US Dollar, Japanese Yen to Remain Volatile Ahead of Key GDP, CPI Reports

Risk trends remain a prominent driver of price action for the US dollar and Japanese yen, and next week may not be any different as Japanese GDP, Canadian CPI, US CPI, and meeting minutes from the Federal Reserve and Bank of England will all be released.

Japanese Gross Domestic Product (GDP) (4Q P) - February 15

On February 15 at 18:50 ET, Japan's Cabinet Office will release preliminary growth readings, and after two consecutive quarters of contraction in Q2 and Q3, the outlook doesn't look good. There are signs that businesses are suffering considerably at the hands of waning domestic and foreign demand. Consumers have very little to work with these days, as the jobless rate has been climbing slowly, and perhaps even worse, pre-tax earnings growth has actually fallen negative compared to a year earlier, according to the latest figures. Meanwhile, Japanese exporters have had to grapple with not only slowing global growth, but also the appreciation of the Japanese yen, all of which has led foreign-bound shipments to tumble a whopping 23.1 percent in Q4 2008, according to preliminary figures published by the Ministry of Finance. As a result, a Bloomberg News poll of economists shows expectations for GDP to fall 3.1 percent in Q4, with the annualized rate forecasted to plummet by the most since 1974 at a rate of 11.7 percent. This could hurt risk appetite during the Asian trading session, lead the Nikkei lower, and thus push the Japanese yen higher amidst deleveraging.

Bank of England Meeting Minutes (FEB 5) - February 18

The Bank of England's meeting minutes tend to be a huge market-mover for the British pound upon release at 4:30 ET, and this time is unlikely to be any different. During the February meeting, the BOE's Monetary Policy Committee (MPC) slashed the Bank Rate by 50 basis points to yet another record low of 1.00 percent, as expected. However, the British pound subsequently rallied as the MPC suggested that they may not cut rates again on March 5. Since then, though, BOE Governor Mervyn King's comments have signaled otherwise and if the MPC's comments and outlooks signal that the central bank will reduce the Bank Rate further, the British pound could pull back.

Federal Open Market Committee (FOMC) Meeting Minutes (JAN 27-28) - February 18

In January, the Federal Open Market Committee (FOMC) left the fed funds target range at 0.0 percent - 0.25 percent, and the minutes from the meeting will likely add to indications that they will leave the target unchanged throughout much of 2009. In fact, the FOMC said in their post-meeting statement that their focus had shift to “support the functioning of financial markets and stimulate the economy through open market operations and other measures that are likely to keep the size of the Federal Reserve's balance sheet at a high level.” The minutes may have an impact on risk trends if the Committee's outlook proves to be more bearish than currently perceived. However, if the news happens to be positive for the stock markets, it may also be negative for the greenback, which has been trading solely as a safe-haven asset lately.

Canadian Consumer Price Index (CPI) (JAN) - February 20

In January, the Bank of Canada issued forecasts for sharp declines price growth this year, making the February 20 release of the Canadian Consumer Price Index (CPI) quite important. At 7:00 ET, CPI for January is anticipated to contract for the fourth straight month at a rate of 0.3 percent while the annualized pace is forecasted to slip to a 2-year low of 1.1 percent. Meanwhile, the Bank of Canada's core CPI measure may actually hold relatively high at 2.2 percent, though this would be down from a 1.5 year high of 2.4 percent. Given the sharp drop in commodity prices since the summer and slowing in the Canadian economy, there is potential for weaker-than-expected readings and thus, the Canadian dollar could pull back further.

US Consumer Price Index (CPI) (JAN) - February 20

At 8:30 ET, the release of the January reading of the US Consumer Price Index (CPI) could lead the term “deflation” to be used abundantly in coming weeks and months (one that became very popular in November, according to Google Trends). Indeed, CPI is forecasted to have edged a slight 0.1 percent higher during January, while the annual rate is anticipated to have fallen negative for the first time since 1955 by 0.1 percent. Excluding volatile food and energy prices, though, core CPI may have risen 0.3 percent during the month, leaving the annual rate to fall to a nearly 5-year low of 1.5 percent.

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Weekly Focus: Protectionism Back on the Agenda

There will be a lot to talk about at this weekend's G7 meeting. Obviously, the financial crisis and how to handle it will be an important theme. However, another pressing issue has emerged recently: Growing signs of protectionism. The US stimulus package, for instance, includes a ‘Buy American' provision requiring that only US materials be used in construction projects funded by the bill. The Buy American clause has been heavily criticised by both the EU and Japan, so the bill has now been softened. It now states that the US will not violate international trade agreements, including WTO and NAFTA rules. How this will be carried into practice is still uncertain, though.

In Europe, France in particular seems to be cultivating its own interests, with a EUR6bn car industry bailout that requires French companies benefiting from the package to stay in France for at least five years. In a dispute with the Czech Republic, French President Sarkozy said that he would encourage French companies - for example, in the Czech Republic - to move their operations back to France. Naturally, this met with heavy protests from the Czech Republic, and the EU has asked for further information on the planned bailout for French carmakers.

Although protectionism is always looming when the world economy is in a crisis, until recently protectionist pressures were largely contained. Recent developments are ominous, though, underlining how important it is for the G7 to take control of the situation very soon. Waging a trade war would simply obstruct a solution to the global economic crisis and be much like scoring a huge own goal - witness the Great Depression of the 1930s, when protectionism just made matters worse.

Euroland: ECB to reach 1% by the summer

Due to a softer rhetoric from the ECB lately and the more downbeat outlook for the Euroland economy we have revised down our forecast for ECB rates (See Flash Comment - Euroland: ECB expected to reach 1% by Summer). We now see the end point at 1.0% rather than 1.5%. We continue to look for a 50bp easing at the March meeting but now expect the ECB to ease by a further 25bp in April and 25bp in June. Why not cut all the way to zero? We believe the expected improvement in PMIs globally will lead the ECB to stop cutting rates when we reach the summer. By then, PMIs should have risen for five to six months and more positive signs in the US are likely to have evolved. This will put the ECB on the sidelines to wait for the stimulus to work.

During the week the ECB's Weber - one of the arch-hawks - gave an interesting speech. He said that "We should not at this point avoid to lower rates aggressively, because we understand at the current juncture all indicators look like the economy is in freefall.” (See Flash Comment - Euroland: Weber confirms shift in ECB focus). The ECB seems to have set aside its aversion to cutting rates to a very low level. That the economy is in freefall was clearly confirmed by Q4 GDP data this week. German GDP fell a whopping 2.1% q/q - weaker than the consensus expectation of -1.8%. Euroland GDP as a whole fell 1.5% q/q. Highlighting the woes for the auto industry in Europe, numbers showed that car sales in Western Europe fell 26.9% y/y in January.

Softer rhetoric from the ECB and weak data has added downward pressure to Euroland yields. Helping in this direction was also the aggressive rate cut from the Riksbank of 100bp and a very dovish Bank of England pointing to zero rates before long (see UK). EUR/USD has traded broadly sideways over the past week at around 129 but we expect it to resume the move lower over the coming months.

Key events of the week ahead

Tuesday: ZEW likely to rise further and signal gradual improvement in surveys in general.
Friday: Flash PMI should recover further in February as the pace of decline in activity tapers off. It will still signal very weak growth, though.

Switzerland: Banks in the spotlight

In Switzerland, the past week has been all about the banks' annual results. Tuesday saw the country's biggest bank, UBS, release miserable results, with total losses for 2008 of CHF19.7bn, and on Wednesday its second-largest bank, Credit Suisse, published losses for the year of CHF8.2bn. While writedowns and losses in the financial sector do not in themselves affect growth in Switzerland, these results do illustrate the difficult environment for financial companies, and we expect the financial sector to continue to make a negative contribution to growth in Switzerland. The sector contributed up to half of overall Swiss economic growth in 2005-07, but throughout last year it practically cut the country's growth in half. Both banks also announced plans for redundancies: Credit Suisse said that it would be cutting 5,300 jobs, and UBS announced a further 2,000 job losses. Despite the big financial package in the autumn and the successful recapitalisation of the banks, UBS in particular has remained one of the hardest-hit global banks, and the financial sector is still - thanks to a large share of the economy by international standards - a significant risk factor for both growth and the CHF.

The week also brought important inflation data. There was a surprisingly big drop in CPI inflation from 0.7% in December to just 0.1% in January. As elsewhere in the world, the slide in commodity prices played a major role in this, with oil products alone contributing a drop of 1.3pp relative to last year. Prices of foreign manufactured goods also fell by 3.8% y/y, pulling down inflation by 1.1pp, which would support the argument that the slowdown in global demand has pushed down prices. But with inflation well below the 2% target and there being a risk of a lengthy period of falling prices, the pressure is on the SNB to ease monetary policy further, although the bank is continuing to maintain that the recent big drops in prices are only temporary.

