Profit taking has been the name of the game in the currency market for the past week. With only jobless claims on the calendar today, the U.S. dollar extended its gains against nearly of the major currencies. The biggest loser was the Canadian dollar which staged a sharp rally on Wednesday for no particular reason. The most resilient currency was the British pound which actually managed to strengthen against the dollar. The turn in the U.S. stock market exacerbated the rally in the greenback by triggering concerns about risk aversion. However we want to point out that today’s move is a story about the dollar and not risk appetite because if that was the case, USD/JPY would be trading lower.
All Eyes on Asia
With Treasury Secretary Geithner in Asia for the Asia-Pacific Economic Cooperation - or APEC – Summit, all eyes are on China. Over the past few months, we have learned how the world can subsist without growth in America as long as China is chugging along. Earlier this week, strong industrial production from China helped to lift higher yielding currencies which indicate that currency traders are watching Chinese reports almost as closely as economic data from some of the G7 nations. Although Chinese revaluation has long been the elephant in the room for any meetings between the U.S. and Asian nations, now dollar weakness is also a big problem. Therefore Geithner went to great lengths to ease these concerns by repeating the U.S.’ strong dollar policy. He also stressed the need for “market-oriented” currencies in Asia that allow exchange rates to be in line with fundamentals. China preempted any further criticism by adjusting their language about currency flexibility in their Q3 monetary policy report to suggest that they will “improve the yuan exchange rate formation mechanism” to follow the principles of initiative, controllability and gradualism, with reference to international capital flows and changes in major currencies.” We would not be surprised to see an even bigger announcement from China ahead of President Obama’s first official visit next week. China is notorious for announcing major changes prior to a U.S. Presidential visit such that when the President arrives, he has no choice but to applaud China’s move and downplay any intended criticisms. In China, its all about face.
Finally, Some U.S. Data
We will finally see some meaningful U.S. economic data tomorrow with the trade balance and the University of Michigan Consumer Confidence survey due for release. The U.S. dollar weakened materially in the month of September and there is a good chance that the currency’s depreciation helped to boost exports. Manufacturing activity also accelerated materially in October which confirms our belief that trade activity improved that month. However, we also expect a drop in the University of Michigan Consumer confidence survey. As indicated by the chart below, since the beginning of the year, the IBD index has had a greater than 85 percent correlation with the University of Michigan consumer confidence survey. This suggests that we should see deterioration in the more widely watched UMich index
The euro fell sharply against the U.S. dollar despite the ECB Monthly Bulletin’s relatively optimistic tone. According to the report released on Thursday, the region’s recovery could be stronger than previously forecasted. Forecasters now see GDP growth in 2009 contracting by 3.9 percent instead of 4.5 percent and for the economy to grow by 1 percent instead of 0.3 percent in 2010. These represent relatively sharp improvements that should ultimately be positive for the euro. Inflation on the other hand will remain muted thanks in part to the strength of the currency. Although one may think that the lack of inflation risk would reduce the central bank’s urgency to unwind monetary stimulus, the report reiterates that not all of its liquidity measures will be needed to the same extent and they will be removed in a gradual and timely manner. There were only two pieces of Eurozone economic data released today – French current account numbers and Eurozone industrial production. The current account deficit in France shrank from EUR4.0B to EUR3.7B while industrial production in the region as a whole grew by 0.3 percent in September. GDP numbers are due for release tomorrow from France, Germany and the Eurozone. Growth is expected to pick up materially in the third quarter. Don’t forget that Q3 growth in the U.S. was the strongest since December 2007. The third quarter marked a period of recovery for many countries around the world and if the Eurozone comes through with solid numbers, the EUR/USD could resume its uptrend.
USD/JPY: DEFLATIONARY PRESSURES STILL EXIST
Today’s rally in USD/JPY and USD/CAD indicates that the dollar is driving the currency market and not risk appetite. Of all the Japanese Yen pairs, the only ones that did not join the sell-off in equities were USD/JPY and GBP/JPY. However even though the others ended the day in negative territory, the losses were nominal. The primary release from Japan last night was the Domestic CGPI index which measures inflationary pressures. Unfortunately prices fell by 0.7 percent, which suggests that deflationary pressures still exist. Government officials seem to be optimistic on the issue, Bank of Japan Deputy Governor Hirohide Yamagushi commented last week that falling prices will not hamper the economic recovery. His theory would be put to a test early next week, when 3rd Quarter GDP will be released. This evening, industrial production and consumer confidence are due for release. Given the recovery in China, if the Japanese IP numbers were to be revised, the odds favor an upward revision over a downward one.With a worse than expected Eco Watchers survey, overall consumer confidence could also decline.
May The Force Be With You.
Eddie's Free Forex Class