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Forex - Central Bank Meetings Flood the Calendar Next Week

FXCM - DailyFX Fundamentals 12-01-06

By Kathy Lien, Chief Strategist of www.dailyfx.com

• Central Bank Meetings Flood the Calendar Next Week
• Contractionary Reading in ISM Sends Dollar Lower
• ECB Set to Raise Rates to 3.25 Percent

US Dollar – For the first time since April 2003, the national ISM survey of manufacturing conditions fell below the 50 mark, indicating that activity contracted rather than expanded in the month of November. With five out of the ten underlying components including employment, new orders and production contracting, the possibility of a recession in the US economy is growing. The weakness of the housing market is finally spreading to the rest of the economy and both traders and economy watchers are worried. The US dollar has fallen once again while the stock market tanked on the back of the report. In addition to the ISM, construction spending also dropped by 1 percent with a comparably large downward revision to the September data. Interestingly enough though, Fed President Plosser as well as the ISM head downplayed the significance of the report. They felt that a one month contraction was too little to deem the entire sector as recessionary. In fact, we would need to 6 months of sub 50 readings to label it as such. We think that if we saw 2 sub 50 readings, it would be time to be very worried. The recent data suggests that GDP in the fourth quarter will most likely take a big hit. There is little chance that the 2.2 percent growth that we saw in the third quarter will be sustained. In fact, it is very possible that we could even see growth drop below 2.0 percent. Bernanke refrained from making any comments about the economy or monetary policy today, but we know where he stands after his speech earlier this week, where he was worried about inflation but weary about growth. Looking ahead, Fed fund futures have already fully priced in a quarter point rate cut by the summer. We continue to expect a great deal of data next week with service sector ISM and non-farm payrolls the primary focus. It is quite obvious that the dollar’s rally has become extended but with the proximity of 1.35 in the EUR/USD and 2.00 in the GBP/USD, those key levels may be too tempting for traders not to take stab at.

Euro and Swiss Franc – The Euro has staged an impressive rally over the past week not because the economy is doing well, but because it is not doing as poorly as the US. Relative weakness is what we have to deal with these days and unfortunately the relative weakness in the US economy is far more dominant. The Eurozone also released manufacturing sector data today that fell short of expectations, but the reading remained comfortably above the 50 boom/bust level for every country within the region. The unemployment rate even improved from 7.8 percent to 7.7 percent thanks to the contribution from Germany, who reported a surprise 86k drop in unemployment in the month of November. For the time being, the Euro’s rally remains very strong and will likely continue until we hear some objections from the European central bank. Next week could provide the perfect forum as the ECB announces their monetary policy decision. Another quarter point hike to 3.50 percent is widely expected by the market but beyond that, policy remains questionable. Even Trichet himself has said that projecting into 2007 may be premature. Given the recent mild slowdown in the Eurozone economy and the potential strain brought on by the strength of the Euro, the ECB will most likely shift to neutral. Inflationary pressures are also being capped by the rally in the currency, which we expect will calm the ECB’s calls for vigilance. The interest rate meeting will be the market’s primary focus next week even though there will be a few key releases including Eurozone retail sales. Over in Switzerland, recent economic data has been really mixed. This morning, third quarter GDP was sharply weaker than expected while the manufacturing sector PMI report hit a fresh high. Earlier this week, leading indicators were softer despite a stronger UBS consumption index. Taken together, the data suggests that even though economic growth has seen moderation, it is not enough to be worried. Next week, the only piece of data that is scheduled for release is the unemployment rate and a speech by SNB President Roth.

British Pound – The British pound charged higher once again, climbing a total of 800 pips since last Wednesday. Part of the reason for the currency’s larger rise against the dollar (compared to the Euro) is the fact that if the US lowers interest rates, UK rates will be on par with US rates, eliminating any negative carry advantage. Over the past week, it has become clear that the housing market is the economy’s primary source of growth. Domestic spending is beginning to falter while manufacturing sector growth, as reported by today’s PMI report is slowing. Even though the UK is not an extremely export dependent economy, as the currency continues to rise, it does make UK companies far less attractive acquisition targets, which could in essence put a stop to the aggressive merger flow that has benefited the British pound. In the week ahead, there are a ton of data in addition to the BoE’s interest rate decision to watch.

Japanese Yen – The Japanese Yen has behaved very differently across currency pairs this week. For the most part, it has sold off against the majors, but the two currencies that it has managed to rally against have been the US and Canadian dollars. This divergence in price action tell us that the market is not really bullish on the yen, but instead, it is very bearish on the US and Canadian dollars. The data released last night was mixed, with consumer prices falling and household spending rising. The weakness of CPI should keep expectations for any rate hikes by the BoJ capped, especially after the more neutral comments from central bank Governor Fukui earlier this week. As a result, for the time being, carry trades continue to hold.

Commodity Currencies (CAD, AUD, NZD) – The Australian and New Zealand dollars have managed to hold onto all of its gains from the past week thanks to the weakness of the US dollar. Australian data has been mixed, with the latest PMI report jumping from 51.9 to 54.4 in the month of November. Next week brings up a lot of key data for Australia including the RBA monetary policy announcement, GDP and employment. New Zealand will also be meeting to discuss rates along with the Bank of Canada. No rate changes are expected from any of the central banks. Canada reported stronger employment numbers this morning, but that his done little to boost the CAD.

 

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