We have published a new interest and exchange rate forecast today (Friday). Our forecast for the SNB's interest rate target is unchanged - we expect this to stay at 0.50% for the rest of the year. However, we think it likely that the SNB will lower the upper end of the band for the 3M LIBOR. We also expect the bank to use alternative instruments to ease monetary policy (such as purchases of corporate and/or government bonds), and have therefore revised down slightly our yield forecast for longer maturities. We have not changed our forecast for the CHF.

Key events of the week ahead

Tuesday, 09.15 CET: December retail sales. The series is usually rather volatile, but it will still be interesting to see how Christmas trading was affected.
Thursday, 08.15 CET: January trade balance.
Thursday, 11.00 CET: ZEW expectations.

UK: Bank of England to follow in Fed footsteps and introduce ZIRP

The Inflation Report this week from the Bank of England (BoE) pointed to further clear downside for interest rates. The BoE painted a very bleak picture of the British economy and paved the way for further easing. The most striking feature in the Inflation Report was the BoE's forecast of inflation. The BoE expects inflation to be only around 1% in the medium term based on current market rates and estimate that the economy will still have a lot of excess capacity on this horizon. This means that even if the BoE cuts rates to zero it would not be enough to push the medium-term inflation rate up to the target of 2%. This is a clear signal that the BoE will indeed cut rates as low as possible - zero - and probably introduce quantitative easing. We can therefore expect the BoE to start buying credit assets without financing this with short T-bills - and hence print money to buy credit assets. This is similar to what the Fed is doing in the US mortgage market, where it buys mortgage-backed securities without funding it with treasuries.

Based on the Inflation Report we now expect the BoE to cut rates to zero in two steps - a 50bp cut in March and a further 50bp cut in April. There is also the possibility that it will cut by the entire 100bp in March. Whether it goes all the way to zero - or as the Fed uses a range of 0-25bp - is not clear. It might choose to have a slight positive interest rate due to technical issues surrounding money market funds.

The minutes from the latest BoE meeting will be released next week and might give more insight into the BoE's thinking. Otherwise focus turns to data for CPI and retail sales. In the past week we saw a little light in terms of the BRC retail sales monitor, which showed a slight improvement. It may be that the stimulus from lower rates and rapid decline in commodity prices is starting to have a stabilising effect. The level of growth is still very low, though, and hence pressure to give more help is still in place.

Key events of the week ahead

Monday: Rightmove house price index could rise m/m as indicated by the HBOS number last week.
Tuesday: CPI likely to show further decline in inflation.
Wednesday: BoE minutes (see above). CBI industrial survey to stay weak.
Friday: Retail sales might improve as signalled by BRC.

USA: Obama's financial rescue plan leaves many questions unanswered

Stateside, the week was all about fiscal policy. Congress managed to agree on a fiscal policy stimulus package running to USD789bn, equivalent to around 6% of GDP. Thus the overall package is only marginally smaller than the original USD819bn proposal from the House of Representatives.

Centre stage, though, was Treasury Secretary Timothy Geithner's unveiling of Barack Obama's rescue plan for the financial sector. The overall impression of the plan is that it leaves more questions unanswered than one might have hoped (see Research US: A united rescue effort, but short on detail). There had been a great deal of speculation about the creation of a federal ‘bad bank' that could take over the toxic assets that are creating uncertainty about banks' solvency, but the new Financial Stability Plan does not provide for a fully government-financed bad bank. Instead there will be a public-private investment fund which will buy up toxic assets for which there is otherwise no market. There are no clear answers yet as to how the fund is to attract private investors, how the risk associated with its assets will be shared, or how prices will be set. All larger banks will also be subjected to a stress test to see whether they have sufficient capital to withstand future losses. Banks that have undergone this stress test will then be eligible for a federal capital injection.

Taken as a whole, the rescue plan will probably remove much of the uncertainty about individual banks' state of health. But with so few details in place and an extensive stress test to be completed first, the plan will take time to implement.
The most interesting incoming data in the coming week are consumer prices for January. We expect the overall CPI to be unchanged from December, with core inflation at 0.2% m/m. The minutes of the FOMC meeting on 27-28 January are due to be released on Wednesday, and it will be interesting to see how much the FOMC members discussed buying up treasuries. The week also brings a number of speeches by FOMC members, the most important coming from Ben Bernanke on Wednesday.

Key events of the week ahead

Tuesday: We expect the NAHB housing index to drop to 7.
Wednesday: Minutes of the January FOMC meeting, a speech from Ben Bernanke, and data for housing starts, building permits and industrial production in January.
Thursday: We expect producer prices to climb 0.3% m/m overall and 0.2% m/m ex. food and energy.
Friday: We expect the consumer prices to be unchanged from December and core inflation at 0.2% m/m

Asia: Japanese growth to plummet in Q4

In Japan, the big event of the week is the release of GDP figures for Q4 08. We expect GDP to contract by no less than 2.5% q/q. It is primarily exports that dragged the economy down during the quarter. Our calculations indicate that exports fell by 12% q/q, with the result that net exports knocked a whole 2.0pp off growth from Q3 to Q4. This massive drop in exports has hit both business investment and the labour market, and so the GDP figures will be weak across the board. We expect private consumption and business investment to fall by 0.9% q/q and 2.5% q/q, respectively. The greatest uncertainty is associated with stocks. We expect stockbuilding to boost GDP growth by 0.3pp q/q, but the figure may well turn out to be higher. This heavy stockbuilding in Q4 means that the growth outlook for Q1 this year is also weak. We currently anticipate further contraction of 0.8% q/q, but we hope to see some stabilisation of activity during Q2.

We expect the BoJ to keep its leading rate unchanged at 0.1% at the monetary policy meeting on Wednesday and Thursday. Anything else would be an enormous surprise. The bank has signalled clearly that it does not want to take its leading rate right down to zero, as this would jeopardise the functioning of the money markets. Interest will therefore centre on any new unorthodox easing. The BoJ has already announced plans to buy financial institutions' commercial paper and shares, and it is possible that the bank will announce concrete plans to buy corporate bonds in connection with the monetary policy meeting. However, it is important to stress that the main problem in Japan is not the banks' inability or unwillingness to lend. The country's weak growth is due primarily to a huge external demand shock. This means that the weak fiscal policy reaction and political uncertainty are ultimately a bigger problem at the moment than the financial sector's woes.

In China, no important news is expected in the week ahead. Economic data are still painting the picture of an economy that has begun to stabilise at the beginning of this year. The rapid acceleration in credit growth from 18.7% in December to 21.3% y/y in January is another sign that the effects of more expansionary monetary and fiscal policy are beginning to feed through. Although inflation will probably remain negative during the spring, the pressure for aggressive easing of monetary policy is abating. We have therefore reduced the degree of monetary policy easing in our forecast for China, see Flash Comment - China: Inflation to temporarily enter deflationary territory.

Key events of the week ahead

In Japan, Monday brings GDP figures for Q4, while Thursday's monetary policy meeting at the BoJ is expected to result in an unchanged key rate of 0.1%.
No important data are expected out of China during the week.

Foreign Exchange: Zero Interest Rate Policy taking its toll on GBP and SEK

During the past month, two trends emerged in the FX market: broad based euro weakness - as the single currency lost against all G10 currencies, but the Swiss franc and the New Zealand dollar - and a very strong appreciation of Norwegian krone. Both movements were in line with our general forecasts, although the strong Norwegian krone rally came sooner than we had expected.

Another tendency has been a turnaround in global activity indicators, most noteworthy a recovery in PMIs, business surveys and shipping rates. Thus, it is natural to raise the question as to whether we have seen a trough in the global cycle. We believe that the evidence is indecisive. First, we have only seen one month of improvement. Second, we are still seeing an accelerating fall in employment, a collapse in global trade, and very weak final demand. Finally, one has to remember than even following a turnaround, global PMIs will still be at very low levels indicating a significant contraction. That said, we forecast a turnaround in activity indicators during H1 and expect the US ISM index to climb above the neutral 50 by year-end. This will be important for the currency market and should, all else being equal, support the pro-cyclical Australian dollar, New Zealand dollar and Canadian dollar against the defensive yen and Swiss franc, which is also factored in to our new forecast.

For some time, the sustainability of the US twin deficits and the possible future impact on the dollar has been a widely debated topic. However, recent data points to a marked improvement in the trade balance, raising the question about whether one leg of the twin deficit, the current account deficit, is in the process of self-resolving. The monthly US trade deficit has narrowed from around USD60bn late summer last year to just USD40bn in December. This suggests to us that the current account deficit could narrow to below 3% of GDP this year, which would be a significant improvement from the close to 6% peak a few years ago. With both lagged effects from past FX movements and the business cycle working for the US current account, this should be less of an issue going forward. Nevertheless, given the state of the US public finances, the currency risks of the other leg of the twin deficit remain in place. The approval of the Obama USD789bn economic stimulus plan will add more to this imbalance.

