Concerns about the US economy are growing as the Dow Jones Industrial Average erases all of its year to date gains, taking the US dollar down with it. The rally that we have seen in the first few days of trading will be difficult to sustain with all of the weak economic data that we expect in this month. Although the US government has thrown a lot of monetary and fiscal stimulus at the US economy, we may not see the fruits of their labor until the second quarter at the earliest. There is a major risk of a sharp drop in this month’s non-farm payrolls, retail sales and fourth quarter GDP reports and only after we have seen the last of depression like numbers can we begin to see a meaningful recovery in the US dollar.
ADP Signals Big Trouble for NFP
This is a big week in the currency market with non-farm payrolls due for release on Friday. The leading indicators for the pivotal labor market report are coming in and the latest report suggests that in the last 2 months of the year, more than 1 million Americans may have lost their jobs. According to the ADP private sector employment report, 693k jobs were lost in the private sector last month. This was much weaker than the market’s -493k forecast and suggests that non-farm payrolls could have dropped by more than 600k in the month of December. Layoffs also rose 274.5 percent according to the Challenger report with the biggest declines seen in the financial sector. Unfortunately big job losses will probably continue with Alcoa and Intel announcing more layoffs. The only silver lining is the rebound in the employment component of the service sector ISM report, which tends to have a very strong correlation with the non-farm payrolls report. With that in mind, we believe that job losses last month will be closer to 500k than 700k. Either way, both numbers spell big trouble for the US labor market. Q4 will be one of the worst quarters for non-farm payrolls that this generation has ever seen which is why the US dollar is weak and may remain weak going into the NFP report.
Forecasts for GDP, Unemployment and Deficit
2008 has been a crazy year in the foreign exchange markets and hopefully 2009 will bring more steady times for the global economy as a whole. The tremendous amount of fiscal and monetary stimulus that central banks around the world have doled out should begin to have their effect in the second half of the year. Countries that will be the first to rise from the ashes are the ones whose currencies have lost the most value in 2008. In contrast, the countries whose currencies soared will have a much more difficult time recovering.
In 2009, we will be celebrating the 10 year anniversary of the Euro and in January, people around the world will cheer the inauguration of brand new US President. Obama embodies change and hopefully that change will help to pull the US economy out of recession.
Make sure you read my 2009 currency forecasts. I talk about what I expect fundamentally and technically for the following currencies in the year ahead.
US dollar forecast
British pound forecast
Japanese Yen forecast
Australian dollar forecast
New Zealand dollar forecast
Canadian dollar forecast
Swiss Franc forecast
Also, I will be soaking up some sun in the Bahamas from Jan 2 – Jan 6, so there will be no new blog posts until January 7th.
Update – 5 Reasons Why the British Pound is Being Pounded – Access my latest article Feb 28, 2010
How Did the British Pound Trade in 2008?
The British pound was one of the worst performing currencies in 2008. It fell to a 6 year low against the US dollar and record low against the Euro in addition to selling off against every other G10 currency. The overwhelming weakness in the currency is a direct reflection of the impact that the credit crisis had on the UK economy. In the month of December, many currencies recovered against the US dollar, but unfortunately the British pound was not one of them. Although the pound could continue to weaken in the first quarter, the government’s aggressive fiscal and monetary stimulus should help the country recover towards the end of 2009.
Official Recession in 2009
Without two consecutive quarters of negative GDP growth, the UK economy is not technically in a recession but that should change in the first quarter of 2009, when the 2008 Q4 GDP numbers are released. Growth has been slowing materially and the weakness is reflected in the British pound. GDP growth fell by 0.6 percent in the third quarter, the largest decline in 18 years. The housing market and the financial sector have been the engine of growth in UK for the past few years and both blew up in 2008. Unfortunately the worst is probably not over for the 2 key components of the UK economy, particularly following the Bernie Madoff’s Ponzi scheme. In addition to losses suffered from the subprime mortgage crisis, many large hedge funds and European banks invested with Madoff’s. In 2009, they will be forced to write down those losses and deal with what could be pretty severe consequences for the financial sector as a whole. With the financial and housing market sectors expected to remain weak in the first half of 2009 and layoffs predicted to rise, GDP growth could fall as much as 2 percent next year. Although we believe that the country could be one of the first to recovery from the global economic downturn, this will not before more pain is felt in the UK economy. The severity of the UK recession will be largely dependent upon how quickly the credit markets are restored in 2009.
