- Currencies At Mercy Of Fiscal Cliff Talks
- JPY: Is A 2% Inflation Target That Big Of A Deal?
- EUR: French Consumers Optimistic Despite Jobless Claims Hitting 15 Yr.-Highs
- GBP: Drops To 8-Month Low Against EUR
- NZD: First Rebound In 8 Trading Days
- CAD: WTI Crude Continues To Trickle Higher
- AUD: Shrugs Off Rise In Chinese Industrial Profits
The schizophrenic price action in equities and currencies reflects total confusion in the financial markets. The Dow was down as much as 150 points Thursday before settling virtually unchanged. With only four more days to the end of the year, no one knows whether Congress will be able to reach a deal to avoid the Fiscal Cliff before Monday's deadline. For the first half of the U.S. trading session, investors were convinced that the U.S. economy would fall off the cliff because the House threw the ball back at the Senate by saying that they will vote on anything the Senate proposes but the Senate has to act first. Then in the last 75 minutes of trading, stocks started to recover, driving risk currencies higher in the process after the House scheduled a special session on Sunday, giving the market hope that they will work through the weekend and vote for a deal the day before the December 31 deadline. According to CNN, President Obama will send a new proposal to Congress, which will most likely be the deal that the House votes on come Sunday. Congressional Leaders also plan to meet with Obama Friday. The hint of progress has led to a sharp reversal in equities but while investors remain optimistic, Senate Majority Leader Harry Reid doesn't think that the Budget Deal will be resolved before the New Year. Republicans and Democrats are deadlocked and optimistically, there's a 50-50 chance that a deal will get done.
For the next four days, the only thing investors will care about is how the U.S. Fiscal Cliff talks are going. Currencies and equities will hold steady unless there is reason to believe that a deal will not be done by the end of the year OR early next year. If no deal is made by December 31 but Congress pledges to make an announcement in the first two weeks of January, currencies and equities could drop only slightly in disappointment because investors will be willing to grant a short grace period. If the talks break down completely and neither side is willing to concede, then we can expect a sharp selloff in currencies as risk appetite drives investors into safe haven assets.
Thursday's U.S. mixed economic reports were completely overshadowed by Fiscal Cliff headlines. Nonetheless, labor market conditions continued to improve with jobless claims falling to 350K from 362K. The four-week moving average also dropped to its lowest level since March 2008 which points to the potential for a nice improvement in payrolls next week. New home sales rose 4.4% in November, which was stronger than expected. Low interest rates continue to provide support to the housing market but fiscal cliff concerns drove consumer confidence to its lowest level in four months. The Chicago PMI report and Pending home sales are due for release on Friday -- neither of these reports are expected to have much impact on the greenback.
JPY: Is A 2% Inflation Target That Big Of A Deal?
With the latest sell-off in the Japanese Yen, the currency has now fallen over 10% against the U.S. dollar. Members of Prime Minister Abe's administration continued to publicly pressure the Bank of Japan to increase monetary stimulus and raise the inflation target. Consumer prices are due for release this evening and the data will show that annualized price pressures are around -0.2%. From this perspective both 1% and 2% inflation will be difficult to achieve. The last time CPI was at 1% was in 2008 and in order to achieve this target once again they will need to increase asset purchases. So in reality what's the difference between a 1% or 2% inflation target? The answer is psychology. By forcing the BoJ to adopt a higher inflation target, the new government is publicly renewing their commitment to boosting the economy by supporting the asset markets. It won't be easy to drive inflation to 2% and by the time it happens, Abe's term may even be over. The last time inflation hit 2% was in 2008 when oil was at $140 a barrel and before that in 1996 when the consumption tax was increased from 3% to 5%. Nonetheless, the mere possibility of a more aggressive monetary policy measures such as a higher inflation target has driven the Yen to its lowest levels since 2010. Abe has succeeded where former Prime Ministers Fukuda, Aso, Hatoyama, Kan and Noda failed in reversing the rise in the Yen. If USD/JPY manages to hold at current levels or head even higher, the export sector will receive a major dose of stimulus that could finally turn things around and help restore the trade surplus in Japan. Thursday night will be a busy time in Japan and therefore the focus will remain on the Yen. Aside from consumer prices, industrial production, manufacturing PMI, jobless rate, overall household spending and labor cash earnings are scheduled for release. The short Yen trade is starting to become overcrowded but with monetary policy expected to support the move, any dip in USD/JPY should be seen as an opportunity to go long at lower levels.