The convergence in world interest rates toward zero is continuing, most recently illustrated by both the Bank of England (BoE) and the Swedish Riksbank (RB). In its latest Inflation Report the BoE presented an inflation forecast undershooting the inflation target by one percentage point indicating a move toward Zero Interest Rate Policy (ZIRP) and potentially a vote in the MPC on quantitative easing. This sent sterling weaker and we expect further sterling depreciation in the months to come. In Sweden, the Riksbank slashed its policy rate to 1% and indicated further rate cuts. There now seems to be a fair chance of the Riksbank cutting rates to virtually zero and adopting unconventional methods of stimulating the economy. Also, the Riksbank indicated that the weakening krona would be welcomed in the current environment.

In our newest forecasts, we have thus pencilled in further Swedish krona and sterling weakness in the short term, while we expect further Norwegian krone strength against the euro. Turning to EUR/USD, we expect further dollar gains in the months to come, while we see limited potential for USD/JPY and EUR/CHF to move much lower.

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Financial Markets Review : BoE Prepares for More Rate Cuts and Quantitative Easing

The pound's recent rally was abruptly ended by the latest Bank of England (BoE) Inflation Report (QIR), outweighing some slightly better than expected UK economic data.

The QIR sharply revised down projections for UK economic growth, with the likely contraction in 2009 estimated at over 3%, with the risks to the downside. Based on market implied interest rates, CPI inflation was projected to be well below the 2% target over the forecast horizon. BoE governor King confirmed further easing in monetary policy may be required and that unconventional measures, such as quantative easing, were already being considered. After closing at a 4- week high (1.4947) on Monday, £/$ ended the week down 2.3% at 1.4410. £/€ rose above 1.15 for the first time since early December, however closed the week 2.4% down at 1.1189 only after a rebound on Friday. The single currency was put under pressure by data showing the euro zone economy contracted by a larger than expected 1.5% q/q in the final quarter of 2008, which fuelled speculation that interest rates have further to fall. €/$ closed the week down virtually unchanged at 1.2878.

The dollar and yen were supported by buying activity after new measures announced to support US banks failed to engender wider market confidence. $/Y closed the week higher at 91.95. The worst performer in the G10 was the Swedish krona after the Riksbank cut interest rates by a larger than expected 1%. In emerging markets, the top performers against the US$ were the Chilean peso and Russian rouble, while the Hungarian forint and South African rand fared the worst.

The focus in the UK this week was on the February QIR. Dovish comments from governor King, highlighting serious downside risks to the UK economic outlook and the need for further policy easing, raised the probability of a cut to 0.5% in Bank rate next month and a move to quantitative easing. The BoE for the first time on Friday announced the benchmark interest rate it will purchase commercial paper using its new were better than expected, but still reflected economic weakness. Claimant count unemployment rose by 73,000 in January, pushing the unemployment rate to 3.8% from 3.6%. The ILO jobless rate rose to 6.3%.

Economic data from the euro zone raised the possibility of a sharp cut in interest rates next month and weighed on the euro. Preliminary estimates showed EU-16 gdp contracted 1.5% q/q in the final quarter of 2008, led by a 2.1% drop in German gdp - the most since 1987. German CPI inflation was confirmed at 0.9% in January, underlining that the ECB has room to cut interest rates. We expect the benchmark rate to be cut to at least 1.5% in March.

Financial markets looked towards the US this week to hear about the government's latest package to help the banking sector and the vote on the $789bn fiscal stimulus programme. A lack of clarity and fears that the measures announced may prove insufficient weighed on investor confidence. However, this actually supported the US$ on safe haven flows. The stimulus plan has not been passed at the time of writing.

Interest rate market review - bonds, cash and swaps

A warning by the Bank of England on the outlook for the UK economy and a successful US quarterly debt refunding was supportive of government bonds and helped yields and swap rates to fall this week. Gilts out performed treasuries and bunds, especially at the front end where UK 2y yields plummeted nearly 40bp. UK 5y swaps slipped back below 3%. UK 3- month libor fell 5bp to 2.07% as the BoE Asset Purchase Facility came into operation on Friday and the Bank prepared markets for quantitative easing.

The quarterly BoE Inflation Report was the marquee event in the UK this week and did not go unnoticed after another downgrade to the UK economic outlook sparked an impressive rally in UK gilts. Gilt futures posted their biggest intra-day gain in history on Wednesday after governor King warned that gdp growth could trough at -4% in Q2. Mr King prepared markets for a further reduction in base rate - we expect a cut in March to 0.50% - and also hinted at the likelihood of quantitative easing to boost liquidity. This consists of the outright purchase of gilts to increase the monetary base via commercial bank reserves. An increase in money supply is the result if banks distribute liquidity to the real economy with an offsetting sales of treasuries. The Bank also said it expects CPI inflation to stay below 2% this year before rising to 2.1% at the end of 2010. Gloomy UK labour markets and mortgage approvals data reinforced the Bank's forecasts and added support to the gilt rally and a steeper curve. A rise in the number of unemployed in December to 1.97mn lifted the ILO unemployment rate to 6.6%. 2y gilts fell 30bp to 1.33% on Wednesday, pushing the yield curve 2s/10s to 228bp. Gilt auctions attracted respectable demand for the 2019 issue (bid/cover 1.75), but the index-linked 2027 auction fared less well (bid cover 1.57). 5yr swaps ended the week down 21bp at 2.88%.

US economic data was overshadowed by record treasury auctions and events in Washington where Treasury Secretary Geithner presented a comprehensive financial rescue plan to remove distressed assets from bank balance sheets and boost lending to the private sector and households. The three government auctions, $67bn in total, were all very well received, especially considering concerns about the record amount of funding still to come and government plans to spend $790bn. Markets listened to Mr Geithner when he presented his rescue plan and concluded that the lack of detail left a lot of uncertainty on how the plan will price distressed assets. Markets are also anxious to hear more details - probably next week - about a new Home Assistance plan designed to stop house prices from falling and slow the rate of foreclosures. Economic data were better than expected this week. Weekly claims fell by 8,000 to 623,000. Retail sales rose by 1% in January led by a 2.6% rise in petrol sales. Weak sales in other categories led markets to dismiss the stronger data. Signs of pessimim surfaced on Friday in the much weaker than forecast Michigan confidence survey. The index fell to 56.2 in February, the 4th lowest ever. With government supply out of the way and the Fed not ruling out the purchase of treasuries, 10yr yields out performed, falling back from 3% to 2.85%. 3-month US libor was unchanged this week at 1.24%.

The worst economic performance for Germany since 1987 led to a deepening of the recession in the euro zone at the end of 2008. Data showed a 1.5% q/q contraction in EU-16 gdp growth in Q4 2008, driven by a 2.1% q/q contraction in Germany. Euro 3-month libor fell below the 2% ECB refi rate to 1.94%, and evidence that the ECB's liquidity operations are effectively working were underlined by a sharp fall in bank daily overnight deposits with the ECB below 100bn euros. 5yr swaps closed the

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FX Briefing : Finance Ministers in the Spotlight

Highlights

US bank rescue plan disappoints markets
Aggressive central banks weigh on pound sterling and Swedish krona
Eurozone recession deepens, GDP contracts by 1.5% in Q4
G7 finmins to discuss crisis measures, financial market regulation, protectionism

This week, the markets have been focused on the two major political events in the US. First, the US Senate has approved the economic stimulus package, thus clearing the way for the joint compromise plan to be approved by both houses of Congress. The stimulus bill is to be signed into law by President Obama within the next few days. Second, the new US Treasury Secretary Timothy Geithner has unveiled his bank rescue plan.

Market participants' hopes were pinned primarily on the bank rescue plan. They had been expecting it to provide fresh impetus. And they were visibly disappointed when it became clear that Mr Geithner had no clear-cut solutions to offer. The new plan is based on much the same lines as before: recapitalisation of financial institutions with the potential to survive, removing toxic assets from banks' balance sheets with combined funds from the public and private sector (this is new), reviving lending to consumers and SMEs by significantly expanding funds to buy securitised loans (up to a volume of $1,000bn), and easing restructuring of existing mortgage loans by offering government aid.

The plan leaves a lot of important questions unanswered, however, particularly in connection with removing toxic assets from banks' balance sheets. Mr Geithner only touches briefly on the main problem - how to obtain a fair valuation of the assets, and how to avoid favouring banks or private investors to the detriment of taxpayers.

Against this backdrop, gains on equity markets crumbled again, and credit spreads widened. In the forex market, EUR-USD, which had been around 1.30 at the beginning of the week, retreated below 1.29. Weak economic data from Japan and the eurozone strengthened this tendency. Both the German and the Japanese trade balance figures show that foreign trade collapsed in December; very bad euro area production data complete the picture. The GDP figures released on Thursday and Friday show an unprecedented collapse in economic activity in Q4: in the eurozone, real GDP fell by 1.5% quarter-on-quarter, and even more dramatically in Germany by 2.1%. The negative impact came mainly from the foreign trade side and fixed investment.

