August, as goods deficits widened and service surplus lowered. Economic sentiment dropped from 80.0 to 74.9 in Nov, much worse than expectation of 78.5. Business climate tumbled sharply to -2.14 while consumer confidence dropped slightly to -25. M3 money supply growth was unchanged at 8.7% yoy in Oct.

UK PM Brown proposed a stimulus package to spend 25.6B pound over 2 years to help the country survive in recession. The plan includes reducing sales tax rate by 2.5% to 15% and tax breaks for small businesses and funds to encourage people to insulate their homes.

In the testimony to parliament's Treasury Committee, BoE Governor King said the outlook for inflation has shifted down and risk that weak demand might pull inflation below the 2% target in the medium term has increased significantly. King emphasized that the most important issue now is to 'ensure that normal bank lending is resumed' and 'without that, the downturn in activity could become protracted and extremely damaging' . It's reasonable to see more rate cuts coming as King expected 'much still remains to be done and very significant policy challenges lie ahead.'

Inline with market expectation, UK Gross domestic product for Q3 dropped -0.5% qoq from Q2. Year-over year grow was at a mere 0.3%. Both are unrevised from preliminary estimates. Nationwide house price dropped another -0.4% mom in Nov with yoy rate down -13.9%. Consumer confidence index by Gfk came in at -35, slightly higher than consensus of -38 and October's -36. However, it's still close to record low of -39 in August.

Swiss KOF leading indicator dropped to five years low of -0.05 in Nov, far worse then expectation of 0.2. Also, this is the first negative reading since Jun 2003. The data suggests sharp deterioration in Swiss economy too.

BoJ monthly report painted a generally pessimistic picture of the economic outlook. The report noted that "the increased sluggishness in Japan's economic activity will likely persist over the next several quarters" as slowdown in the global economy becomes "more evident." Both external and domestic demand are expected to decrease. Production will continue decreasing and even with a "faster" pace in the immediate future. BoJ minutes of the Oct meeting revealed that members are divided on monetary policy response to the global economic crisis. Four members voted for 20bps cut, three preferred 25bps cut while Mizuno voted for no change. Governor Shirakawa cast the deciding vote.

Japan corporate service prices dropped -1.4% in Oct compared with consensus of -0.5% after a 0.1% annual expansion in September. This was the first decline in two years and the steepest fall in five years. Manufacturing PMI for November fell to 36.7 (Oct: 42.2), the ninth consecutive fall and a record low since the survey started in 2001. Household spending fell -3.8% in October on annual basis worse than -3.4% as market expected. Japan retail sales dropped 0.6% in October from a year ago and marked the decline for the second month. National CPI fell to annualized 1.9% in October, inline with consensus and lower than 2.3% in September. Industrial production declined sharply 3.1% in October. Housing starts rose 19.8% yoy in Oct, below consensus of 29.3%.

Canadian retail sales rebounded stronger than expected by 1.1% mom in Sep with ex-auto sales rising 0.8% versus expectation of 0.3% and 0.2% respectively. Trade surplus narrowed to 5.64b in Q3. Oct PPI was flat mom.

New Zealand's recorded a trade deficit of NZ$942M in October, slightly lower than consensus of NZ$1000M.

Suggested Readings:

• FX Briefing: Dollar Unfazed by Fed Policy
• This Week's Market Outlook
• Weekly Foreign Exchange Insights
• Weekly Focus: Rescue Packages vs. Economic Data
• FX Crossroads: It is all about risk
• Throwing Cash Like Monopoly Money
• Financial Markets Review: Equities Rebound Strongly and Bond Yields Fall
• What Will Happen To The Dollar As Fed Cuts Brings Rates Near Zero?

The Week Ahead

Four major central banks will announce rate decision this week. ECB, BoE, RBA and RBNZ are all expected to cut rates again but opinion on the depth of the cuts are divided. Generally speaking markets expect:

• ECB to cut 50bps to 2.75%
• BoE to cut 100bps to 2.00%
• RBA to cut 75bps to 4.50%
• RBNZ to cut 150 bps to 5.00%

However, we won't be surprised to get some surprise as there are just too many variables, including inflation, growth and the stock markets that could affect the views of those central bankers.

Also, note that, as mentioned above, outlook in Euro deteriorated sharply after Nov HICP showed sharper than expected moderation to 2.1%, just slightly above ECB's target of 2.0%. There are increasing speculation that ECB could cut deeper than 50bps and such speculations will likely continue to pressure the common currency ahead of the rate announcement.

Technically speaking, another key factor to watch is whether dollar index could sustain the late rebound last week to extend to prior high of 88.46. Both ISM indices as well as Non-Farm Payroll will play an important part in determining the trend in the greenback.

Other important data include Eurozone PMIs, retail sales, GDP, UK PMIs, Swiss SVME PMI, CPI, GDP, Canadian GDP, Ivey PMI, job report, Aussie retail sales, GDP.

Suggested Readings:

• Economic Calendar Summary 12/1 - 12/5
• The Week Ahead Canada & U.S.: Canadian and U.S. Employment, ISM Manufacturing
• The Week Ahead UK & Europe: ECB and BOE Interest Rate Decisions
• The Week Ahead Japan and Australia: RBA Decision, Australian GDP
• Next Week
• US Dollar Bound to See Weak ISM, NFP Results - What Impact Will They Have?
• The Weekly Bottom Line
• Australian & New Zealand Weekly: The Case for the RBA to Cut by "Only" 75bps
• RBNZ December MPS Preview: OCR to be Cut 100bp to 5.50%

Longer Term

• Euro Forecasts for December
• Japanese Yen Forecasts for December
• British Pound Forecasts for December
• Swiss Franc Forecasts for December
• Canadian Dollar Forecasts for December
• Australian Dollar Forecasts for December
• New Zealand Dollar Forecasts for December
• Recession Probability: Recession to Persist for Next Six Months
• Could Deflation Derail De Fed?

EUR/USD Weekly Outlook

EUR/USD rebounded strongly to as high as 1.3080 last week but subsequent fall dragged 4 hours MACD below signal line, indicating that such rebound has completed. Initial bias is mildly on the downside for retesting 1.2423 support. Break will indicate that consolidation from 1.2329 has likely completed and recent down trend is resuming for 50% retracement of 0.8223 to 1.6038 at 1.2131 next. On the upside, above 1.3080 will indicate that rise from 1.2423 is still in progress for 1.3290 resistance or above. Though, upside is still expected to be limited below 1.3768 cluster resistance and bring down trend resumption.

In the bigger picture, as discussed before, the strength of the fall from 1.6038 reinforces the case that whole decline from 1.6038 is developing into a five wave impulsive fall with first wave completed at 1.3881, second at 1.4867, third at 1.2329. Consolidation from 1.2329 might represent the fourth wave consolidation. Hence, another decline is still expected before making a medium term bottom. Below 1.2329 will target next long term fibonacci level of 50% retracement of 0.8223 to 1.6038 at 1.2131 or even further to 1.1639 key medium term support. On the upside, sustained break of 1.3768 cluster resistance (38.2% retracement of 1.6038 to 1.2329 at 1.3746) is needed to invalidate this view and indicate that whole decline from 1.6038 has made a medium term bottom.

In the long term picture, 1.6038 is no doubt an important long term top and the long term trend has definitely changed. The question is how far such down trend can go. Would EUR/USD retest historical low of 0.8223? There is no clear answer for the moment. Nevertheless, the impulsive nature of the fall from 1.6038 suggests that the development after EUR/USD makes a medium term bottom will be corrective in nature and then be followed by at least one more medium term decline before completing the whole long term down trend.

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