EUR: French Consumers Optimistic Despite 15-Yr.-High Jobless Claims
It has been a topsy-turvy day for the EUR/USD, which took its cue from U.S. equities. In the middle of the New York trading session, the Dow Jones Industrial Average was down more than 150 points and a that time, the EUR/USD turned negative for the day but by the market close, the Dow was down a mere 18 points and the euro was slightly higher against the U.S. dollar. The only thing that matters to the EUR/USD right now is Fiscal Cliff talks. If a deal is reached in the next few days, the EUR/USD will rally in relief. If the talks are deadlocked and the U.S. economy ends up falling off the cliff, the EUR/USD could slip back towards 1.30. The only pieces of Eurozone economic data released Thursday were from France. Producer prices declined but consumer confidence increased even as jobless claims hit their highest level in 15 years. This is certainly an interesting dynamic as it is almost hard to believe that the French are growing more confident even as they are losing more jobs. Nonetheless the stability in European asset markets and the progress made on resolving the region's debt crisis has gone a long way in boosting sentiment. On Friday, we'll learn if this increase in confidence was enough to drive stronger consumer spending in France.
GBP: Drops To 8-Month Low Against EUR
The British pound ended the day lower against the U.S. dollar and euro. This has been an extremely quiet week in terms of U.K. data with the loans for house purchases being the only economic report on the calendar. According to the British Banker's Association, home loans rose to their highest level since January. A total of 33,634 mortgages were approved in the month of November, up from 33,128 mortgages. This data is encouraging and suggests that the government's Funding for Lending scheme is finally working, but we are skeptical. For the most part, there is very little momentum in the housing market and we don't expect this to change until the economy gains momentum. While sterling is stuck in a range against the dollar, it dropped to its lowest level against the euro in more than 8 months. This weakness reflects the changing dynamics in Europe. Investors are less worried about the Eurozone's sovereign debt crisis and more worried about the possibility of a ratings downgrade in the U.K. During the first half of this year, many Eurozone investors sought safety in U.K. assets and now that the outlook for the Euro zone has brightened, the money is flowing back into the euro.
NZD: First Rebound In 8 Trading Days
After falling for eight consecutive trading days, the New Zealand dollar managed to muster a very small rally against the greenback. For the most part, commodity currencies remain weak with the Australian and Canadian dollars ending the U.S. trading session virtually unchanged. Even when European currencies were rising Thursday, the comm dollars failed to participate in the rally. A 3% increase in Chinese industrial profits also failed to lend support to the AUD and the same is true of higher oil and gold prices. In fact, USD/CAD rose to its highest level in one month on an intraday basis, which suggests that some traders continue to sell the CAD to hedge the Fiscal Cliff talks. The Fiscal Cliff is the number one concern for central banks around the world and if their concerns materialized, Canada would be among the hardest hit. The gradual recovery in the U.S. economy in the second half of 2012 lent support to Canada and gave the central bank the confidence to openly consider raising interest rates. However if U.S. falls off the cliff and investors become worried about the consequences on the economy, the Canadian dollar could suffer greatly as traders unwind their long Canadian dollar positions. At a time when most central banks are increasing monetary stimulus, the Bank of Canada is the only one talking about raising interest rates and a fall off the Fiscal Cliff could force the Bank of Canada to drop its hawkish monetary policy bias.
Kathy Lien, Managing Director of FX Strategy for BK Asset Management