The pound sterling and the Swedish krona weakened significantly. In the previous fortnight, the pound had recovered quite well: at the beginning of the week, GBP-USD had improved from its low of around 1.35 to 1.50; at the same time, EUR-GBP had lost about 8 pence to around 0.87. In his statement on the release of the Inflation Report, BoE governor Mervyn King clearly signalled that the economic situation and the tight financial market situation might make further monetary policy easing necessary. He also confirmed that the BoE was considering quantitative easing. A combination of crumbling equity markets, dismal macroeconomic prospects and BoE interest rate cut hints weighed on the pound: the euro rose to over 0.89, cable fell back to 1.45.

The Swedish krona suffered a similar fate when on Wednesday the Riksbank unexpectedly cut interest rates by 100 basis points to a mere 1.0%. It referred to the rapid deterioration in the economic situation: according to the Swedish central Bank's revised estimates, real GDP will shrink by 1.6% in 2009, while the unemployment rate could more than double to 8.0%.

At the weekend, the G7 finance ministers and central bank governors are meeting in Rome, to discuss measures to combat the financial and economic crisis. In our view, they are not likely to come up with a magic solution. We see a slight danger here of the markets' hopes of a quick solution being dashed - which would support the dollar. In addition, currency matters will probably be discussed in the normal manner. The new US government has already signalled that it also considers the yuan undervalued. The G7 statement is therefore likely to contain a reference to China again. In the markets, there had been some speculation as to whether Japan could bring up the subject of the appreciation of the yen. But finance minister Shoichi Nakagawa has since denied this.

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Forex Trading Weekly Forecast

US Dollar Could Gain If Bernanke, US Retail Sales Ignite Risk Aversion
Euro Forecast Remains Bearish Ahead of Key GDP Releases
Japanese Yen Falters on S&P Rebound, but Forecasts Remain Bullish
British Pound Looks To Capitalize On BoE's Shift Towards Neutral Policy
Swiss Franc At Risk Of SNB Intervention As Deflation Concerns Mount
Canadian Dollar Threatened as Traders Boost Interest Rate Cut Expectations
Australian Dollar May Break Higher If Risk Appetite Holds Up
New Zealand Dollar Fundamentals Foreshadow A Deepening Recession

US Dollar Could Gain If Bernanke, US Retail Sales Ignite Risk Aversion

Fundamental Outlook for US Dollar: Bearish

ISM non-manufacturing held below 50 for the 4th straight month, signaling a contraction in activity
US personal spending fell for the 6th straight month amidst slipping incomes
US non-farm payrolls fell by 598,000 in January, the most since 1971

The US dollar ended the past week down versus most of the major currencies as a surge in risk appetite weighed on low-yielders, including the Swiss franc and Japanese yen. For what it's worth though, the dollar index hasn't done much but consolidate below its January highs, and it will take a large shift in risk trends to get the greenback to break higher or lower. With event risk due to be fairly high this week, such a break seems possible.

On Tuesday, Federal Reserve Chairman Ben Bernanke is scheduled to testify in front of the House Financial Services Committee on the central bank's lending programs at 13:00 ET, and this could prove to be one of the biggest market-movers of the week due to its potential impact on risk sentiment. Part of this will probably include explanations as to why the Federal Reserve announced on Friday that they would delay plans to start lending under a $200 billion program called the Term Asset-Backed Securities Lending Facility (TALF). TALF will allow the central bank to lend to holders of AAA rated debt backed by newly and recently originated loans, including education, car, credit-card loans, and loans guaranteed by the Small Business Administration. Overall, though, if Chairman Bernanke is bearish on prospects for the financial markets and global economy, his comments could have very negative repercussions for the stock markets, and we could see flight-to-quality spark demand for Treasuries, the US dollar, and Japanese yen. On the other hand, if he manages to inspire confidence that conditions will not get significantly worse, risky assets could rally.

On Thursday, the Commerce Department is forecasted to report that US retail sales fell negative for the seventh straight month in January, as even the most aggressive discounting wasn't able to offset the impact of a deteriorating labor market, tighter credit conditions, and a year-long recession. More specifically, advance retail sales are anticipated to have contracted 0.8 percent during the month, and excluding auto sales are expected to have slumped 0.4 percent, initiating what may end up being a consistent trend through the first half of 2009 as well. As we saw with US non-farm payrolls, the impact of a disappointing result may be limited, as the Federal Reserve has already cut the fed funds target to a record low range of 0.0 percent - 0.25 percent and has no room to cut further. - TB

Euro Forecast Remains Bearish Ahead of Key GDP Releases

Fundamental Outlook for Euro This Week: Bearish

European Central Bank leaves rates unchanged, has it fallen behind the curve?
German Retail Sales and Producer Prices hurt Euro fundamentals
Russian debt downgrade sparks flight to safety, euro drops against US Dollar

The Euro finished the week broadly lower against the world's major currencies, as increased stresses on Euro Zone stability and the prospects of a pronounced recession clearly cut into the currency's fundamentals. A clear (if temporary) improvement in global risk sentiment left the Euro marginally higher against the Japanese Yen and US Dollar, but its losses against other key counterparts underline the case for further declines. Unexpectedly neutral rhetoric from ECB President Jean Claude Trichet left many doubting whether the bank was doing enough to forestall the worst economic crisis in recent times. The prospect of higher interest rates has normally been enough to boost a currency against lower-yielding counterparts, but it is clear that current times are far from normal. An especially bearish outlook for European economic growth may continue to hurt the Euro through the foreseeable future.

Euro Zone economic growth will continue to dominate headlines in the week ahead, with highly-anticipated Gross Domestic Product figures due Friday the 13th. Jokes about the ominous release date aside, the GDP figure is expected to show truly dismal European growth numbers for the final quarter of 2008. The Bloomberg News consensus forecast calls for the biggest economic contraction in the survey's 23-year history - underlining the malaise across the continent. Forecasts may nonetheless shift with several Euro Zone member countries reporting their fourth quarter GDP results in the days leading up to the broader EZ figure. Of course, many analysts peg risks for aggregate economic expansion figures to the downside; a near-constant stream of disappointing economic reports give little reason to believe that GDP figures will be better than currently expected. Disappointing numbers will only add further pressure on the ECB to cut interest rates aggressively in order to stimulate economic growth.

It will otherwise be important to watch overall risk trends - especially as they relate to the Euro/US Dollar and Euro/Japanese Yen exchange rates. The short-term correlation between the Euro and the S&P 500 has recently been trading near its highest levels on record, and it remains clear that risk aversion continues to move the European currency. Financial risk appetite generally improved through the past week of trade. Said rallies should have been enough to force bigger gains out of the EUR/JPY and EUR/USD. Yet it remains clear that there are other important factors driving sentiment, and the Euro remains in a broader downtrend. We will have to watch for key shifts in Euro fundamentals - especially as it relates to European growth outlook and Euro Zone stability. - DR

Japanese Yen Falters on S&P Rebound, But Forecasts Remain Bullish

Fundamental Outlook for Japanese Yen: Bullish

Japanese Yen tumbles on a post-NFP's surge in stocks - what gives?
Russian credit rating downgrade nonetheless boosts Japanese Yen through earlier trade
View our monthly US Dollar/Japanese Yen Exchange Rate Forecast

The Japanese Yen was the worst-performing G10 currency through the past week's trade, as a clear (if temporary) improvement in financial risk appetite led the currency substantially lower against higher-yielding counterparts. The JPY nonetheless benefited from intra-week flare-ups in financial market tensions - including a Russian sovereign debt rating downgrade and various disappointments in major economic data. Such positive reactions to bearish financial market developments leave the Yen in an ideal position to benefit from deterioration in risk appetite. Given a near-constant stream of bearish global economic developments and clear downtrends in global risky asset classes, it is perhaps unsurprising to note that our overall trading bias remains bullish for the JPY. Of course, short-term developments could just as easily force further retracements in the previously high-flying Japanese currency.

Trends in the foreign exchange market and broader asset classes favor 'short-risk' trades, and the Japanese Yen continues to be a prime recipient of such fear-related money flows. JPY price action in the week ahead will subsequently depend on the trajectory of the US S&P 500 and other key risk barometers. That being said, predicting short-term price action in extraordinarily volatile assets remains nearly impossible. We would otherwise look to key economic event risk out of any given economy to dictate price action in the domestic currency, but FX traders have proven almost completely indifferent to Japanese economic fundamentals. Such dynamics admittedly make it difficult to provide a weekly trading outlook with relative conviction.

We will continue to defer to broader price trends as far as the Japanese Yen is concerned, and its incredible ascent against all major global currencies leaves our medium-term trading bias firmly to the topside. Watch for major market moves surrounding the 5 key Forex Market Events in the week ahead - especially as it relates to broader risk trends. A resumption of the global bear market in major equity indices would almost definitely leave the Japanese Yen higher against major counterparts. - DR

British Pound Looks To Capitalize On BoE's Shift Towards Neutral Policy

Fundamental Outlook for British Pound: Bullish

The Bank of England cuts its benchmark another 50 basis points and adds commentary that sparks speculation of a hold
Service and manufacturing sector contractions ease, but still far from expansionary levels
Confidence in credit conditions deteriorate after Barclays' debt rating is lowered

The British pound exhibited extraordinary strength this past week; and GBPUSD was even able to break through significant resistance in a trendline that can be traced all the way back to October. This is a substantial shift for the battered sterling; but fundamentals will need to feed a sustainable rally or the currency may face a collapse that could spur the needed momentum to finally pulls the pound through to new lows. And, looking at the frail sentiment that is currently driving the currency as well as the dour outlook for scheduled economic event risk, the odds are stacked against the beleaguered currency.