Inflation to Fall Back to 2%
How Did the Euro Trade in 2008?
Exactly one year ago, the Euro was trading at approximately 1.47 against the US dollar, 5 percent higher than current levels. In 2008, this type of move is considered mild especially when compared to the Euro’s 20 percent rally against the British pound and New Zealand dollar and 27 percent decline against the Japanese Yen. However the mild year over year change in the EUR/USD masks a tremendous amount of volatility during the year. In the first half of 2008, the EUR/USD soared to a record high above 1.60. After that, it fell 22 percent to a 2 year low but recovered more than half of those losses in the month of December.
Eurozone’s to Underperform in 2009, Expect a Prolonged Recession
It is no secret that 2009 will be a tough year for many countries, but things will be particularly difficult in the Eurozone. Every major central bank has cut interest aggressively, driving their currencies significantly lower in 2008. The ECB on the other hand has been reluctant to follow suit, leaving the Euro only marginally lower for the year. Although the Eurozone is in a recession, growth has not been nearly as weak as the US. Annualized GDP growth in the Eurozone during the third quarter was +0.6 percent, compared to -0.5 percent in the US. The Eurozone’s outperformance in 2008 however could be short-lived as the central bank forecasts a 1 percent contraction in growth next year. As an export dependent region, the strength of the Euro will make a recovery difficult. German companies have already scaled back production as global demand eases. Looking ahead, unemployment is expected to rise, slowing consumer spending and forcing the ECB to continue to cut interest rates. If German unemployment hits 9 percent, we could easily see Eurozone rates hit 1 percent.
ECB Could Become One of the Most Aggressive Central Banks in 2009
On the eve before Thanksgiving, the price action in the currency market has been very erratic. Equities rallied for the fourth straight trading session while the US dollar weakened against the Australian and New Zealand dollars but strengthened against the Euro, British Pound and Japanese Yen.
Currencies appear to be decoupling from equities on this low volume pre holiday trading session. Over the past few weeks, strength in equities has translated into strength in the EUR/USD but that was not the case today. US economic data was very weak, but hope continues to supersede reality as President Elect Barack Obama adds former Federal Reserve Chairman Paul Volcker to his team.
Obama’s Economic Dream Team
Rather than having to pick from Timothy Geithner, Larry Summers and Paul Volcker, Obama has decided to add all 3 of these well respected and talented men to his Economic Dream Team. The equity markets turned around after Obama announced that Volcker will the Chairman of a new White House advisory board that is tasked with stabilizing the financial markets and pulling the US economy out of recession. This new Economic Advisory Board will give their opinions in briefings to the President and include experts outside the government with the goal of “infusing ideas from across the country and from all sectors of the US economy.” Even before taking office, Obama is proving to be a President who wants to hear every possible viewpoint before making his decisions. He is on track to hit the ground running come January 20th and the equity markets have responded very favorably to his appointments and the initial details of his economic recovery plan. Over the next 24 days, Obama will play a critical role in helping to maintain confidence in the financial markets.
Latest String of Economic Data Hits Multi-Year Lows
Confidence will be extremely important as the US economy continues to come face to face with weak economic data. On the eve of Thanksgiving, we have had a harsh reminder of the problems plaguing the US economy. With the shortened holiday trading week, there were a lot of US economic data released today and a number of those indicators hit multi-year lows. As we have previously warned, because third quarter GDP only slipped by 0.5 percent, fourth quarter GDP could be very weak.
Is There a Risk of a Breakout on Friday?
For the currency market, the Thanksgiving Day holiday usually leads to low liquidity and thin volumes. Although this should mean range trading for all of the major currencies, watch out for a post Thanksgiving Day breakout. Low liquidity makes it extremely easy to exacerbate the volatility that we have been seeing in the currency market. In 2007 and 2006, the EUR/USD’s trading range on the Friday after Thanksgiving was more than 3 times its trading range on Thanksgiving Day.