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· Durable Goods Increase 3.4%, Consensus Was 0.7%
· Mixed UK Data - Lower GDP, Stronger Retail Sales
· Weaker Japanese Tertiary Activity Index


EURUSD

Stronger US durable goods sent the euro tumbling against the dollar. The report was almost five times higher than the market’s forecasts, catching even the most optimistic economists by surprise (more about durable goods in USDCHF section). Meanwhile, today’s comments from ECB Issing did not shed any new light on the interest rate outlook for the Eurozone. Instead, he essentially echoed yesterday’s comments from Trichet, emphasizing the importance of a recovery in consumer spending and a rebound in confidence. Comments from both officials suggest that monetary policy is on hold for the time being, but they do not rule out the possibility of a future rate cut. The ECB has repeatedly indicated that lower rates may not help to stimulate spending. Although most economists still believe that the dollar will decline in the medium to long term, in the week ahead, the euro should remain under pressure as economic data will most likely be supportive for the dollar and negative for the euro. We start off Monday with the IFO business climate survey - this past Tuesday’s shockingly disappointing ZEW survey signals that there is significant downside risk for the IFO.

USDCHF

With today’s exceptionally strong durable goods report, it will be difficult to continue questioning the sustainability of the manufacturing sector recovery. This is particularly promising for the labor market, since the strong demand will eventually force manufacturing firms to increase hiring. The manufacturing sector has been shedding jobs since August 2000. Last month, job growth was flat in the sector, but today’s data suggests that this could be the beginning of a new uptrend. Encouragingly enough, FOMC member Moskow said that job growth is off to a good start in the first quarter and the slack in the US economy is beginning to decrease while slowing productivity gains should help to boost hiring. The most important US economic data scheduled for release next week is Friday’s advance estimate for first quarter GDP. All evidence point to above trend growth in Q1, upside risk will help to support the dollar. Meanwhile, in Switzerland, SNB Hildebrand failed to make any significant comments on monetary policy.

GBPUSD

The UK released contrasting data today - stronger retail sales, but a weaker first quarter GDP report. Retail sales increased 0.6% during the month of March, tripling estimates. The strong housing market has continued to fuel consumer spending, which will be a persistent concern for the Bank of England’s Monetary Policy Committee. If you recall, BoE officials have been worried that previous rate hikes has failed to let steam out of the housing bubble or slow consumer spending. However, as we have learned this past week, even though the BoE still fears that a sharp collapse in house price valuations could lead to a destructive consumer retrenchment, low consumer price inflation may prevent them from raising rates in May. Meanwhile, GDP slowed from 0.9% to 0.6% in the first quarter as a result of a contraction in manufacturing output. According to the statistics office, there is a high likelihood that the first estimate will be revised since the Easter Holiday delayed the collection of data from some companies.

USDJPY

Japan’s tertiary activity index declined more than expected during the month of February, giving back the previous month’s stronger gains. There are lots of important Japanese economic data scheduled for release next week including consumer confidence, retail sales, industrial production, unemployment, intervention data for the month of April and a BoJ monetary policy meeting. We continue to believe that sooner or later, Japanese fundamentals will return to the forefront, allowing the yen to return to its natural course. The monthly intervention data from the MoF will be particularly interesting, since USDJPY has appreciated significantly over the past month, The market believes that the BoJ has been mostly absent from the market therefore, if the data should indicate otherwise, we may be poised for more volatility in USDJPY. According to the latest IMM data, for the first time in four weeks, speculators are net short yen.

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Bank of Canada Rate Decision (13:00 GMT) (Current Rate: 2.25%, 25bp Rate Cut Expected)

The Bank of Canada is scheduled to announce their monetary policy decision tomorrow. According to a Bloomberg News survey, 14 out of 17 economists polled expect the central bank to lower rates from 2.25% to 2.00%. The latest GDP and employment data has been particularly daunting. Since the beginning of this year, Canada shed 19,600 jobs, surprising the market, which had expected the labor force to increase in March (instead it shrank by 13.3k). Inflation fell to 0.7% yoy in February, the lowest level since 2001. This is substantially below the central bank's 2.0% target, indicating that the economy needs another round of easing.