Looking ahead to fundamental trends heading into the new week; we first need to gauge the catalyst for this tentative, bullish breakout for the pound. There were some modest improvements in economic data; but overall, the indicators were just off their respective recent record lows. The real driver is a combination of a possible rebound in risk appetite and speculation that the Monetary Policy Committee (MPC) will curb its appetite for further rate cuts. Through the past 18 months, the British currency has been one of the hardest hit currencies as speculative and carry flows have been unwound. Pushing levels that even a bear would admit were probably oversold, it makes sense that the sterling would be one of the first to recover in a general improvement in sentiment. However, such a significant shift contradicts the negative trend in growth and yields; so caution will be an indelible aspect of this rebound. The weaker driver behind the pound's advance is found in speculation that the central bank is ready to take a neutral stance on interest rates and thereby prevent the benchmark from reaching zero - a point at which the market truly recognizes the policy authority is running out of options (like the BoJ for the past decade). This bold assertion seems to be based on the comment that “past cuts…would in due course …have a significant impact.” These are certainly ambiguous comments that do not provide for a halt to rate hikes in any certain terms. As confirmation, traders will look for commentary from policy member, to the institution of their commercial asset purchasing facility scheduled to begin on Friday and Wednesday's quarterly policy report.

Officially, the BoE's broad assessment is called the Quarterly Inflation Report; but realistically it covers growth and financial market activity as much as it does price pressures. For the economy that the IMF expect to be suffer the worst recession among the major industrialized nation, growth and market health are far more essential that inflation at this point. Considering the statement that accompanied this past week's rate decision, we would expect cautious optimism buffered heavily by the disappointing data that has crossed the wires recently. Language that suggests Europe's second largest economy is set to rebound much more quickly and sharply than speculators and economist are expecting would go a long way towards restoring confidence - especially if this comes in conjunction with a general rebound in confidence. Aside from this lagging wrap up on the economy, we will also see a set of notable but more mundane market-movers. BRC retail sales and the RICS house price balance will gauge consumer sentiment; but it will be the labor data that truly benchmark optimism. Also, the visible trade numbers will measure not only the outflow of capital from the UK but also the global level of demand as a gauge of growth. - JK

Swiss Franc At Risk Of SNB Intervention As Deflation Concerns Mount

Fundamental Outlook for Swiss Franc: Bearish

Swiss unemployment rose To 3.3% from 3.0% which was the highest since January, 2007.
The SVME PMI index fell to a record low of 35 from 36.5 in December, due to manufacturers cutting production
Swiss Exports Dropped The Most In At Least 11 Years in December As the Trade Surplus Narrowed To 217 million.

The USD/CHF is clearly in an upward trading range with the upper Bollinger band and the 20-Day SMA serving as the upper and lower levels of the range. The pair continued to trade between both technical indicators sending it above 1.1700 before it found resistance. The current weakness in the Swiss economy was spelled out in the Trade Balance which saw its surplus narrow to 217 million from 2.25 billion Swiss francs. The contraction sis expected to continue as the SVME-PMI reading showed that companies plan to cut output and spending. This will weigh on the labor market which saw unemployment rise to 3.3%, which was the highest since .

The deteriorating labor market is expected to have sunk confidence to the lowest level since 2003, the country's last technical recession. That year growth contracted 0.7% on an annualized basis for consecutive quarters. Considering the 3Q GDP annualized reading was 1.6% the economy may contract in 1Q 2009. Adding to the concerns is that deflation may be on the horizon as consume prices are expected to fall to 0.6%, while producer & import prices are expected at -0.1%. SNB Vice-Chairman Phillip Hildebrand hinted at intervention for a third week in a row. The verbal tactic has paid dividends as the franc weakened against the dollar, euro and pound. The central bank goal is to weaken the currency in order to make Swiss goods more attractive. Considering the export driven nation is on the verge of posting a trade balance deficit and prices continue to fall, the MPC may be forced to resort to unlimited intervention. Therefore, we could see the USD/CHF look to test 1.2000. However, a bout of risk appetite could lead to broad based dollar weakness and may put the central bank on hold, as any intervention would lose its impact.- JR

Canadian Dollar Threatened as Traders Boost Interest Rate Cut Expectations

Fundamental Outlook for Canadian Dollar: Bearish

Ivey Purchasing Managers' Index Shows Business Confidence at Record Low
Economy Sheds 129 Thousand Jobs, Largest Loss In Over 30 Years

The Canadian Dollar could see downward pressure in the coming week as evidence of deepening recession boosts expectations of deeper interest rate cuts. The trade surplus is expected to narrow to a meager C$0.5 billion in December, the smallest in over 16 years, as tepid US demand and falling oil prices deflate export volumes. Canada counts on the US to absorb close to 80% of all its outbound shipments, so the downturn in the world's largest consumer market has been especially pronounced for Canadian producers. Meanwhile, the price of oil shed another 18.3% through December. The Bank of Canada forecasts that withering export demand will trim 2.6% from GDP, with overall output shrinking -1.2% in 2009. Elsewhere on the docket, Housing Starts are set to rise just 169.3k, the weakest in over 7 years, while the New Housing Price Index shrinks for the third consecutive month, shedding another -0.3%. The heavy dollop of red ink comes on the heels of a record drop in business confidence and the biggest monthly job loss since records began in 1976, fueling speculation that policymakers will have to gear up substantially more stimulus in the weeks and months ahead. Indeed, overnight index swaps show priced-in interest rate cut expectations added a whopping 73% from last week, with traders now betting on over 50 basis points in easing over the next 12 months. The fallout is already materializing: the Loonie diverged sharply from the rest of the commodity dollar bloc, ending the past week just 0.84% against the greenback whereas NZDUSD and AUDUSD rose 4.48% and 5.93%, respectively.

Technical positioning further supports Canadian Dollar weakness: a narrowing consolidation range originating from late October has seen USDCAD form a Pennant chart pattern. This is typically indicative of continuation, and the broader trend has been convincingly bullish since the pair broke above multi-year resistance at a trend line connecting major highs from May 2004. Current positioning sees prices stalling above the 1.21 and we expect renewed bullish momentum to push USDCAD higher for another test of the triple top at 1.30.

Australian Dollar May Break High If Risk Appetite Holds Up

Fundamental Outlook for Australian Dollar: Bearish

The Reserve Bank of Australia cuts its benchmark lending rate another 100 basis points to 3.25 percent
A rebound in risk appetite helps carry the high-yielding Australian dollar higher

The Australian currency posted the biggest rally against its safe-have US counterpart this past week; but the this may ultimately be a fragile fundamental driver to be dependent on for strength over the week and beyond. Gauging the general sentiment behind the markets; there is a certain sense that the rebound in risk-related assets (like the Australian or kiwi dollars, yen crosses, equities, etc) is more a pull back in fear than a genuine rebound in optimism. This may seem the same thing, but there is a clear distinction. Easing fear does not necessarily put investors on the hunt for yields, it simply means that they are not scrambling for the assets in otherwise circumspect positions. In contrast, a true rebound in risk appetite leads capital to high yields - which the Australian economy currently enjoys.

Gauging the future of market-wide sentiment is a highly speculative proposition. Global growth has faltered (the IMF expects a pace that hasn't been seen since WWII); the financial system is still suffering from a persistent lack of liquidity and absence of lender confidence; and a trend in global interest rates towards zero have essentially wiped out the incentive for taking on risk so soon after a severe collapse in capital market just a few months ago. Some of the notable events that could help spur a positive outlook next week are the Bank of England's plans to start buying commercial debt; the potential for either the UK and/or US setting up a 'bad bank' to absorb toxic assets from Bank's balance sheets; and most prominently the expected approval of a massive US financial stimulus package. As we have seen time and again in the past, just one or two of these initiatives will not be able to carry optimism on its own. However, with the cumulative effort adding up, a confluence of these policy efforts may be able to turn sentiment around.

Turning our focus away from these vague events, we will also have a significant amount of Aussie data for immediate volatility and perhaps some lasting guidance on long-term growth forecasts. Without doubt, the top event risk for the entire week is Wednesday's employment data. Not only is this indicator a known volatility generator, it is holding greater and greater significance over the future of the economy as consumer spending is now seen as the key to growth going forward. Forecasts for yet another month of job losses and a rise in the unemployment rate are certainly not shocking; but a negative surprise could certainly undermine bullish sentiment developed from other sources. Other consumer related indicators are the Westpac's confidence gauge and the inflation forecast report. Both of these, as well as the business confidence survey due Monday, could be fodder for a dovish hold on RBA policy going forward. - JK

New Zealand Dollar Fundamentals Foreshadow A Deepening Recession

Fundamental Outlook For New Zealand Dollar: Bearish

New Zealand's unemployment rate rises to a five-year high of 4.6%
New Zealand Dollar - US Dollar Exchange Rate Forecast

The New Zealand dollar is likely to face increased selling pressures over the following week as the economic docket is expected to show a deepening recession throughout the region. And, as market participants hold a weakening outlook for global interest rates, expectations for another round of rate cuts by the Reserve Bank of New Zealand will continue to weigh on the higher-yielding currency over the near-term. Moreover, as the flight to quality continues, safe haven flows could spark increased downward pressures on New Zealand's exchange rate as investors remain risk adverse.

