Weekly Forex Currency Review 02-02-2007

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Report by Kathy Lien and Sam Shenker

The Week Ahead

Although Non-Farm payrolls on Friday could very well set the tone for the following week, looking ahead, we are expecting four central banks - Australia, New Zealand, Canada, and the UK to make interest rate announcements. The Reserve Bank of Australia is expected to keep rates the same at 5.5 percent on Tuesday. The Reserve Bank of New Zealand is expected to raise their rate to 7.25 percent to combat inflation.

The Bank of Canada could very well to raise its rate for the third time to 3.25 percent as the economy is continuing to operate near capacity, putting heavy upward pressure on prices in the economy. However it is expected that despite consistently weak data coming from the UK, the Bank of England will keep its target rate at 4.5 percent and not drop the rate again to attempt to spur economic growth.

The Euro-zone is looking to be much quieter after the roller coaster ride in the euro this week; although the data is not looking to be very inspiring. Monday, many of the countries will be releasing services PMI figures from November. The survey will also include an outlook for December which will be the first survey to reflect sentiments on this week’s rate by the ECB. Retail sales figures for October will be seen later that day most likely reflecting a drop in consumer spending from record high oil prices and the next day will be a release of the Euro-zone retail PMI for November.

As the critical holiday shopping season began during the month and oil prices came down off of highs, retailers should have seen a rise in sales however it is unclear that consumers are going to be spending as heavily during this holiday season as many are very pessimistic about the state of the economy. German factory orders also look to have fallen during October from the month prior as the largest economy in the Euro-zone is faltering. The pound starts with a quiet week.

Monday, the BRC retail sales monitor, an initial reading of sales on High Street, is released and will hopefully show an improvement in sales at the start of the holiday shopping season. Retail sales in the UK have been depressingly weak however and retailers are not optimistic about sales through the end of the year. Industrial production is expected to have only grown 0.2 percent in October and have fallen from October 2004 as the sector continues to falter.

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Traders, however, will be waiting for Wednesday when the Bank of England meets. Finally, the dollar will see mostly positive news during the week, possibly allowing it to continue to rally. Monday, ISM non-manufacturing index is expected to fall, but only slightly, for November from 60 to 59.1, still staying over 50 (the level indicating expansion). On Tuesday, non-farm productivity figures for the third quarter is expected to be revised upward to a 4.3 percent rise.

Factory orders during October are also expected to rise, after falling off in September, despite high oil prices. Wednesday, MBA mortgage applications will be watched as the effect of rate raises by the Fed continues to have an effect on the housing market. Consumer credit is expected to rise to $5.7 billion, after being announced at -$0.1 billion in September, as consumers borrow to fuel spending as oil prices rose to record heights.

Technical Outlook

EUR/USD

Market Recap - Euro remains confined to a large downward sloping channel that has dominated the price action since the beginning of September, with the recent price action remaining in a tight trading range.

Short-Term - As the pair continues to consolidate within a 1.1700-1.1900 trading range, the price rejection above the 1.1863, a 23.6 Fib of the 1.2584-1.1642 USD rally, continues to signal an existence of active offers that are ready to take advantage of any potential retraces toward the psychologically important 1.2000 handle. However a break below the 1.1700 will reaffirm the recent greenback strength and the dollar rally should continue toward the 1.1500 figure.

Stochastic is neutral at 52.19. ATR remains high as volatility remains high due to narrow trading range. A positive momentum indicator is treading above the zero line and favors the Euro longs.

Long-Term - Break of the consolidation range to the downside will most likely see the pair head lower and test the bids around 1.1642, a 2005 low, and with sustained momentum to the downside aiming toward the psychologically important 1.1500 handle.

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GBP/USD

Market Recap - Cable remains confined to a downward sloping channel and continues to consolidate within a narrow trading range following the rejection of the price below the 1.7100 figure.

Short-Term - British pound continues to consolidate in a tight trading range after the pair established a new 2005 low at 1.7048. A failure by the greenback longs to keep the pair below the 1.7100 level gave the sterling longs a chance to retaliate and push the pair above the 1.7300 handle, where they ran out of steam as the pair failed to break above the 20-day SMA at 1.7305. A failure to break above the 20-day SMA by the pound longs adds to the outlook that the short-term correction will most likely give the dollar longs a chance to enter the market at attractive levels and push the pair lower.

Stochastic is neutral at 32.63. ATR remains high as volatility remains high due to narrow trading range. A negative momentum indicator is treading below the zero line and favors the dollar longs

Long-Term - A break below the consolidation range will most likely see the dollar once again try to break below the psychologically important 1.7000 handle.

USD/CHF

Market Recap - Swiss Franc remains confined to a large upward sloping channel that dominated the price action since September, with the latest swing to the downside failing to break below the 1.3041, a 23.6 Fib of the 1.2240-1.3289, thus reaffirming the overall dollar strength.

Short-Term - Swiss Franc remains confined to a narrow 1.3000-1.3289 trading range that dominated the price action during November. A failure by the Swissie longs to break below the psychologically important 1.3000 handle and the subsequent rejection of the price below the 1.3100 handle adds to the outlook that the next move to the upside will most likely see the dollar resume its advance. A break above the consolidation range and the collapse of the 1.3289, the most recent 2005 high will most likely see the dollar traders sweep the stops above, which would add to the overall momentum.