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EURUSD
European and London markets remained closed today for the Easter holiday. The absence of these traders has resulted in very thin trading throughout the US session. Geopolitical risk continues to weigh on the dollar as the number of US casualties in Iraq increases. Although the market has become more desensitized to the developments in Iraq and threats of terrorism, the lack of any new catalyst has propelled this concern back to the forefront. Of course, the situation has intensified with the kidnapping of Japanese and Chinese nationals - prompting their respective governments to reevaluate their participation in the region. For the Eurozone this week, the market will turn its focus to the second Q4 GDP release and inflation data. Growth should remain below trend in the fourth quarter as the region struggles to recover. While there is a risk of an upward revision in inflation for the month of March, it still remains below the ECB’s 2% target.

USDCHF
Although the market’s core focus remains on next week’s testimony by Greenspan to Congress, there is enough data due out this week to shift the market’s focus away from Iraq. The week begins with the retail sales for the month of March due out tomorrow - there is speculation that the report could be exceptionally strong with broad based gains in autos, department and chain stores sales. Tax refund checks are expected to have boosted spending, while higher gasoline prices should have increased gas station receipts. The market expects retail sales to increase 0.7%, a sharply higher number could prompt a move in the euro below 1.20. Other data scheduled for release this week should also confirm the strength of the US economic recovery. Earnings season has just begun, the firms who have released thus far have on average reported exceptionally strong earnings. M&A activity has also picked up, with March reporting the largest cross border flow in two years. Despite the market’s mixed reading into the latest payrolls report, earnings releases and M&A flow is a sign that overall economic activity is picking up and even if payrolls do not deliver the 200-300k that the market expects, the Fed will have to begin exploring an exit strategy from their accommodative monetary policy.

GBPUSD
Tomorrow, we are expecting the latest data on house prices from the Office of the Deputy Prime Minister. There is little sign that the housing market is slowing despite reports today that Tony Dye, a prominent fund manager who was criticized for forecasting that the US tech bubble would burst in late 1990s/early 2000, now predicts a sharp crash in London house prices. However, a continued acceleration in house prices does increase the risk of a rapid collapse, which is one of the primary concerns of the Bank of England. A stronger report will add to the speculation that the BoE will be looking to raise rates by 25bp in May. The most important hint into the minds of the Monetary Policy Committee will still be next week’s release of the minutes from last month’s interest rate meeting.

USDJPY
The biggest news today comes out of Japan. Another round of astounding data is released from the country - both consumer confidence in Tokyo and the current account surplus rose to record levels. Compared to the previous year, the current account increased 46%, beating analyst estimates as exports to China and other global markets continued to soar. However, Japan’s reliance on Chinese demand is a bit concerning as China’s government is taking active measures to slow growth. For the third time since last September and the second time in three weeks, the Chinese government has raised reserve requirements from 7.0% to 7.5%. Increasing reserve requirements of banks generally slows down lending activities, which will have a ripple effect throughout the economy. Slowing growth in the region will impact the sustainability of China’s demand for US and Japanese imports.

USDCAD
The Bank of Canada is scheduled to announce their monetary policy decision tomorrow. According to a Bloomberg News survey, 14 out of 17 economists polled expect the central bank to lower rates from 2.25% to 2.0%. The latest GDP and employment data has been particularly daunting, while inflation remains significantly below target. Today’s sharp move upwards in USDCAD is reflective of position adjustments in the IMM, as speculators increased their CAD long positions to a whopping 41,865 last week, which is the largest level since March 2003.