As RBNZ Governor Allan Ballard and Co. projects growth prospects to deteriorate further, the fundamental data scheduled for the following week are expected to reinforce a weakening outlook for the isle nation, and a significant fall in private demands would certainly weigh on nation's exchange rate. Economic conditions are likely to only get worse throughout the year as the International Monetary Fund forecasts a global recession for 2009, and as a result, fading demands from home and abroad are likely to push the commodity-based economy into a deeper recession over the coming months as trade conditions falter.

Nevertheless, as policy makers pledge to steer the economy out of the recession, efforts by the government should help to mitigate the downside risks for growth, but as the industrialized economies throughout the Pacific are gripped by financial uncertainties paired with a weakening outlook for global economy, the odds for improved growth remains unlikely. As a result, Credit Suisse overnight index swaps currently show that investors expect the RBNZ to lower the official cash rate by more than 75bp over the next 12 months in an effort to stimulate the economy, while 11 economists polled by Bloomberg News forecast the central bank to cut between 50-100bp, and as market participants continue to raise bets for lower borrowing costs, the New Zealand dollar is expected to weaken further against its major currency counterparts throughout the medium-term. - DS

DailyFX

Disclaimer

EMU Economic Indicators Preview

(Week of 9 to 15 February 2009)

German GDP (Q4 2008): down
EMU GDP (Q4 2008): down
EMU industrial production (December): down

German GDP will probably have plummeted quarter-on-quarter in Q4 2008, just as output in the producing sector did. The previous quarters' data might be revised slightly. On 13 February, Destatis (the German Federal Statistical Office) is publishing its “flash release” on Q4 German GDP; a detailed breakdown of the components will follow on 25 February. Private consumption could have remained more or less unchanged, while all other components are expected to have decreased. Net exports, changes in inventories and investment in machinery and equipment are likely to have been the main drag on overall GDP growth. French, Italian and EMU GDP are all likely to have contracted significantly in Q4 too.

French, Italian and EMU industrial production will probably have continued declining in December, because all of the correlated indicators dropped. Following the seasonal pattern, the German trade balance will probably have deteriorated in December, whereas the German current account might have even improved.

German consumer price inflation in January is likely to be confirmed at -0.5% mom and 0.9% yoy. In the coming months, inflation is expected to decrease further due to oil price related base effects. Furthermore, the ongoing recession and the financial crisis are dampening aggregate demand, thus limiting the scope for raising prices.

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This report has been prepared by BHF-BANK Aktiengesellschaft on behalf of itself and its affiliated companies (together "BHFBANK Group") solely for the information of its clients.

Forex Trading to Remain Choppy on Employment, GDP, Retail Sales Releases

Event risk for the US dollar, Japanese yen, euro, British pound, and Australian dollar will pick up at a gradual pace throughout the week amidst testimony by Fed Chairman Bernanke, UK and Australian employment reports, US retail sales, and an expected record drop in Euro-zone GDP.

Fed Chairman Bernanke Testifies on Fed Programs at House Panel - February 10

Federal Reserve Chairman Ben Bernanke is scheduled to testify in front of the House Financial Services Committee on the central bank’s lending programs at 13:00 ET, and this could prove to be one of the biggest market-movers of the week due to its potential impact on risk sentiment. If Chairman Bernanke is bearish on prospects for the financial markets and global economy, his comments could have very negative repercussions for the stock markets, and we could see flight-to-quality spark demand for Treasuries, the US dollar, and Japanese yen. On the other hand, if he announces a new type of policy action or if he manages to inspire confidence that conditions will not get significantly worse, risky assets could rally.

UK Jobless Claims (JAN), Bank of England Quarterly Inflation Report - February 11

Jobless claims in the UK are anticipated to rise for the twelfth consecutive month in January, adding to evidence that the combination of a slowing global economy, sharp declines in domestic consumption, and the continuous collapse of the UK housing sector are bound to make the UK economic contraction extend for a lengthy amount of time. Indeed, the jobless claims change is anticipated to rise by 88K, the largest single-month gain since 1991, and while this could impact the British pound upon release at 4:30 ET, the announcement of the Bank of England’s Quarterly Inflation Report may be more important. The BOE’s latest policy statement suggests that the Monetary Policy Committee may opt to leave rates unchanged at 1 percent going forward, but if the report shows that this isn’t the case, the British pound could sell-off.

Australian Employment Change (JAN) - February 11

The Australian labor markets started to deteriorate during the second half of 2008, and this is likely to continue through 2009. Indeed, the January unemployment rate is forecasted to rise to a more than two-year high of 4.7 percent from 4.5 percent, while the net employment change is anticipated to fall for the third straight month by 18,000. The latter report tends to have a greater impact on the Aussie since the figure rarely meets expectations and can lead to volatile short-term price action for the Australian dollar immediately following the news at 19:30 EDT.

US Advance Retail Sales (JAN) - February 12

The Commerce Department is forecasted to report that US retail sales fell negative for the seventh straight month in January, as even the most aggressive discounting wasn’t able to offset the impact of a deteriorating labor market, tighter credit conditions, and a year-long recession. More specifically, advance retail sales are anticipated to have contracted 0.8 percent during the month, and excluding auto sales are expected to have slumped 0.4 percent, initiating what may end up being a consistent trend through the first half of 2009 as well. As we saw with US non-farm payrolls, the impact of a disappointing result may be limited, as the Federal Reserve has already cut the fed funds target to a record low range of 0.0 percent - 0.25 percent and has no room to cut further.

Euro-zone GDP (4Q A) - February 13

In 2008, the release of Euro-zone CPI drew significant attention and sparked major volatility for the euro. However, indicators of growth have become more important, as the European Central Bank has shifted its focus away from inflation and on to the global and regional economic slowdown. As a result, the advanced reading of Q4 GDP and is forecasted to slump 1.5 percent from the previous quarter, marking the third consecutive period of contraction and the worst drop since record keeping began in 1995. Such data would only raise the odds that the European Central Bank will move to cut rates at their next meeting on March 5, which could trigger steep losses for the euro.

DailyFX

Disclaimer

The Weekly Bottom Line

HIGHLIGHTS

January's job losses kick off 2009 with a hiss
Canadian budget and bigger U.S. stimulus built into TD Economics' forecasts
Political wrangling over U.S. stimulus package: Buy American vs. Buy! Americans!

Some pieces of data you just can not ignore. The U.S. and Canadian job numbers out this week were two such examples. In Canada the drop in employment close to tripled consensus expectations, while in the U.S. a third straight month of job losses exceeding 500,000 have brought total losses to 3.6 million, making this recession the worst for jobs since 1982. The numbers put into sharp context the scope of this downturn and the difficulties North American economies will face pulling themselves out. All this as the U.S. congress wrangles over how best to stimulate the economy and concerns rise amongst America's trading partners that a Buy America provision would cut into world trade and further worsen the global economic situation.

January, the month of empty pockets...

For some time we have been tracking the relative performance of the Canadian job market compared to the overall economy and cautioned that after several months of job growth exceeding the growth in the number of goods and services produced, the risk of a turnaround was high. That fear was realized with the release of the January Labour Force Survey. Total employment in Canada fell by 129,000 jobs in the month, a whopping decline of 0.8%. No matter which metric you use to compare the data, the number is simply horrible. In percentage terms it is the worst single month of job losses seen in Canada since January 1975. For manufacturing, where the bulk of the losses took place, the fall exceeded 5% of total employment in the sector. Losses were primarily in full-time work and amongst core-aged adults, 25-54 years of age and came almost entirely in Canada's three largest provinces - Ontario, Quebec and British Columbia.

The extent of the losses is all the confirmation needed that the Canadian economy slipped into recession in the final months of last year. Since October, the Canadian economy has shed over 212,000 jobs, a decline of 1.2%. B.C. and Ontario have been particularly hard hit, falling by 1.9% and 1.8% since October, respectively. The unemployment rate in Ontario now sits at 8.0%, exceeding the national average by 0.8 percentage points - the biggest gap on record. B.C. too has taken its share of the lumps - the unemployment rate has risen a full 2.0 percentage points since January of last year, the steepest rise among the 10 provinces. Unfortunately, as bad as January was, it will not be the last of job losses to hit the Canadian economy. While the pullback in manufacturing is nothing short of dreadful, it reflects the extraordinary plunge in U.S. demand that has taken shape over the last year. What we haven't seen yet (but expect is around the corner) are increased job losses in the construction and services sector. All told, even if Q1 represents the worst of the expected quarterly declines, Canadian job losses are likely to exceed 320,000 before a trough is reached, pushing the unemployment rate to a peak of 8.8% nationally. The dramatic deterioration in the Canadian job market is further validation of our expectation that the Bank of Canada will cut interest rates by another 50 basis points when they meet next in early March.

