Market Directions

- USD weakens, but still within a range
- Commodities outpace all other markets
- JPY repatriation has begun
- More US housing and other key data next week

USD weakens, but still within a range

The dollar gave up further ground against other major currencies as fresh signs of economic slowing materialized, but the overall ranges continue to hold. US data mostly came in on the weak side, while data elsewhere generally surprised to the upside. US Jan. core CPI was a touch higher at 0.3% MoM and 2.5%YoY, highlighting the ongoing threats from inflation. Jan. housing starts were slightly improved, but building permits, the leader in the cycle, fell further to 1048K from 1080K, suggesting there is no end to the downturn in new home building and the larger housing market. Jan. leading indicators declined -0.1%, while Philadelphia-area manufacturing sentiment fell even further to -24.0 from -20.9; forecasts had been for an improvement to -10.0. Minutes from the Jan. 29-30 FOMC meeting revealed a Fed highly concerned about the extent of the US downturn and clearly focused on stabilizing the US economy through lower rates. Markets remain convinced the Fed will cut rates a further 50 bps at its next meeting on March 18, with the weaker Philadelphia Fed Index inspiring some to expect 75 bps of easing.

Data out of the Eurozone showed a sharp increase in monthly inflation data, with German producer prices rising 0.8% MoM and 3.3% YoY. High current inflation readings essentially leave the ECB with no choice but to keep rates steady, despite expectations for slowing growth ahead. (The IMF on Friday cut its forecast for German 2008 growth to 1.5%, below the German government's and EU's forecasts of 1.7-1.8%.) Eurozone advance Feb. purchasing managers' indexes (PMI's) also came out a bit better than forecast. The service sector PMI rose solidly to 52.7 from 50.6, and the manufacturing index declined in line with expectations to 52.3 from 52.8. Together, the Eurozone composite PMI rose to 52.7 from 51.8 in contrast to forecasts for a dip to 51.5. UK Jan. retail sales surprised to the upside as well, gaining 0.8% MoM versus expectations of only a 0.3% monthly increase. Still, the BOE MPC minutes left the market expecting additional rate cuts later this year.

The net result of this past week's data in currencies was for the USD to weaken against most other major currencies. The other key development was that JPY-crosses (e.g. EUR/JPY, AUD/JPY, etc.) stalled in their advance and are showing signs of staging a reversal lower. This coincides with renewed stock market weakness and an increase in risk aversion. Over the prior two weeks, risk appetites improved slightly on the back of better stock market performance and lower overall volatility. Weaker US data, however, have undermined still fragile market sentiment leading to renewed declines in US stocks. I continue to view rebounds in risk appetite as unsustainable and still favor using associated strength in the JPY-crosses as a selling opportunity.

Commodities outpace all other markets

Commodities stole the spotlight this week as oil prices pierced the magical $100/bbl level and gold surmounted the $950/oz. level. But the gains appear in doubt as neither of those psychological price levels were sustained for any meaningful length of time, and may very well have been rejected. The commodity frenzy is just that, a highly speculative push higher in relatively vulnerable markets. With US growth slowing and global growth likely to weaken as a result, commodity prices are in danger of a sharp setback. Certainly the psychological and positioning factors are in place for a sharp reversal. Market commentators had been obsessed with oil breaching $100/bbl and are frothing over the prospects of $1000/oz gold. I would also note some candlestick patterns that call the current advance into question: a double Doji pattern is evident on gold daily candlestick charts for Thursday and Friday, suggesting indecision in the current advance, with a likely volatile resolution in coming sessions. A ‘hanging man' pattern is evident on oil candlestick charts, also an indicator of a potential price reversal after a move higher. The CRB commodity index is also just below psychological resistance at the $400 level, having made a high today at $399.22.

For currency traders, it's important to keep an eye on those commodities as they have been highly correlated to EUR/USD, in particular: higher oil and gold prices are supportive of strength in EUR/USD; weakness in those commodities translates to weakness in EUR/USD. If EUR/USD fails up here toward the upper end of its recent range again, it also augurs poorly for those commodities.

JPY repatriation has begun

The end of March is the close of the Japanese financial year and the weeks leading up to it typically sees significant amounts of JPY-repatriation, which usually translates into sustained JPY-buying. Japanese asset managers typically liquidate large amounts of existing positions and turn the proceeds into JPY for balance sheet window-dressing and year-end results. The recent failure of USD/JPY in the mid-108 area suggests just such a development at work this past week. I continue to look for strength in the JPY-crosses to be limited by such repatriation selling interest, with the bulk of JPY-buying likely to be completed before the third week of March.

More US housing and other key data next week

Next week sees a heavy data calendar out of the US along with a slew of Fed speakers, including Fed Chairman Bernanke on Wednesday. Monday sees January existing home sales, which are forecast to decline another-1.8%. Tuesday sees January PPI, Dec. and 4Q S&P Case/Shiller home price index, Feb. consumer confidence, Richmond Fed manufacturing index and the 4Q OFHEO house price index. Wednesday sees Jan. durable goods orders and new home sales. Thursday sees the first revision to 4Q GDP, which is expected to be revised slightly higher on the back of higher exports, and weekly jobless claims. Friday concludes with Jan. personal income and spending, Jan. PCE core inflation, Feb. Chicago PMI and the final Feb. Univ. of Michigan consumer sentiment index. Fed speakers on Monday include Governors Kroszner on risk management and Mishkin on inflation. Vice Chair Kohn speaks on the economic outlook on Tuesday. Fed Chair Bernanke testifies before the House on Wednesday and before the Senate on Thursday. On Friday, Treasury Sec. Paulson speaks on the economy.

In the Eurozone, the data begins in earnest with German 4Q GDP and related reports along with Feb. IFO corporate sentiment gauge. Tuesday sees German Jan. import prices and the German March GfK consumer sentiment survey. Thursday sees French Feb. consumer confidence and German Feb. unemployment reports. Friday sees preliminary German Feb. CPI, Jan. Eurozone CPI, various Eurozone Feb. confidence gauges, and German Jan. retail sales. There are also a number of ECB speakers scheduled, including Trichet on Monday and Bundesbank Pres. Weber on Tuesday-expect both to be hawkish.

Japanese data begins on Tuesday morning with the Jan. corporate service price index for Jan. followed by Feb. small business confidence in the afternoon. On Thursday morning, preliminary Jan. industrial production and Jan. retail trade are due. Friday morning sees Jan. employment data, Jan. household spending, Feb. Tokyo-area CPI and Jan. national CPI reports, followed by Jan. housing starts and construction orders in the afternoon.

UK data on Tuesday sees preliminary 4Q total business investment and the Feb. CBI distributive trades report. Wednesday sees 4Q preliminary GDP and associated reports along with 4Q import/export totals. Friday sees Feb. Nationwide Building Society house prices, Jan. consumer credit and Feb. GfK consumer confidence survey. Bank of England Dep. Gov. Rachel Lomax is to speak on Tuesday morning and Dep. Gov. Gieve on Wednesday afternoon.

In Canada, keep an eye out for Bank of Canada Dep. Gov. Jenkins on Tuesday morning; he is set to testify to the House of Commons on currency matters.

Joseph Trevisani
Chief Market Analyst
FX Solutions