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Technical Outlook
A break above the 10-day SMA and the previous day’s bullish engulfing like pattern gives EUR/USD a slight short-term bullish bias. The true test of bullish conviction, however, will come in the 1.2200/50 area as it marks a convergence of the 20-day SMA/50-day EMA and 23.6% fibo of the recent down move. Sustained break above required to undo bearish implications of last week’s price action and set up a re-test of the range highs. A clear failure to break the confluence could see another selloff but only a break below 1.1980 re-instills the downside initiative. Even then, downside follow through could be limited as the 200-day SMA (1.1900) and 50% fibo from the Sep - Feb bull wave (1.1850) await 100-points below. An inside day from USD/JPY as the pair consolidates above the 10-day SMA. Intermediate-term bias remains lower but multiple closes above the 105.00 successfully relieves short-term downside pressure. Break below 104.90 required to spark renewed downside momentum. We see some scope for another upside squeeze but any upside looks limited to the 107.40 100-day SMA. No follow through from Cable yesterday as the pair ran into stiff resistance at the 50-day SMA. Next few sessions will be critical in determining if the 1.7900 neckline will come under assault. Short-term bias is neutral as the pair is wedged between the 50-day SMA on the upside and the 50-day EMA on the downside. Clear break above/below need to signal the next playable directional move. Recent progression of higher highs slightly favors the upside and a test of the 1.8550 fib zone. USD/CHF confirmed Monday’s outside day like reversal with a break below the 1.2820 10-day SMA. Strong support is expected all throughout the 1.2760/00 zone as it marks a confluence of various important moving averages and fib levels. Break below needed to prolong downside momentum.

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Technical Outlook
Bullish engulfing like pattern on the EUR/USD daily just above the 200-day EMA relieves some short-term downside pressure. Clear break below yesterday’s 1.1980 low and 1.1950 200-day EMA now required to negate bullish implications of the reversal pattern and re-instill fading downside initiative. Even if this is to occur, downside follow through could be limited as the 200-day SMA (1.1900) and 50% fibo from the Sep - Feb bull wave (1.1850) await 100-points below. We see some scope for a potential earlier than expected EUR/USD up move but resistance at the 10-day SMA would need to give for this to become more of a viable scenario. Until then, the path of least resistance is still lower. A sharp move in USD/JPY yesterday as weak hand shorts were squeezed out of the market. The resulting tail reversal off the medium-term significant 50-day EMA now favors a resumption of the long-term downtrend. Break below yesterday’s 104.90 low required to confirm. Another close above 105.00 would change the picture but only a clear break above the 107.40 100-day SMA turns the outlook bullish. A strong showing from GBP/USD yesterday as aggressive shorts were forced to cover on the move back through the 50-day EMA. Shaven head swing low on the daily favors more upside and a test of the high-end of the recent range. A break of the 1.8550 50-day SMA is our key short-term pivot. Head & Shoulders pattern remains a medium-term overhang but not a real concern (for now) as we are still over 4-big figures from the potential neckline. Progression of higher lows over the past month puts into question the validity of the pattern but a break above the 1.8600 handle with follow through is required to completely negate the pattern’s implications. USD/CHF’s failure just shy of the 200-day SMA sets up a potential double top on the daily. While it is far too early to turn bearish, the potential ominous reversal pattern does make us doubt the strength of the recent uptrend. Immediate support is expected around the 10-day SMA, with only a break below setting up more downside. Breach of long-term resistance at the 1.3100 200-day SMA now required to re-instill upside momentum.

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Euro - Where are We Headed Next?

Published Date: April 5, 2004

With the euro tumbling close to 7% from its all-time highs in the past 7 weeks, it is once again time to publish another article in our Euro - Where Can It Go? series. The tables have turned and the market is becoming increasingly bullish on both the US economy and the US dollar. The euro is now flirting with the 1.20 level, which leads us to question whether we will see 1.15 before 1.25 or the reverse. There are two primary reasons to explain the euro’s recent move. First, the US has finally delivered what the market has been anxiously waiting for, which is evidence that the labor market is finally turning up. On the other hand, the Eurozone’s largest economies have been struggling to grow after rising from recessionary conditions last year, spurring widespread speculation that the ECB will be easing monetary policy over the next few months.

ECB signals the possibility of a rate cut

Unlike the Fed, the ECB prefers to prepare the market for any intended changes in monetary policy and uses its words to steer their currency. As a “say it as it is” central banker, ECB President Trichet’s comments has a history of moving markets. If you recall, it was his warning that the ECB is “not indifferent” to the brutal moves in the euro back in January that sent the pair tumbling 600 pips in under a week. His more recent warnings that should consumption fail to pick up, the ECB could change monetary policy, has intensified speculation about a rate hike. Although the ECB left interest rates unchanged at 2% on April 1st and Trichet’s comments at the accompanying press conference were more hawkish than the market had anticipated, an interesting change in the statement as well as diverging comments from Trichet this weekend suggests that the ECB’s next move will be a reduction in rates.

