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Saturday March 8, 2008 - 00:46:51 GMT

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FOREX RESEARCH - Federal Reserve Is On High Alert

Written by Kathy Lien, Chief Strategist

• Canadian Employment at Record Highs but Risk Aversion Hits the Commodity Currencies
• Euro Hits a Record High but Retreats

Federal Reserve Is On High Alert
Non-farm payrolls dropped for the second month in a row but interestingly enough, that was not the biggest story of the day. Instead, the Federal Reserve is on high alert, having announced plans to pump 200 billion dollars into the banking system to "address liquidity pressures in the funding markets.” Although they denied that this was related to the weak jobs report, the timing is certainly suspect. The announcement may have been aimed at preventing a non-farm payrolls induced collapse in the stock market, which worked for about an hour before stocks completely reversed all of its gains. Whether this is true or not, the one thing that is certain is the fact that the Federal Reserve is very worried about the current state of the US economy and the financial markets. Today’s payroll numbers tell us that the US economy is already in a recession and it will just be a matter of time before retail sales turn negative as well. The only reason why the unemployment rate dropped was because prospective employees were so discouraged about the outlook of the labor market that they simply gave up. This seals the fate for the Fed rate decision in less than 2 weeks - they will have no choice but to cut interest rates by 75bp. In the coming months, we expect the labor market to worsen which will force the Fed to bring interest rates down to as low as 1.50 percent. Two back to back months of job losses is still nothing compared to the 15 consecutive months of negative job losses between 2001 and 2002. In our non-farm payrolls preview, we said that as much as 100k jobs could have been cut from US payrolls last month. If your strip out the contribution of government jobs to the February report, the private sector actually reported a net job loss of -101k. Retail sales are the big event risk for the US dollar next week. 4k jobs were cut from the retail sector and according to Wall Street Journal, sales at most retailers other than discounters have been weak. With gas prices skyrocketing, foreclosures hitting a record high, the labor market weakening and confidence at a record low, discretionary spending may be the last things on the consumer’s mind. In addition to retail sales, we are also expecting the trade balance and consumer price report. Both numbers should be dollar positive because the weakness of the greenback should help to improve the trade deficit while record high commodity prices will boost inflation.

Canadian Employment at Record Highs but Risk Aversion Hits the Commodity Currencies
The US government should be envying Canada, its northern neighbor who reported stunning job growth in the month of February. The market was forecasting an increase of only 3k jobs, but to their surprise, 43k new jobs were added to Canadian payrolls, keeping the unemployment rate at a 33 year low of 5.8 percent. The increase in jobs was concentrated in the Ontario region and in the construction, public administration, service and trade sectors. Wages were also very strong with a 4.9 percent increase in the average hourly rate, more than double the rate of inflation. Although this did lead to significant strength in the Canadian dollar, weak US job growth erased those gains on the fear that slower US growth will spillover to the Canadian economy. This is a significant possibility, but we believe that the strength of the Canadian data should lead to a further rally in the loonie in the coming week. The only piece of economic data scheduled for release from Canada is the trade balance, which we expect to be firm. Meanwhile Australia will be releasing employment numbers while New Zealand will be reporting retail sales. This set of data will be market moving for both currencies.

Tell us what you think on the Canadian dollar Forum.

Euro Hits a Record High but Retreats
The Euro hit a record high of 1.5463 after the US non-farm payrolls report but it ended up retreating almost instantaneously as carry trades came under pressure and news that the Federal Reserve expanded their lending hit the markets minutes after the NFP report. Eurozone economic data continues to be firm with German industrial production rising more than expected. Unlike the Federal Reserve, the ECB is not particularly worried about the liquidity pressures in the financial markets. Instead, ECB member Weber warned that the markets are underestimating inflation risk. With coffee, corn, rice and other food prices hitting significant highs, we believe that he is 100 percent right. In the week ahead, the two most important releases out of the Eurozone will be the German trade balance and the ZEW survey. Although economic data suggest that analyst sentiment should improve, this group of critics always tend to lean towards pessimism. Meanwhile the Swiss National Bank has a monetary policy meeting next week. Interest rates are not expected to be changed.

Visit the Euro Currency Room for resources dedicated specifically to the Euro.

British Pound Hits YTD Against US Dollar
Despite the lack of any UK economic data, the British pound soared to a year to date high against the US dollar. This price action is very interesting because the British pound also rallied against the Euro which should have been supported by the stronger Eurozone economic data. This may be due to the fact that higher inflation numbers are expected from the UK Monday morning. PPI should be hot given the rise in food and energy prices. Later in the week we are expecting the UK trade balance which should also be improving.

Visit the British Pound Currency Room for resources dedicated specifically to the Euro.

US Dollar Falls to 8 Year Low Against the Yen
Even though many of the Japanese Yen crosses ended the day unchanged, there was a significant amount of intraday volatility. USD/JPY hit an 8 year low of 101.42 before rallying to an intraday high of 103.24. This was largely due to the big swings in the stock market which led to big reversal candles in all of the Yen crosses. The Bank of Japan kept interest rates unchanged at 0.50 percent while the BoJ monthly report said that even though the economy is still expanding, the pace of growth is moderating.

Visit the Japanese Yen Currency Room for resources dedicated specifically to the Euro.

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