Over the past 48 hours, the U.S. dollar has come under aggressive selling pressure and I think USD/JPY is set to test its year to date low below 87. Here is a chart of the Dollar Index that shows a break of a major trendline which suggests that the dollar’s weakness will not be limited to just the Yen. I meant to post this yesterday but got caught in FX360 work. Sorry!
U.S. fundamentals have taken a turn for the worse with retail sales falling short of expectations, manufacturing activity slowing and producer prices falling. Even the Fed who normally prefers to assure investors has turned pessimistic! This means that not only will the U.S. central bank leave rates on hold for the remainder of the year, but in the context of improving economic data and successful bond auctions in Europe, fundamentals have made the dollar has attractive.
As a result, I think that USD/JPY is headed for at least 87.00.
Dollar bashing has driven the U.S. dollar to an 11 month low against the Euro and 1 year low against the Australian dollar. If you have caught my interviews on CNBC and Bloomberg, you would know that I have been bearish dollars and bullish Aussies and Euro for the past 2 months. Now that key levels have been broken, there is room for more gains for those currencies which means losses for the U.S. dollar.
Although the comments from the U.N. meeting triggered the sell-off in the dollar, recent economic data indicates that the for the time being, the recovery trade is still on. We have seen upside surprises in data from the U.S., Eurozone and the U.K.
It is very important for the EUR/USD to hold above 1.45 and as long as it does, resistance doesn’t come in until 1.4720. For the AUD/USD, my updated target is 89 cents and I am sticking to it. I think USD/JPY could also break support, but I explored that in more detail in my special report “Will USD/JPY Also Test Its 2009 Lows?”
The sell-off in the dollar is of course contingent upon continued strength in equities. If stocks start to lose momentum, the rally in the EUR/USD and the AUD/USD will fade as well. That is why the charts that matter has to include the S&P 500. The key levels to watch are 1039.47, the 2009 high and 1016.50, which is Friday’s high. If stocks rise above the yearly high, we could see an extension to 1100. If the index falls below 1016.50, we could see a move below 1000.
All Eyes on Gold
I was on Bloomberg last night talking about the odds of Dollar Reserve diversification and the outlook for the dollar. Click on the image to access the video:
The Federal Reserve cut interest rates by 75bp to a range of 0 to 0.25 percent, the lowest level that this generation has ever seen.
In our FOMC preview, we talked about how the Fed may consider adopting a BoJ style rate cut that takes interest rates somewhere between 0.25 and 0 percent. Although that was exactly what we saw today, we expected it to happen in March and not December. The Fed has taken another page out of the Bank of Japan’s book and will continue to follow in the footsteps of the Japanese central bank as they formally adopt Quantitative Easing even though they refuse to use those words explicitly.
It is no surprise to see the US dollar selling off aggressively as it is now the lowest yielding G10 currency. This was the right move for a central bank that wants to be proactive and no longer just reactive. There is no point for the Federal Reserve to play games anymore by denying what is already being priced into the markets. Cutting interest rates to 0.25 percent was inevitable and they rather deliver this stimulus now than later. Fed funds were trading as low as 0.15 percent going into the FOMC meeting. The Federal Reserve expects to keep interest rates at “exceptionally low levels for some time,” and to employ all available tools going forward including the purchase of long term Treasuries. In other words, the Federal Reserve is telling us that they are formally moving to Plan B, which is Quantitative Easing.
There is no question now that the Federal Reserve is the most aggressive central bank. Since 2007, they have cut interest rates by 500bp and since the beginning of year, they have cut by 325bp. With the economic outlook weakening and the financial markets remaining quite restrained, the Fed wanted to over rather than under deliver. This morning’s consumer price numbers also raises the risk of deflation, which may have pushed the Federal Reserve to make the larger move. The Fed did not indicate in the FOMC statement whether zero interest rates are still on the table, but an interest rate of 0.25 percent is just as bad.
The US dollar has embarked on a new downtrend and today’s interest rate decision only cements that. We expect more dollar weakness in the first half of 2009. There is a reasonable chance that USD/JPY could fall to 85 and the EUR/USD could break 1.43. And of course, I still love the AUD/USD trade.
Comparing the FOMC Statements:
FOMC Statement December 16, 2008
US retail sales and producer prices were basically in line with expectations but that does not undermine the fact that the data was very weak and confirms that the Federal Reserve will be cutting interest rates by 75bp next week. USD/JPY hit a 13 year low last night after news that the automaker bailout plan is not going happen before the new year. Everyone had hoped that the automaker saga would come to an end, but lawmakers are not letting that happen. On Wednesday, I said that USD/JPY could hit to a new 13 year. At that time, the currency pair was trading at 92.50-93.00. The possibility of the US taking interest rates below Japanese levels should keep the US dollar soft going into the Fed interest rate decision on Tuesday.
Consumer spending fell for the fifth month in a row while producer prices dropped for the second straight month. The two biggest inputs into GDP are retail sales and trade. Consumers cut back spending more aggressively in October and November which suggests that GDP growth could take a big dive in the fourth quarter, especially with the widening of the trade deficit.
GDP Could Contract by 4 to 6% in Q4
GDP could decline as much as 4 to 6 percent in Q4, which would be the largest contraction in growth since the 1980s. In the first quarter of 1982, GDP fell -6.4 percent. A 4 to 6 percent drop in GDP would not be out of the ordinary given the current conditions in the US economy. In the fourth quarter of 1990, GDP contracted by 3 percent and in the first quarter of 1991, it contracted by 2 percent. The currrent recession is worse than the one the US economy experienced in the 1990s, so a contraction in growth exceeding 3 percent would actually be expected.
The biggest drop in consumer spending came from gasoline station receipts. Prices at the pump have fallen more than 50 percent since the summer and gas stations are suffering as a result. The only silver lining in the retail sales report is the fact that not every sector saw slower sales. Electronics and sporting goods were in demand but this rebound after at least 4 consecutive months of softer spending is probably related to Black Friday sales.
BTW: EUR/GBP is at the brink of hitting 90 cents – a move that I called on Dec 8