In the statement from the April 1st monetary policy meeting, the ECB changed their wording from the “current monetary policy stance is appropriate” to the current monetary policy stance “remains in line with the maintenance of price stability.” The most notable change in the wording is the elimination of the word “appropriate.” In the past, the removal of the word “appropriate” usually corresponds with a change in rates over the next two monetary policy meetings. Trichet tried to undermine the significance of this change by going out of his way in the Q&A session to say that the change in wording does not signal a change in monetary policy, but we think that more likely he was trying to inject some two-way risk into the market. Some however may argue that he was trying to appease the other members of the monetary policy committee. The latter reason although a bit preposterous since Trichet has a history of having extremely adept political skills as a result of spending years dueling with French politicians over interest rates and growth, did find some support from the media. The market is currently fixated on an article published in the UK Telegraph that said that Trichet wanted to reduce interest rates at the last monetary policy meeting, but faced strong resistance and was eventually overruled by Germany’s Issing and Holland’s Wellink, both of whom did not want the ECB to appear that it was cutting rates because of political pressure. Regardless of whether the article has any validity, there are 2 things that are true - Trichet is softening his stance on keeping rates unchanged, while the latest string of economic data from the Eurozone, particularly industrial production and service sector PMI reports indicate that the economic rebound in the region has been extraordinarily weak. With CPI at 1.6%, which is less than the ECB’s target rate of approximately 2%, the central bank has ample flexibility to loosen monetary policy.

The US delivers the strong data that the market has been anxiously awaiting

After months of waiting for the labor market to catch up with the growth in the rest of the economy, the US has finally delivered what the market has been waiting for. Although it is only one-month worth of data and the underlying components do not paint an equally optimistic picture, euphoria has captured the markets as it starts to convince itself that we no longer have a jobless recovery. As we have mentioned in one of our previous articles, until we see more evidence of a strong pickup in job creation, the economy and the US dollar will have a difficult time springing out of its restrained state. The data for March IS evidence that a pickup in job creation is happening - but whether it is strong or not still remains questionable. Since payrolls turned positive in September, the average monthly gain in payrolls is 108k. At this stage in the recovery in the 1990s, payrolls were averaging 220k per month. Furthermore, including the latest data, 1.89mln jobs have still been lost since President Bush took office. Nevertheless, the outlook for the labor market is positive, especially given the recent tick-up in durable goods orders, industrial production and the ISM manufacturing and service sector reports. The health of the manufacturing sector is particularly important since the industry has experienced 43 consecutive months of job losses (in March, the sector did not lose jobs, but it also did not add any as well). The strength of the March data will help to boost the dollar, but what will determine whether we will see 1.15 before 1.25 in the euro is the Federal Reserve and their monetary policy bias.

But it all depends on the Fed ……

Now that we have the jobs, we need the rates. What will turn the recent moves in the dollar into a full-fledged reversal are hints by the Federal Reserve that they are shifting their monetary policy stance from a neutral bias to a tightening bias. What we are worried about is that the market may have overdone interest rate expectations. According to the Eurodollar interest rate futures, the market is pricing in almost a 100% probability of a 25bp rate hike at the August 10th monetary policy meeting. Although the latest data could prompt the Fed to move forward the inevitable tightening cycle, they have repeatedly reiterated their intentions to be “patient.” With inflationary pressures still inconsequential, the Fed has the flexibility of waiting for growth in both the economy and the labor market to accelerate to the point where they will need to take a proactive measure to slow down the expansion by raising rates. With the economic recovery still fragile, it is unlikely that the Fed will want to raise rates too early in fear of putting the recovery at risk.

What this means is that until we see more positive comments from the Federal Reserve, the dollar could potentially recoup some of its extensive losses, resulting in more range trading. There are a few major events to keep an eye on in the weeks ahead. Positive developments will clear the way for a test of 1.15, unchanged and neutral developments could result in more range trading and retracement of recent losses, towards 1.25:

1) April 21st - Greenspan is testifying before the Joint Economic Committee (expected to be a mini “Humphrey Hawkins)
2) May 4th - FOMC rate decision (focus on statement)
3) May 7th - April non-farm payrolls (still looking for more jobs data)