Weekly Review and Outlook: Focus Turn to UK and US GDP after G20, More Dollar Upside Ahead?

By: Milla Shaw in Forex Consultant on Oct. 22, 2010

Markets were generally cautiously towards the end of last week as investors awaited G20 meeting. Though, some underlying developments are worth noting. Firstly, dollar did seem to found a bottom as we anticipated, with expectation gradually shifting from an aggressive one-off QE II program to a gradual one with an open end. Secondly, Sterling was noticeably the weaker major currency as there were growing believe that the government’s austerity plan would need to be accompanied by another round of quantitative easing from BoE. Thirdly, Canadian dollar was also noticeably weak after BoC turned somewhat dovish and revised down growth forecasts. Fourthly, gold is possibly in progress of a deep near term correction to 1300 and below and has been providing some support to dollar and yen.

The G20 meeting in Seoul over the weekend did end with some progress, if just a small step. Firstly, the G20 countries agreed to “move towards more market determined exchange rate systems” and “refrain from competitive devaluation of currencies.” Secondly, advanced economies agreed to be “vigilant against excess volatility and disorderly movements in exchange rates” and such actions would “help mitigate the risk of excessive volatility in capital flows facing some emerging countries.” Thirdly, members will “pursue the full range of policies conducive to reducing excessive imbalances and maintaining current account imbalances at sustainable levels”. More importantly, there will be indicative guidelines to be agreed on current account balances to be rolled out at the meeting of G20 leaders in Seoul next month.

Dollar should have found a at least a near term bottom earlier this month after Bernanke’s speech and such view was affirmed by last week’s price actions. Recent Fedspeaks triggered speculation that Fed would probably implement QE II in a gradual, incremental way, at 100b per month, without a concrete end. This would be in contrast to markets’ pricing of around 1T to 1.5% QE II. The readjustment was clearly felt in Gold’s sharp correction from record high of 1388. There were some talk here and there that dollar would stage a more noticeable rebound after all is said and done and QE II is confirmed on November 3 after next Fed meeting. However, in situations like this, markets would probably start moving before market anticipated timing. So, beware of 78.36 resistance in dollar index and break of which will likely bring another strong rebound in near term.

At the release of the Spending Review, UK Chancellor of the Exchequer George Osborne outlined his plan to reduce the country’s budget deficit by 156B pound. Debt interest payments will be lowered by 1B pound in 2010, then 1.8B pound in 2013 and 3B pound in 2014 – a total of around 5B pound by 2015. The BOE minutes unveiled that policymakers voted 7-1-1 in October to leave the Bank Rate unchanged at 0.5% and the asset buying program at 200B pounds. While the majority continued to support staying sidelined, Adam Posen preferred to maintain the policy rate at 0.5% and increase the size of the asset purchase program by +50B pound to a total of 250B pound while Andrew Sentance preferred an increase in Bank Rate of +25bps and to maintain the size of the asset purchase program at 200B pound. After all, there were increasing expectation that BoE would need to expand to QE program to support the economy in backdrop of spending cuts. Though, BoE might weight for the Quarterly Inflation Report before acting.

As expected, the BOC kept the overnight rate unchanged at 1% and revised lower growth forecasts for 2010 and 2011, saying ‘the output gap is slightly larger and that the economy will return to full capacity by the end of 2012 rather than the beginning of that year’. Policymakers said that a weaker US outlook, moderate growth in emerging economies and slowdown in domestic economic outlook suggest further reduction in monetary policy stimulus would need to be ‘carefully considered’. More in BOC Leaves Interest Rates Unchanged, Revised Down Economic Forecasts.

To cool inflation, China unexpectedly hiked rates for the first time since 2007. One year deposit rate was hiked from 2.25% to 2.5% while lending rate was hiked from 5.31% to 5.56%. To prevent inflow of speculative money, it’s believed that China would tighten up capital controls further. The rate hike would probably eased some pressure on yuan appreciate as it will take part of the job to cool inflation. Though, it’s believed that China would continue to use both means. The move helped lift Japanese yen on risk aversion even though strength in yen faded a bit towards the end of the week.

Technical Highlights

Dollar index’s break of 77.93 resistance last week confirmed that a short term bottom is formed at 76.15. While some sideway trading might be seen initially this week, we’d anticipate another rise through 78.36 to 38.2% retracement of 83.56 to 76.15 at 78.98 after consolidation finishes, and possibly further towards 80 psychological level.

In the longer term view, it’s still early to conclude that dollar index has bottomed out after being held above medium term rising trend line support. Focus will remain on 80 psychological level and decisive break of this level is needed to confirm reversal. Otherwise, a break of 76.15 will open up the bearish case for dipping further to 70.70/74.19 support zone.

The Week Ahead

Initial focus will be on reactions to G20 statement but focus will quickly shift to a number of heavy weight economic data. In particular, we’ll have Q3 GDP readings from UK and then US. Two central banks will meet this week, RBNZ and BoJ and both are expected to leave rates unchanged. We’ll also have inflation data from Australia, which would be important to determine whether RBA will hike rates in Q4.

Monday: Japan trade balance; Australia PPI; US existing home sales
Tuesday: German Gfk consumer sentiment; UK Q3 GDP; US consumer confidence
Wednesday: Australia CPI; Eurozone M3 money supply; US durable goods, new home sales; RBNZ rate decision
Thursday: BoJ rate decision; Germany unemployment; US jobless claims; New Zealand trade balance
Friday: Japan CPI, unemployment, household spending, industrial production; Eurozone CPI, unemployment rate; Swiss KOF; Canada GDP; US GDP

USD/CAD’s rebound from 0.9979 extended further to as high as 1.0371 last week before turning sideway. The development indicates that whole fall from 1.6071 has completed. Hence, further rise is now in favor after finishing the consolidation from 1.0371. Above will target a test on 1.0671/5 resistance zone. On the downside, below 1.0167 will bring deeper pull back towards 0.9979 low. But we’d still anticipate strong support from parity to contain downside.

In the bigger picture, USD/CAD did get strong support from parity as we expected and the development reaffirms our view that price actions from 1.0851 are just consolidation to rise from 2007 low of 0.9056 only. Break of 1.0671 resistance will indicate that such rebound from 0.9056 is resuming for another high above 1.0851. On the downside, though, break of 0.9979 will invalidate this view and target a test on 0.9056 instead.

In the longer term picture, firstly, there is no clear indication that the long term down trend from 2002 high of 1.6196 has reversed. Secondly, the medium term fall from 1.3063 is so far looking corrective. Hence, we’re slightly favoring the case that price actions from 0.9056 are developing into a long term corrective pattern.