The Week Ahead

After a volatile week full of important economic events, the forex markets actually ended up having not much progress and ended in previous week’s range. With the Fed now more comfortable on growth and inflation, markets seem to have reached consensus that Fed will keep rates on hold the first half. Attention will be turned to central bank meeting this week, in particular ECB’s press conference and whether Trichet will signal rate hike in March. Also, G7 speculations will likely continue to trigger volatility in the Japanese yen.

The focal point of last week for the forex market was the FOMC
meeting. As widely expected, the Fed left rates on hold at 5.25%. And the Fed modified the accompanying to reflect recent solid economic data by saying that “recent indicators have suggested somewhat firmer economic growth” instead of “recent indicators have been mixed”. Also, housing market is viewed as having “some tentative signs of stabilization” instead of undergoing “substantial cooling”. Also, the Fed has now referred directly to the improvement in core inflation saying that readings on core inflation “have improved modestly in recent months” instead of ” have been elevated”. All in all, the fed is more comfortable with growth an risk, which is also reflected in the first unanimous vote since Jun 06. This is inline with the view that Fed will keep rate unchanged throughout first half this year.

Economic data in US was mixed. Q4 GDP came in stronger than expected by growing 3.5%, much better than expectation of 3.0% thanks to strong private consumption, exports and government spending. However, GDP price index moderated to 1.5% growth with core PCE moderated to 2.1%, suggesting price pressure continued to moderate.

Markets ignored the positive GDP report and FOMC statement but reacted to disappointing Chicago PMI which triggered dollar weakness. Chicago PMI fell to 48.8 in Jan, the first sub-50 contractionary reading since Apr 03. Further dollar weakness was then triggered by disappointing ISM Manufacturing index which fell back to sub-50 contractionary reading of 49.3 in Jan again.

The much anticipated Non-Farm Payroll report came in with a weaker-than-expected headline number of 111k job growth in Jan only, much below expectation of 149k. Unemployment rate also edged higher to 4.6% from 4.5%. However, the negative effect was offset by strong upward revision in Dec’s number from 167k to 206k. The total of the last two months’ job growth is 317k, which is similar to original expectation of 316k (167k in Dec and 149k in Jan).

After all, sentiments in the greenback seems stabilized. Dollar’s earlier rebound in Jan was supported by change of expectation from a rate cut in first half to on hold after a series of upbeat data. While the Fed now sounds more comfortable with both inflation and growth outlook, there still isn’t any solid evidence to shift market expectation to expect a hike. Hence, focus of the markets should be on the development of monetary policy of each major central bank. In other words, the major pairs will likely continue to be out of sync like it started earlier in Jan, instead of being in a one-way market that was driven by the greenback.

Data from the Eurozone were weak except German retail sales which grew 2.4% in Dec, much higher than expectation of 1.3%. German unemployment rate also improved more than expected to 9.5%. However, both German and Eurozone Manufacturing PMI were weaker than expectation and dipped further to 58.5 and 55.5 respectively. More importantly, the Eurozone HICP has remained at 1.9% in Jan, instead of rising to 2.1% as market anticipated. These developments, together with prior retreat in Ifo index, prompted some speculations that ECB might be on hold for the new few months.

The Japanese yen weakened in the early part of last week after weaker than expected retail sales and household spending data. However, the yen was supported by further speculation on G7 meeting and rebounded strongly as the week went on. Further speculation was triggered after US Treasury Paulson stated that he was looking “very, very closely” at the yen’s value which suggested he might back EU Finance ministers in their criticizing the yen’s weakness in the upcoming G7 meeting. But such speculation dimmed after Paulson clarified that he is “very comfortable that the yen is set in a competitive marketplace.”

Sterling has been very volatile last week as the initial sharp decline was supported by stronger than expected consumer confidence and manufacturing PMI as well as mid week weakness in the greenback.

The Swiss Franc was briefly supported after better than expected KOF leading indicator which came with a reading of 1.71 versus expectation of 1.56. However, that didn’t change that fact that this leading indicate has now had a seventh straight decline in a row since prior month’s reading was revised up from 1.60 to 1.75. Swiss PMI also came in weaker than expectation at 62 versus expectation of 63.8.