While comparatively January's job losses in Canada were worse than those in the U.S., the extent of U.S. job losses can not be understated. For thirteen straight months the U.S. has been shedding jobs, but even worse than that, the pace of job losses has been worsening. For the first seven months of the recession, employment was dropping at a pace of close to 150,000 jobs per month, in percentage terms a decline of around 0.1%. But in the past three months monthly job losses have increased to over 500,000 (a decline of 0.4%). Already, cumulative job losses are worse than both the 2001 and 1990s recessions and with the peak-to-current sitting at -2.6%, we are edging ever closer to the 1982 peak-to-trough of -3.1%. In all likelihood that benchmark will be met later this year, making this recession the worst one for the U.S. labour market in over fifty years.

Economic Stimulus & TD Economics Forecasts

While signs of the increased depth of the North American recession have risen since our last Quarterly Economic Forecast, so too has the policy response. The passing of the Canadian Federal Budget and its $40 billion in spending over the next two years (equivalent to 2.5% of GDP) has led us to revise our forecasts for Canadian economic growth. We estimate that increased spending by Federal and Provincial governments will raise Canadian real economic growth by close to 0.5% in 2009 and a further 0.6% in 2010. These estimates are lower than those proposed by the Federal Government but we feel are also more realistic given the structure of the Canadian economy and its exposure to forces largely out of its control (i.e. growth prospects south of the border).

Unfortunately, the Federal Budget was not the only new piece of information to come into play since our December forecast. Data on Canadian economic performance in the final months of 2008 led us to revise down our forecast for growth in the fourth quarter of that year. The Canadian economy likely contracted by 2.8% compared to our December forecast of 1.4%. Moreover, signs of worsened conditions at the outset of 2009 have also lowered the near-term outlook. On net, the downside adjustments to near-term growth offset the upside from higher government spending. All told, the Canadian economy is likely to contract by 1.4% in 2009 before improving to positive growth of 2.8% in 2010.

In the U.S, the size of its fiscal stimulus package has also expanded. In our December Quarterly Economic Forecast we had built in an assumption of $600 billion. Since then the size of the stimulus plan has risen by over $250 billion. Recent talk is that the total stimulus could reach over $900 billion. Now, it must be noted that this total package encompasses spending over the next 10 years and much of it falls outside of our forecast horizon. Nonetheless, according to the CBO, over 64% of the stimulus should hit the economy within the next two years. With much of the government infrastructure spending (which is likely to have a bigger bang per fiscal buck than the front-loaded tax-cuts) tilted towards 2010, the fiscal package is expected to add 1.9 percentage points to 2010 growth and 0.7 percentage points in 2009.

UPCOMING KEY ECONOMIC RELEASES

Canadian Housing Starts - January

Release Date: February 9/09
December Result: 172K
TD Forecast: 160K
Consensus: 169K

The worsening domestic economic fundamentals and weak labour market conditions have not been kind to the Canadian housing market. Add to this the tighter lending conditions constraining access to credit and the growing consumer anxiety, and it becomes apparent why the weakness in the Canadian housing market is expected to continue for time. For January, our call is for residential construction activity to fall a further 7% M/M to 160K, as Canadian builders moderate their construction activity in the face of waning housing demand. The unusually cold and wintery conditions in January are also likely to be an important factor adversely affecting building activity. Both single-family and multi-family units should post declines. And given that we expect the labour market and domestic economic conditions to remain soft, further moderation in building activity should not be surprising.

Canadian International Trade - December

Release Date: February 11/09
November Result: $1.3B
TD Forecast: $0.9B
Consensus: $0.8B

Since the middle of last year, the Canadian merchandise trade surplus has been battered by the stunning 75% plunge in commodity prices, and further bruised by the onslaught of the intensifying global economic recession which has translated into shrinking U.S. and global demand for Canadian manufacturing products. Indeed, since reaching $5.6B in June, the Canadian trade surplus has steadily dwindled on account of these factors, and we expect this disturbing trend to continue. For December, our call is for the trade surplus to fall to $854M (its lowest level in almost 15 years) as the weakening U.S. economy and 20% drop in energy prices during the month more than offset whatever benefits may have otherwise accrued from the weaker Canadian dollar. During the month, exports should fall a further 3.5% M/M, which will be the fifth consecutive monthly drop in this indicator, while imports are expected to also decline, though by a slightly more modest 2.5% M/M. In the short term, we expect the trade surplus to drop even further with a growing risk that the Canadian economy may run its first merchandise trade deficit since the 1970s.

U.S. International Trade - December

Release Date: February 11/09
November Result: -$40.4B
TD Forecast: -$36.7B
Consensus: -$36.4B

Plunging energy prices have become a welcome boon for the U.S. international trade balance (and the economy as a whole), as it has single-handedly chopped one-third from the U.S. trade deficit between July and November last year. This despite the spectacular 17% surge in the trade weighted U.S. dollar during the same period. In fact, excluding trade in petroleum, the U.S. trade deficit has been virtually unchanged since July, and with crude oil prices plunging a further 22% M/M in December, we expect the U.S trade deficit to narrow further, falling to $36.8B and bringing of trade imbalance to its lowest level since 2002. During the month, we expect imports to fall a further 4.5% M/M, following the 12.0% M/M in November, while exports should fall a more modest 3.2% M/M. In the months ahead, with the worsening U.S. economic conditions continuing to dampen import demand, and crude oil prices likely to remain weak, we expect the U.S. trade balance to narrow further.

U.S. Retail Sales - January

Release Date: February 12/09
December Result: total -2.7% M/M; ex-autos -3.1% M/M
TD Forecast: total -0.8% M/M; ex-autos -0.4% M/M
Consensus: total -0.4% M/M; ex-autos -0.4% M/M

The distresses facing U.S. consumers are well documented, and there is precious little evidence that they are likely subside any time soon. In fact, with the number of job losses mounting, plunging equity and housing prices eating away at household wealth, and tighter lending conditions limiting access to credit, an argument can be made that things are only going to get worse for U.S. consumers before they get any better. With this in mind, we expect U.S. retail sales to decline for an unprecedented seventh consecutive month in January, with a further 0.8% M/M drop. However, with the headline number likely to be weighed down by the continued weakness in auto purchases, sales excluding autos should post a more modest 0.4% M/M drop. In the months ahead, we expect retail sales to remain quite soft as fallout from the prolonged economic recession continues to constrain U.S. consumer spending.

TD Bank Financial Group

The information contained in this report has been prepared for the information of our customers by TD Bank Financial Group. The information has been drawn from sources believed to be reliable, but the accuracy or completeness of the information is not guaranteed, nor in providing it does TD Bank Financial Group assume any responsibility or liability.

This Week's Market Outlook

Highlights

Sentiment rebounds on a wing and a prayer
Important price levels to watch
Treasury refunding will gauge appetite for US paper
Horrid employment report and a bleak 1H09 ahead
Key data and events to watch next week

Sentiment rebounds on a wing and a prayer

In last week's report, I suggested "we are either very near a top in the USD or set to see a new phase of risk aversion and a safe haven surge into the USD." This past week saw the former scenario play out, as investor optimism rebounded, and the USD was sold lower alongside the JPY, sending the risky FX assets (JPY-crosses) sharply higher by the end of the week. Investors are betting that the US will finally pass a fiscal stimulus package and, more importantly, the US Treasury will at noon on Monday unveil a reportedly comprehensive plan to stabilize the US banking system. As such, the nascent rally in optimism is based on hope rather than any material change in the outlook, which remains bleak at best. In terms of FX movements, major pairs have simply gone from testing range lows to testing range highs, so we do not yet have evidence of a concrete break out. However, many of the building blocks and tell tale signs of a reversal are appearing and I would caution against fading the breaks if they materialize. ('Fading' refers to trading against a directional move, such as selling into a rally or buying into a decline.) The risk next week is that the ranges are maintained and all the frothy optimism that emerged at the end of this week evaporates in the face of the long haul ahead.

In terms of the tell tale signs of a potential reversal for the USD, the commodity currencies (AUD, CAD, NZD) frequently lead overall turns in the USD. Friday saw outsized price gains for all the commodity currencies against the USD, with even CAD shaking off the largest monthly job loss on record (it roughly equates to a monthly US job loss of more than 1.8 mio), even as commodity prices declined. GBP is another leader of overall USD direction and the pound displayed significant strength throughout the week despite BOE rate cuts and grim warnings on the outlook. Also, USD/JPY closed above its 55-day moving average for the first time since the beginning of September, after making a double bottom at 87.50. Importantly, other financial markets beyond FX are also showing signs of reversing, but currencies appear to be leading at the moment, which increases the potential that FX is wrong or premature in suggesting a reversal. Next week promises more volatility and traders will need to remain flexible and avoid getting married to directional positions while market conviction remains so weak.

