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Friday April 25, 2008 - 23:57:57 GMT

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Forex Research - Dollar Looking at a Perfect Economic Storm

Friday, 25 April 2008 22:34:59 GMT

Written by Kathy Lien, Chief Strategist

• Pound Rallies Unexpectedly as Growth Cools To Three Year Low
• Japanese Yen Crosses Mixed as Inflation Hits Decade High

Dollar Looking at a Perfect Fundamental Storm
There was little to alter the greenback’s slow but steady rise through the week’s end Friday. The only economic indicator to cross the wires was the final reading of the University of Michigan’s consumer confidence survey. And, while the revision is rarely a market mover, the downside adjustment to a new 26-year low stands as a poignant reminder of why economists and traders are still wary on the outlook for the US economy and the dollar. Looking ahead to next week, volatility is almost guaranteed with an economic calendar that is crowded with the top market moving indicators. Taking the oncoming tidal wave day-by-day, things begin slow with a report-free Monday. Tuesday will offer the Conference Board’s measure of consumer sentiment for April; though with the University of Michigan’s figure already ingrained into the market, there is likely to be limited reaction to number. The following day’s docket holds the greatest potential for a fundamentally-driven run in the majors. The morning brings the advanced reading of first quarter GDP. Oddly enough, the consensus from economists is calling for a 0.5 percent annualized pace of expansion (a tick below the fourth quarter clip) despite a deepening housing recession, a turn in employment and contractions in both the services and manufacturing sectors. Such a moderate forecast opens the market to considerable surprises; but a reaction could be dampened by a FOMC rate decision due later that afternoon. Fed Fund Futures are pricing in only a 74 percent chance of a 25bp rate cut while the remaining 26 percent is calling for no change. This is a considerable change from where we were only a few weeks ago, but we have also seen evidence that the credit crunch is easing. After the calendar crests on Wednesday, ISM manufacturing will represent a lull for fundamental traders the following session considering the previous day’s event risk and Friday’s NFPs. Payrolls are expected to have fallen by 78,000 jobs this month, what would be a fourth consecutive drop.

Pound Rallies Unexpectedly As Growth Cools To Three Year Low
Theoretically, we would expect the currency of an economy that just reported a drop in growth to fall; however theory clearly didn’t follow with today’s UK GDP release. The advanced reading of first quarter expansion came in line with expectations with its quarterly measure, but fell short of the official consensus with its annualized figure. The 2.5 percent pace of growth through the year was a slight miss of economists’ 2.6 percent forecast, but set a three-year low for economic activity nonetheless. It comes as no surprise that  the biggest weight on expansion was the cooling in the financial services component (which makes up 28 percent of the economy) to a five-year low given the ongoing credit crunch that forced the BoE to nationalize Northern Rock and offer ever more aggressive liquidity injections. So why the pound rally? Well, considering the IMF has forecasted the worst pace of growth since 1992, traders likely expected much worse.

Euro Ends The Week At A Three Week Low
Though the European economic calendar has been relatively light this week, the euro has still managed to close at its lowest level in three weeks against the benchmark dollar. What would ultimately be a more than 500-point plunge in EURUSD was further depressed on Friday by mildly dovish comments from ECB members and declines in two second tier inflation indicators. This morning, central banker Lorenzo Bini Smaghi noted that inflation in the region had reached an acceptable level and further that the euro was pressing record highs largely due to the weakness in its US counterpart. Policymaker Christian Noyer offered the same inflation sentiment. From the economic docket, both the German Import Price Index and Euro Zone money supply numbers for March cooled. The German inflation report was still near its 19-month high, but marked a notable slip. The money supply number on the other hand slipped to a 12-month low 10.3 percent pace of annualized growth; and considering ECB President Trichet’s constant mention of “vigorous” M3 growth, this makes an interesting point.

Japanese Yen Crosses Mixed as Inflation Hits Decade High
The Japanese yen ended the day very mixed across the majors, as the low-yielding currency fell against the US dollar and the British pound but rallied versus the euro and high-yielding Aussie and Kiwi dollars. Indeed, Japanese fundamentals have had little bearing on price action in the yen pairs for quite some time, but it is worth noting that Japanese headline inflation jumped to an annual rate of 1.2 percent in March, the highest reading in a decade. Most of the pick up can be attributed to the recent rallies in oil and other commodity inputs, as the index excluding the costs of fresh food and energy brings the metric down to a tepid 0.1 percent pace. Inflation driven by rising costs will discourage spending by firms and consumers alike and leaves the Bank of Japan in a precarious position. While the policy board likely remains in favor of rate normalization, substantial downside risks to exports and faltering consumption will force the Bank to leave rates unchanged and if anything, will lead them to consider cutting rates. Nevertheless, with interest rates already at an ultra-low 0.50 percent, the stimulating potential of a 25bp rate cut would be extremely small and leaves the odds in favor of steady rates for much of this year.

Will the Comm Dollars Falter?
The Australian and New Zealand dollars faltered on Friday as commodities including metals and agricultural goods pulled back, while resilient oil prices helped support the Canadian dollar against the strengthening greenback. There was little in the way of economic data to move the currencies, but traders should watch out for next Monday’s New Zealand trade balance – as the surplus is forecasted to widen – while Friday’s Australian retail sales figures are anticipated to show that consumption contracted during the first quarter. Furthermore, according to Technical Strategist Jamie Saettele, the Loonie, Aussie, and Kiwi may all be in for declines based on Elliott Wave counts. 




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