The Week Ahead

With a relatively light economic calendar, central bank meetings will be the major focus in the week ahead.

There are many economic data to be released out of US in the coming week. Focus will basically be on Monday’s ISM Non-Manufacturing Index. Also, as FOMC members are still concerned about the tight labor market and high wage growth which will cause core inflation to pick up again, Wednesday’s Q4 unit labor costs and productivity. will be closely watched too. Besides, market will pay particular attention to speech of Bernanke and Paulson on Tuesday.

ECB is widely expected to keep rate unchanged at 3.5% at Thursday’s meeting. Focus will be on whether Trichet will use the major word “vigilance” to signal a rate hike in March, which most of the market participants still expect after last month’s disappointment. However, there are some risks to this, in particular as inflation is now at 1.9%, below ECB’s target inflation rate and sign of loss of momentum in the Eurozone economy. Should the ECB failed to signal a hike in March, a sharp sell off of Euro could be triggered. Other economic data from Eurozone include Service PMI on Monday, retail sales and Germany factory orders on Tuesday, German trade balance on Thursday and German WPI on Friday.

There were brief expectation of another rate hike from BoE in Feb after the Jan’s surprise raise. Such expectation has significantly scaled back after BoE minutes which revealed a much tighter than expected vote of 5-4 instead of 7-2. Thus, BoE is expected to hold rate unchanged at 5.25% this time as the Jan hike was viewed as actually a Feb hike pulled ahead. Focus should actually be on UK data including Services PMI, industrial and manufacturing production for evidence on supporting further tightening down the road.

The Japanese will likely remain volatile as G7 meeting approaches. Speculation will likely continue to fly around on whether yen’s weakness will be a topic in the meeting. And, no matter whether this will really happen or not, traders will likely continue to lighten yen short positions as this remains an event risk to them.

Expectation on whether RBA will raise rate in Feb has changed drastically after disappointing Q4 inflation data from Australia which showed a 0.1% fall for the quarter that dragged the yoy inflation rate to 3.3%. With the data in hand, RBA could now hold rates steady until further information is obtained.

Other economic of interest include Swiss unemployment and CPI as well as IVEY PMI, housing and unemployment from Canada.

USD/JPY

USD/JPY edged higher to 122.17 level last week but upside was limited there. Subsequent retreat has pushed USD/JPY through short term rising channel with bearish divergence condition in 4 hours MACD and RSI. A short term top should be formed at 122.17. Hence, even though the retreat was supported at 120.07, after meeting 120.16 support and rebounded on Friday, short term outlook remains consolidative and risk of another fall remains. Below 120.07 will encourage further correction towards 55 days EMA (now at 119.28). Firm break above 122.17 is needed to indicate rise from 114.41 has resumed.

In the bigger picture, fall from 121.38 to 108.99, with its three wave nature, should be corrective, no doubt. However, whether the current medium term rise from 108.99 represents resumption of whole up trend from 101.66 or part of a wide range, long term consolidation pattern that started at 121.38 is still in question. The structure of the rise from 108.99 is not giving much information neither. But still, with this medium term up trend remains in force, and with multi-year falling trend line (147.68, 135.20, 121.38) taken out, the former case is in still in favor.

The preferred interpretation of the rise from 108.99 is that the first move has completed at 117.87. Subsequent price actions to 113.95, 119.86 and 114.41 is treated as interim consolidation that’s skewed upward by the rise to 119.86. Rise from 114.41 is treated as resumption of the whole up trend. With this interpretation, the correction from 122.17 should be contained above 117.96 support and bring further rally towards next upside target of 100% projection of 108.99 to 117.87 from 114.41 at 123.29.

However, decisive break of 117.96 support will rise some doubt about this interpretation In such case, a deeper decline should follow to retest medium term rising channel (now at 115.68) first. A break of this channel will swing favors back to the case that another medium term decline should be seen towards 108.99 low before completing the whole long term consolidation that started at 121.38.



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