Is the USD Back on the Outs?

Highlights

• Is the USD back on the outs?
• In a QE2 world... Is bad data now bad for the buck?
• ECB avoids the knight in shining armor role
• Interest rate decisions likely to be non-decisions
• Key data and events to watch next week

Is the USD back on the outs?

The US Nov. employment report is widely described as disappointing, but we need to keep it in context. No one should have been expecting a sudden surge of job creation given still elevated jobless claims data, so why should we be so severely disappointed that the number came in about -100K below expectations? After all, the margin of error on NFP reports is easily +/- 100K and that leaves the Nov. number roughly within the range of expected outcomes. The jump in the unemployment rate is a psychological blow, for sure, but it's largely due to an increase in the labor force and not a meaningful indication of future job prospects. At the end of the day we are left with what we already knew to be the case: US labor markets remain depressed and are likely to stay so for many more months to come. Other US data continue to show encouraging signs that the US recovery is gaining traction, so we will take the Nov. jobs report with a grain of salt.

Across the pond, Eurozone debt concerns have taken a breather for the time being, but we don't think there has been any meaningful change in the debt dynamics of the Eurozone. The ECB increased its purchases of peripheral nation debt to combat panicky markets. The ECB will on Monday publish the amounts of bonds purchased and if the amounts are as large as expected, it could be viewed as unsustainable. We think it's only a matter of time before European debt fears trigger another wave of capital flight out of the EUR (see more below).

Broadly looking at various other asset markets, it appears that USD weakness has resurfaced as the catalyst to gains in other markets (see below). While there has been some technical damage done to the USD this past week, we think it may still be only a minor correction within an overall USD recovery. In particular, we would note the US dollar index was rejected from the bottom of its weekly Ichimoku cloud, and price has fallen back inside the daily cloud, both potentially USD bearish indications. Elsewhere, we would note that US stocks are hesitating at recent highs, alongside gold and silver, as potential signs of uncertainty in the risk rally. The CRB commodity index has closed the gap from Nov. 11-12 and faces resistance from prior highs around 320 as well. In short, we are on the cusp of a further break down in USD/higher in risk assets. However, given the negative outlook for the Eurozone debt crisis and the risks of an imminent tightening out of China, we prefer to maintain a dollar positive stance for the moment. It will not take much further USD weakness/risk strength to force us to reverse course, but for now we'll treat this is as a minor USD correction.

In a QE2 world... Is bad data now bad for the buck?

There's no two ways about it, today's U.S. November employment report came up lame of economists' expectations - Nonfarm Payrolls +39k vs. exp. 150k; Unemployment rate 9.8% vs. exp. 9.6%. However, it appears there has been a paradigm shift in the market's reaction to poor data with regards to the U.S. dollar. Over the last few years such a scenario would have seen considerable risk aversion. Typically, the response has been significantly lower equities, higher bonds (lower yields), higher USD vs. other currencies - outside of the JPY or CHF (risk averse currencies), and mixed vs. commodities depending on their mood. In terms of today's price action, equities are only marginally lower, yields initially fell dramatically but have since stabilized, commodities have soared and the USD has been crushed across the G10. In this post-QE2 environment, it seems the dynamics have changed for the dollar whereby positive US data is good and negative data is bad. This rationale is based on the belief that a faltering U.S. economy increases the likelihood of the Fed completing the entire $600 billion in asset purchases, which has been in question of late, and potentially brings the topic of QE3 back on the table.

From a technical perspective, earlier in the week the buck looked poised to make another run higher, however after today's sell-off that has come into question in the week ahead. Luckily, support/resistance areas are well defined and with a light calendar upcoming next week, the market should broadly trade based on the technical's. Key levels to note are as follows: EUR/USD resistance at 1.3450, USD/JPY support from 81.50-70, GBP/USD resistance near 1.5845, USD/CHF trendline support at 0.9640/50, USD/CAD support by 0.9980, AUD/USD resistance near 0.9950/60, EUR/JPY resistance around 111.50, AUD/JPY resistance at 83.00, Gold all-time highs $1425, Silver multi-decade highs $29.35 and Crude Oil resistance at $90.50 (September 2008 low). While these levels hold the USD rebound still remains plausible, however if they falter a significant reversal lower in the dollar and rally in risk would be expected into the holidays.

ECB avoids the knight in shining armor role

Europe dominated the first half of last week as details of the Irish bailout emerged along with an ECB meeting. The Irish bailout failed to be the panacea for the Europe's peripheral debt markets. Instead it was left to ECB President Jean Claude Trichet to calm the markets and spark a rally in risky assets.

Even though Trichet was ambiguous about the degree of support the ECB is willing to lend to the peripheral nations during his monthly press conference, it has delayed its exit policy and increased its special liquidity operations until at least the first quarter of next year. This eases the immediate pressure on the peripheral nations' banking sectors, some of which remain addicted to ECB funding. Trichet also said that its bond buying programme would remain open.