Important price levels to watch

With the global economic outlook still very weak and sentiment lacking in conviction as a result, I like to focus on price levels for directional cues, with the key frequently being a daily close above/below a particular price level. Below I highlight some key levels to watch in major FX pairs and a few other markets. Note that in many cases the Ichimoku cloud becomes very thin over the next few weeks, which weakens its strength as support or resistance.

EUR/USD: Trading below the fastest Ichimoku line (Tenkan) at 1.3018. A daily close above suggests initial potential to the Kijun line at 1.3382. The cloud is above at 1.3524. The 21-day sma is at 1.3062 and the 55 and 100 day averages converge at 1.3319 and 1.3298, respectively. The key support zone is at 1.2700/30, with a drop below targeting weakness back to 2008 lows near 1.23 initially

USD/JPY: Currently trading inside its Ichimoku cloud, base at 91.26 and top at 93.85, the Tenkan line is set to cross up over the Kijun line in a few days, likely generating a moderate strength buy signal if price remains inside the cloud/strong if price is above the cloud. Price closed above the weekly Tenkan line for the first time since mid-September, which is also a bullish indication.

GBP/USD: Tested into the cloud from below, but failed to close inside. The cloud base falls from 1.4832 on Friday to 1.4815 on Monday. A daily close inside the cloud would target a move to the top of the cloud, which is at 1.5513 all week. The Tenkan line (1.4387) is set to cross up over the Kijun line 1.4438, possibly by Monday, generating a buying signal. Cable also closed above the weekly Tenkan line for the first time since mid-July 2008 when GBP/USD was around 2.0000.

AUD/USD: Trading inside its cloud, it failed to break above the cloud top at 0.6822 (rises to 0.6859 on Monday). The Kijun line is nearby support at 0.6758. The bottom of the cloud is at 0.6573 (also rising next week), and the Tenkan is at 0.6526 and rising. AUD is set to close slightly above the weekly Tenkan line at 0.6758. The 55-day sma is at 0.6704 and the 100-day sma is at 0.6829.

BKX ($BKX on e-Signal; banking index, key as a leader of overall stocks and JPY-crosses): closed above the Tenkan line (28.79) after making a double bottom at 25, targeting possible gains to Kijun line at 35.17.

S&P 500: Here the cloud becomes very thin over the next few weeks, but price is currently above the Tenkan line at 845 and tested near to the cloud base at 874, where it remains until late February. Strength above 885/890 would break above the cloud and signal further gains ahead.

Treasury refunding will gauge appetite for US paper

The US Treasury is poised to issue $67 billion in government paper next week in their refunding auctions. This is composed of $32 billion in three-year notes, $21 billion in 10-year notes and $14 billion in 30-year bonds. The announcement of the size pushed Treasury yields markedly higher this past week as the massive influx of supply sent prices lower. Concerns remain widespread that the US borrowing needs will reach astronomical levels - in the realm of more than $2 trillion for 2009. This coupled with recently stirred up tensions between China and the US (on Geithner's comments that China is manipulating its currency) has seen bond prices of late come off the boil. Indeed, 10-year yields touched 3.00% recently, the highest level since late November, after putting in a 2.04% low in mid December. The key next week will not be so much in the price/yield action, but rather in the appetite for US Treasury paper witnessed in the auctions.

Typical bid/cover ratios for the respective notes and bonds has been between 2.2/2.4 over the last few months. This means that for each $1 auctioned, there was a little more than $2 in bids. Next week we expect these ratios to remain relatively stable as the Fed's recent hints that it is willing to purchase Treasury paper if the need arises should put a floor on demand. That said, the risk remains that we get poor auctions on the back of the massive supply and that bid/ask ratios come in below 2 times. These outcomes should weigh on the USD in the near-term as they would likely fuel speculation that the US is finding it increasingly difficult to finance its exploding deficit. Thus we would recommend that traders keep these auctions on their radar screen next week.

Horrid employment report and a bleak 1H09 ahead

The US employment report for January was nothing short of awful as nonfarm payrolls plunged a sharper than expected -598K after a downwardly revised -577K the prior month. The January release also meant benchmark revisions for 2008, where the BLS goes back and revises every month for the prior year. The verdict was dreadful as revisions show an additional -385K jobs lost last year. This brings the tally for the recession to -3.6 million jobs, the sharpest post-war decline. The unemployment rate was no better as it jumped to a higher than expected 7.6% from 7.2% previously and now at a 16-year high.

Perhaps the worst part of the report was the additional decline in aggregate hours which fell
-0.7% on the month to an annual rate of -4.6% from -4.2%. The three month growth trend is now at a bleak -9.2% from -8.6% and the weakest print since 1975. The rub here is that hours tend to lead bodies when it comes to employment. This suggests the pace of job losses is only likely to worsen as we muddle though the first half of 2009. Indeed, I would not be surprised to see a -1M print in NFP in the months ahead.

Hope that the fiscal stimulus will soon be passed looks to be keeping the risk trades somewhat supported near-term. However, the Congressional Budget Office reported recently that the "stimulus" is likely to have little impact on economic growth or employment until 2010 at the earliest. Thus while a short-term bounce on hope is certainly feasible over the next few weeks, it looks even more likely that risk trades will test new lows before any significant secular rally emerges. In this environment, the USD still looks like the best of the worst and risk aversion over the next few months looks likely to drive investors back to the relative safety of the greenback.

Key data and events to watch next week

The US economic calendar is modestly busy on the data front. The action kicks off on Tuesday with wholesale inventories. Wednesday sees the trade balance and monthly budget statement while Thursday has the all important retail sales report, business inventories and weekly jobless claims. Friday rounds out the week with the University of Michigan consumer sentiment index. Also look out for Treasury Secretary Geithner and Fed Chairman Bernanke who will be testifying on TARP and Fed programs on Tuesday.

The eurozone is likewise not very busy. Monday starts it off with French business confidence and the German trade balance. Tuesday has French industrial production lined up while Wednesday brings German consumer prices. Thursday sees eurozone industrial production while Friday is busy with eurozone GDP, French employment, French GDP and German GDP on deck. The euro-area Finance Ministers meeting on Monday is also noteworthy.

It's a relatively quiet one in the UK. The RICS home price numbers and the trade balance kick it off on Tuesday. Wednesday closes out the action with employment data and the Bank of England quarterly inflation report.

Japan is characteristically on the light side as well. Sunday has the current account and machine orders due. Tuesday then sees consumer confidence while Wednesday has corporate goods prices lined up.

Canada has little going on too, but the data is top-tier nonetheless. Housing starts kick things off on Monday. Wednesday we'll see new home prices along with trade numbers. Friday closes out the week with new motor vehicle sales.

Finally, the agenda down under looks busier than usual. New Zealand home prices start off the week on Sunday. On Tuesday we'll get Australian business and consumer confidence surveys. Thursday rounds out the action with New Zealand retail sales, Australian inflation expectations and Australian employment.

Brian Dolan, Chief Currency Strategist
Jacob Oubina, Currency Strategist
Forex.com
http://www.forex.com

DISCLAIMER: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase of sale of any currency. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.

Forex News and Trading

Calendar

US Dollar, Japanese Yen to Remain Volatile Ahead of Key GDP, CPI Reports

Weekly Focus: Protectionism Back on the Agenda

Euroland: ECB to reach 1% by the summer

Switzerland: Banks in the spotlight

UK: Bank of England to follow in Fed footsteps and introduce ZIRP

USA: Obama's financial rescue plan leaves many questions unanswered

Asia: Japanese growth to plummet in Q4

Foreign Exchange: Zero Interest Rate Policy taking its toll on GBP and SEK

Financial Markets Review : BoE Prepares for More Rate Cuts and Quantitative Easing

Interest rate market review - bonds, cash and swaps

FX Briefing : Finance Ministers in the Spotlight

Forex Trading Weekly Forecast

US Dollar Could Gain If Bernanke, US Retail Sales Ignite Risk Aversion

Euro Forecast Remains Bearish Ahead of Key GDP Releases

Japanese Yen Falters on S&P Rebound, But Forecasts Remain Bullish

British Pound Looks To Capitalize On BoE's Shift Towards Neutral Policy

Swiss Franc At Risk Of SNB Intervention As Deflation Concerns Mount

Canadian Dollar Threatened as Traders Boost Interest Rate Cut Expectations

Australian Dollar May Break High If Risk Appetite Holds Up

New Zealand Dollar Fundamentals Foreshadow A Deepening Recession

EMU Economic Indicators Preview

Forex Trading to Remain Choppy on Employment, GDP, Retail Sales Releases

The Weekly Bottom Line

UPCOMING KEY ECONOMIC RELEASES

Canadian Housing Starts - January

Canadian International Trade - December

U.S. International Trade - December

U.S. Retail Sales - January

This Week's Market Outlook

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