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Thursday December 11, 2008 - 22:49:54 GMT
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Forex Research - US Dollar Takes a Hit on Weaker Economic Data

US Dollar Takes a Hit on Weaker Economic Data Last Updated 12/11/2008 5:17:00 PM EST (GMT +5)



CURRENT US INTEREST RATE: 1.00% Traders Favor 75bp Rate Cut in December!
  12/16 Meeting 01/28 Meeting
NO CHANGE 0.0% 0.0%
CUT TO 25BP 0.0% 5.0%
CUT TO 50BP 16.0% 15.1%
CUT TO 75BP 84.0% 79.9%


The US dollar took a beating today as weak economic data raises the risk of a 75bp rate cut by the Federal Reserve on Tuesday. Jobless claims rose by the largest amount since November 1982 with continuing claims hitting the highest level in 26 years. The current recession is the worst that we have seen since the 1980s and the latest jobless claims report only confirms that. However the labor data was not the only piece of bad news pressuring the dollar today, the trade deficit widened unexpectedly, household wealth plunged 11 percent in the third quarter compared to a year ago and the $14B bailout for automakers is having a very difficult time passing the Senate. In the past, the US dollar has actually rallied on weaker economic data because of its low interest rate and flight to safety but it was only a matter of time before investors realized that the US economy is in such bad shape that the dollar may not be safest place to hide. 

Revisiting the 1980s

We have previously pointed out that non-farm payrolls tend to double-dip during recessions, meaning that we first see a large drop in employment by the hundreds of thousands, followed by a retracement and then another month of major job losses that is comparable to previous decline. In this case, that would mean another month of job losses that comes close to or exceeds the -533k jobs that were lost in the month of November. This was what happened in 1981. The first time jobless claims printed above 500k in the 1980s was in October 1981. Non-farm payrolls had started declining in August and in January of 1982, non-farm payrolls dropped by 327k. It then rebounded significantly the next month (-6k), but that was only a precursor to another 10 consecutive months of job losses with non-farm payrolls revisiting the -300k levels in July (NFP in July 1982 was -343k).  We expect the same thing to happen again in 2009 especially after Bank of America announced this afternoon that they will be cutting 35,000 jobs over the next 3 years. The weekly jobless claims number will add pressure on the Federal Reserve to cut interest rates by 75bp next Tuesday. Fed Fund futures are already pricing in a 75bp rate cut from the Federal Reserve next week. This would take US rates to 0.25%, making the US dollar the lowest yielding currency in the developed world. If the Fed takes interest rates to zero, we could see USD/JPY fall to 13 years lows and the Euro to return to 1.35.

Trade Deficit Data Signals to Big Dive in GDP

The two biggest inputs into GDP are consumer spending and trade. Therefore the 2.8 percent decline in retail sales and the surprise widening of the trade deficit in the month of October suggests that GDP growth could take a big dive in the fourth quarter. Word on the street is that some economists are calling for GDP to decline as much as 4 to 6 percent in Q4, which would be the largest contraction in growth since the 1980s.  In the first quarter of 1982, GDP fell -6.4 percent. A 4 to 6 percent drop in GDP would not be out of the ordinary given the current conditions in the US economy.  In the fourth quarter of 1990, GDP contracted by 3 percent and in the first quarter of 1991, it contracted by 2 percent. If you agree that the current recession is worse than the one in the 1990s, then it would be logical to expect a contraction in growth exceeding 3 percent. 

Don’t Expect Retail Sales and Producer Prices to Help

Retail sales and producer prices for the month of November are due for release tomorrow. Another large decline in consumer spending will only support our thesis that GDP will see a big contraction in the fourth quarter. All of the leading indicators for retail sales that we follow point to very weak consumer spending last month despite stronger Black Friday sales. SpendingPulse, the retail data service of MasterCard Inc. reported that retail sales excluding autos dropped by the largest amount in 5 years. Chain store sales as measured by the International Council of Shopping Centers also dropped by 2.7 percent last month, the largest decline in at least 8 years. Don’t forget that November was also the month that non-farm payrolls fell 533k.  Americans were more worried about keeping their jobs last month than spending liberally. The Treasury market is already pricing in the possibility of deflation and depression with yields in zero to negative territory for the first time since the Great Depression. Although we don’t think that the US will fall into a depression, the data certainly supports tougher times ahead for the US economy.


The Euro completely decoupled from equities today on the back of higher oil prices and not so dovish comments from the European Central Bank. Weak US economic data is making it increasingly clear that the gap between US and Eurozone interest rates will not narrow anytime soon. There was no Eurozone economic data released today, but ECB member Weber said a January rate cut is not a done deal. He pointed out that the ECB has never taken interest rates below 2 percent and that the central bank doesn’t have enough information to decide whether to cut interest rates again in January. Market tensions are expected to ease next year and he really wants to avoid negative real interest rates. More importantly, Weber added that when the economy recovers, the ECB will need to raise interest rates promptly. In terms of monetary easing, the ECB has been one of the least aggressive central banks this year. They have only cut interest rates by 150bp, compared to the 325bp by the BoE. This is why EUR/GBP has continued to press higher. With the Fed cutting interest rates next week, the latest comments from the ECB could fuel further gains in the EUR/USD going into the US rate decision - there is nothing standing in the way of currency pair hitting 1.35.  Meanwhile the Swiss National Bank cut their target interest rate range by 50bp to 0.0 – 1.0 percent, making the Swiss Franc, the second lowest yielding currency in the developed world for the time being. This SNB has materially revised down their inflation forecast and they expect GDP to contract between 0.5 to 1 percent next year. Although they did not talk about zero interest rates specifically, they did say that they will implement further measures should the situation so require. There is a strong chance that we will see further gains in EUR/CHF.