What Trichet failed to disclose was that the ECB was reportedly purchasing large amounts of Irish, Portuguese and Spanish government debt leading up to the ECB meeting. This complicates its strategy regarding the peripheral nations as it is saying one thing and doing another. At the moment markets seem to be giving the peripheral nations a break, and bond yields have been falling. However, the ECB's extension of liquidity support is only a short-term fix. Spain has to raise over EUR100bn in the debt markets between Q2 and Q4 next year. If there are any signs that the Eurozone's fourth largest economy is having difficulties funding itself in the capital markets then the ECB may have to extend its liquidity facilities or step up its bond-buying programme.

The FX markets have shrugged off peripheral debt fears for now. The euro has retraced more than 25 per cent of the down move that began at the start of November. A close above 1.3375 - Ichimoku cloud base, would herald further gains to 1.3450 - the 38.2 per cent retracement of the November move. While the single currency may continue its rally in the short-term, longer-term charts show that it is still in a down trend and we think any gains will prove to be temporary due to lingering sovereign concerns within the Eurozone.

Interest rate decisions likely to be non-decisions

The week ahead is chock full of interest rate announcements out of major economies beginning with Australia on Tuesday. Downside data surprises (Q3 GDP was +0.2 against expectations of +0.4%), potentially weakening external commodity demand as a result of China tightening, and subdued Q3 inflation are likely to see the RBA keep the target rate unchanged at 4.75%. However, we believe this to be a mere pause in the RBA's tightening cycle and expect a continuation of rate hikes early next year. The Bank of Canada is up next on Tuesday and is likely to keep rates steady at 1% as economic growth has hit a brick wall. Stagnant job creation out of the U.S., Canada's largest trading partner, as evidenced by the putrid NFP print is also likely to play a factor in the BoC's decision. Furthermore, surprisingly weak 3Q GDP growth of +1% annualized may have Governor Carney and company questioning their decision to initiate a tightening policy earlier in the year. Thurs. morning local time/Wed. evening GMT sees New Zealand's rate decision which is likely to remain unchanged at 3% with post-earthquake reconstruction and recent policy shifts keeping pressure on the NZ economy. The final major interest rate announcement is set for release on Thursday out of the UK. The BOE is likely to leave policy unchanged as inflation risks are offset by the weakening outlook ahead of government austerity measures beginning in 2011. The announcement is likely to be a non-event as the BOE typically does not comment when no policy changes are made.

Key data and events to watch in the week ahead

United States:

• Monday - Fed's Lacker speaks on Economic Outlook
• Tuesday - Dec. IBD/TIPP Economic Optimism, Oct. Consumer Credit, Dec. ABC Consumer Confidence
• Wednesday - Dec. MBA Mortgage Applications
• Thursday - Weekly Jobless Claims, Oct. Wholesale Inventories
• Friday - Oct. Trade Balance, Nov. Import Price Index, Dec. Preliminary U. of Michigan Confidence, Nov. Monthly Budget Statement

Euro-zone

• Monday - Euro-Area Finance Ministers meet in Brussels, Dec. Sentix Investor Confidence
• Tuesday - Oct. German Factory Orders
• Wednesday - Oct. German Current Account, Oct. German Trade Balance, Oct. German Industrial Production
• Thursday - Nov. German Consumer Price Index
• Friday - EU's Rehn gives speech in Athens

United Kingdom

• Tuesday - BRC retail sales monitor, Oct. Industrial Production, Oct. Manufacturing Production
• Wednesday - BRC shop prices, Nov. Halifax House Prices
• Thursday - BOE Interest Rate Announcement, Oct. Trade Balance
• Friday - Nov. PPI Input & Output

Japan

• Monday - Nov. Official Reserve Assets
• Tuesday - Oct. Coincident Index, Oct. Leading Index, Oct. Current Account Total, Nov. Bank Lending, Oct. Trade Balance, Oct. Machines Orders, Nov. Bankruptcies
• Wednesday - 3Q Final GDP (QoQ & YoY)
• Thursday - Nov. Machine Tool Orders, 4Q BSI Large All Industry & Manufacturing, Nov. Domestic CGPI
• Friday - Nov. Consumer Confidence

Canada:

• Monday - Oct. Building Permits, Nov. Ivey Purchasing Managers Index
• Tuesday - BoC Interest Rate Announcement
• Wednesday - Nov. Housing Starts
• Thursday - Oct. New Housing Price Index
• Friday - Oct. International Merchandise Trade

Australia & New Zealand:

• Monday - Australia Nov. AiG Perf of Construction Index, Nov.TD Securities Inflation, Nov. ANZ Job Advertisements
• Tuesday - Australia RBA Interest Rate Announcement, New Zealand Nov. House Prices
• Wednesday - Australia Oct. Home Loans and Investment Lending, New Zealand 3Q Manufacturing Activity
• Thursday - Australia Nov. Employment Report, RBNZ Interest Rate Announcement, NZ Nov. Card Spending
• Friday - NZ 3Q Terms of trade index

China:

• Thursday - Nov. Trade Balance

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