Stochastic is neutral at 50.09. ATR is rising, pointing to a jump in volatility. Momentum indicator is above the zero line continuing to favor greenback longs.

Long-Term - A break above 1.3289, the most recent 2005 High will most likely see the pair head higher and aim toward the psychologically important 1.3500 figure.

USD/JPY

Market Recap - Japanese Yen remains confined in an upward sloping channel, with the latest move to the upside breaking above the psychologically important 120.00 handle.

Short-Term - Yen remains confined in an upward sloping channel, with the latest swing to the upside breaking above the psychologically important 120.00 handle. A further move to the upside will most likely see the pair head higher and test the offers around 122.05, a target established by the 1.382 Fibonacci Extension of the May-Aug USD rally. A pullback toward the channel’s lower boundary will most likely provide any prospective dollar bulls with an opportunity to join the trend. However a confirmed break below the channel’s lower boundary will issue a strong reversal signal. Indicators are mixed.

Stochastic remains overbought at 80.67. ATR is indicating a drop in volatility. Momentum indicator is above the zero line thus adding further support to the greenback bulls.

Long-Term - A move above the 120.00 handle will most likely see the pair head higher and aim for the 122.00

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Key Events

• Dollar Emerges out of Holiday Weekend with Support of Strong Data
• ECB Raises Rates for the First Time in Five Years
• BoJ - The Bank that Cried Rate Hike

Dollar Emerges out of Holiday Weekend with Support of Strong Data

The markets and newswires returned from the holiday weekend with a busy week ahead of them. On a day devoid of any significant economic data, we saw a rather violent reversal in the dollar but economic data got a somewhat slower start. The week kicked off on a softer note with Black Friday and weekend holiday shopping coming in slightly weaker than expected. Although retailers overall had a good weekend, most of the revenues were generated by deep discount retailers such as Wal-Mart while mall based and specialty stores failed to see any major jumps in revenue.

Evidently, the market has also not forgotten about the Fed’s cautious comments from the prior week. In the minutes from their November 1st meeting, some members warned about going too far with rates and the group mulled over the need to change the rate language before long. However, Tuesday served up a large helping of positive US data and the dollar recuperated much of its losses. Durable goods rose 3.4% in the month of October, more than double the median expectation.

Given that the ex-transportation number rose a less-than-expected 0.3%, we can be assured that the end to the Boeing strike played a big role in the boost in orders. Even though bankruptcies in the US airline industry are something that we have all become quite familiar with, across the Atlantic, the airline industry remains healthy. Both Boeing and Airbus have benefited from the emergence of deep discount airlines.

After Monday's weaker existing home sales report, today's new home sales report blew away any immediate concerns for a major housing market slowdown. Sales of new homes surged 13% to a record high of 1.424 million. The average price of homes also rose 1.5%. To top that all off, consumer confidence also rose by the biggest amount in 2 years to 98.9, far above the market's 90.2 forecast. With such strong optimism, holiday shopping this season may not be as weak as signaled by the weekend's revenues.

Trichet Backs Rate Hike Despite Warnings From All Directions

Despite the first interest rate hike in five years by 25bp to 2.25%, the Euro failed to hold onto yesterday’s gains. The sell-off began immediately after the rate decision, as residual speculation for a 50 bp rate hike pushed the EUR/USD lower. The much awaited comments from ECB President Trichet failed to lend the currency pair much support. For the most part, Trichet repeated earlier comments giving little hints that the central bank will follow-up with a series of rate hikes.

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For a market heavily concerned with interest rate differentials, this caused a blow to the Euro with an interest rate much lower than that of the dollar and the pound. There were mixed reactions from government officials in the Euro-zone, who had been pushing the bank to put off a rate hike due to slow growth in the countries. The ECB does feel that the Euro-zone can withstand this small hike without jeopardizing economic growth; that it must stay with its main purpose of keeping stability of prices

BoJ – The Bank That Cried Rate Hike

For the past few months, Bank of Japan Governor Fukui has been making sporadic comments, hinting that the central bank may soon depart from its zero interest rate policy. However, also over the past few months, economic data, along with the Japanese government, has begged to differ and so far this week, we’ve seen more of that. Monday’s retail sales numbers for the month of October came in weaker than expected while the Japanese government continues to crush hopes for an end to the country’s zero interest rate policy.

According to LDP Chief Nakagawa, Japan has yet to “completely overcome deflation.” This echoes the Prime Minister’s recent comments that the country may not be prepared for a move away from quantitative easing. The rest of the week’s economic data released was more mixed and highlighted the murky outlook for the Japanese economy. Although the jobless rate increased unexpectedly from 4.2% to 4.5%, the change was not due to an increase in jobs lost, but instead due to a growing number of people re-entering the job market as prospects brighten for the labor market.

Worker’s household spending also rose by a more than expected 1.3% in the month of October, with higher wages and better job prospects boosting. Small business confidence also rose for both November and December. However, industrial production rose by only 0.6%, considerably lower than economists predicted, as companies are meeting high demand by selling off inventories. Also, auto production actually fell for the first time in three months by 1% as domestic demand slowed. The mixed tone of data signals to the Bank of Japan that, despite the optimistic outlook being imparted by some, it is still not time for a rate hike anytime soon.

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