The British pound is trading back above the 1.50 level against the US dollar, albeit only marginally. Although the CBI Industrial Trends survey improved in the month of December, the export index fell to the lowest level since 2003 while the output expectations component fell to the lowest level since 1980. The CBI number reports the conditions in the manufacturing sector and can be used as a leading indicator for manufacturing PMI. The data tells us that the manufacturing sector remains in bad shape which is in line with the overall trend in the UK economy. Even though the British pound has rallied against the greenback, it continued to press lower against the Euro. Central bank officials around the world have been under extreme stress and Bank of England’s Blanchflower is the first one to cave. He announced plans to step down in May after pushing for interest rate cuts every month since October 2007. He called for a recession in the UK economy in November 2007, before any other member of the committee. His sharp ability to analyze the UK economy will be a big loss for the Bank of England. 


The Australian, New Zealand and Canadian dollars rallied today on the combination of US dollar weakness and strength in commodity prices. Oil rose 10 percent on the expectation that OPEC will cut its production at next week’s meeting by as much as 2 million barrels a day. Australian employment dropped by 15k last month, driving the unemployment rate to the highest level in 1 year. Although the number was weak, compared to the rest of the US, it is enviable. New Zealand retail sales fell 1.3 percent in the month of October, the largest decline in 4 years. The contraction in consumer spending was due almost entirely to weaker demand for autos as spending ex autos rose 0.8 percent in the same month. Meanwhile the Canadian trade surplus narrowed in October, but not by as much as the market had expected; house prices fell 0.4 percent. Capacity utilization and new vehicle sales are due for release tomorrow. These are not very market moving numbers for the Canadian dollar.  


The US dollar fell to a seven week low against the Japanese Yen as the Dow tumbled 196 pips. Although dollar weakness dominated trading today, USD/JPY has been in a strong downtrend since August. The currency pair has become grossly oversold which is why the dollar’s weakness today was more predominant against higher yielding currencies such as the Euro, British pound, Australian and New Zealand dollars. The rally in the EUR/USD and GBP/USD was so significant that it kept EUR/JPY and GBP/JPY in positive territory despite the 196 point decline in the Dow. Foreign buying of Japanese stocks and bonds has plunged in the past week while Japanese buying of foreign stocks and bonds have surged. Industrial production is due for release this evening along with consumer confidence. Both figures should confirm the recessionary conditions in Japan. 

EUR/USD: Currency in Play for Next 24 Hours

The currency in play for the upcoming 24 hours is EUR/USD. There is plenty of influential economic data that is set to be released starting with Euro-zone Industrial production at 5:00AM EST or 10:00GMT and followed by the US Retail Sales and PPI reports at 8:30AM EST or 13:30GMT. Further in the day, the University of Michigan Consumer Confidence survey is expected to be released at 10:00AM EST or 15:00GMT. 

The EUR/USD has seen drastic gains as the pair broke uprising triangle and Bollinger Bands, continuing the momentum to the upside. The overall pair is slightly overbought, although it is showing a definite reversal from the bottom which was established in the middle of October. The first resistance is placed at the 1.3500 which is a psychological barrier for traders. Followed by the 1.3600, which is a 50% retracement from the September high and October low. Current support is placed at the level of 1.3200 which is the second standard deviation of the Bollinger Bands along with a 23.6% retracement of July high and October low. With increased volatility and influential data released in the United States, either levels are in reach for the pair. While the EUR/USD is clearly reversing for the bottom, any positive data from the U.S could lead the pair slightly lower.

About The Author

Lien has extensive knowledge within the interbank market, particularly in trading spot FX and options. She has written for numerous publications, is frequently quoted on financial media outlets, and is the author of several books, including Millionaire Traders. Read more >>

DISCLAIMER: This forum and the information provided here should not be relied upon as a substitute for extensive independent research before making your investment decisions. Global Forex Trading is merely providing this column for your general information. This forum and its information does not take into account any particular individual’s investment objectives, financial situation, or needs. All investors should obtain advice based on their unique situation before making any investment decision based upon this forum or any information contained within. In addition, any projections or views of the market provided by the author may not prove to be accurate. Global Forex Trading and Kathy Lien will not be responsible for any losses incurred on investments made by readers and clients as a result of any information contained in this column. Global Forex Trading and Kathy Lien do not render investment, legal, accounting, tax or other professional advice. If such advice is sought, or other expert assistance is required, the services of a competent professional should be sought.





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