US Dollar Marks its Sharpest Rally in Three Months but will it carry through to Friday?

•    Euro Looks to Take Control of its Own Fundamental Future with 3Q GDP Numbers
•    Australian Dollar at Risk of Being Pegged Fundamentally Overbought
•    Japanese Yen’s Correlation to Risk has Waning as Recovery Develops

US Dollar Marks its Sharpest Rally in Three Months but will it carry through to Friday?
The US Dollar enjoyed its most impressive daily advance in months Thursday at the expense of investor confidence. Personifying its macro role as the ubiquitous safe haven currency; the greenback would forge its biggest advance against its primary trade partner, the euro, since August 7th. And, immediately erasing any arguments that this was a currency-borne move; we saw the S&P 500 fall over one percent, gold tumble 1.2 percent and the second tier economic data on the US docket disappoint.

While the contents of today’s calendar lacked in their precedence for market-moving potential, they nonetheless offered important status updates on the economic and fiscal health of the United States. Considering the dollar’s primary function as of late is to fill in as a funding currency for strong carry flows, there are few more imperative fundamental considerations for traders than gauging its suitability in this role. Aside from the forecast for growth and interest rates (where the US actually leads many of its liquid counterparts), the preponderance of bloated deficits and record levels of government debt helps to keep the greenback on the short-side of most yield plays. The October monthly budget statement released by the Treasury added to the policy malaise. A $176.4 billion shortfall was the largest for that particular month and was the fifth largest on for any period. Looking at the breakdown, spending declined by 2.7 percent through the year while revenues and other income plunged 17.9 percent. It is clear that though officials are already moving towards a measured exit from stimulus, the impact of the recession on tax income will maintain budget deficits at extraordinary levels for years to come.

From fiscal struggle to economic recovery, the bullish outlook for the housing sector was dealt a blow by the MBA’s weekly mortgage applications report for the period ending November 6th. Though the headline reading rose 3.2 percent, filings for home purchases dropped 11.7 percent to the lowest level since December of 2000. This leads us to question whether the vital artery of growth can sustain its recovery without government assistance. The silver lining to the day was seen in employment. Initial jobless claims for ht week through November 7th fell more than expected to its lowest level since the first week of January. Continuing claims for the previous week followed suit with sharp contraction to levels not seen since early March. While these figures on their own are not confirmation of a halt to firing and rebound in hiring; they bring the US one step closer.

Looking ahead to tomorrow, the question that every trader is asking is whether the dollar will follow through on its impressive run today. Considering the currency is now on the verge of possibly turning its dominant trend (EURUSD and the Dollar Index are just off their respective channel extremes); it will likely take a considerable shift in either the dollar’s market status or underlying risk appetite to advance such a development. The University of Michigan Consumer Sentiment gauge doesn’t necessarily hold the influence needed and it is somewhat late in Friday’s session. On the other hand, the European growth numbers could make a broader appeal to sentiment. However, considering the effort required to force a breakout; it is the more probable scenario that the greenback will either retrace its gains or settle into the weekend.

Euro Looks to Take Control of its Own Fundamental Future with 3Q GDP Numbers
As a prelude to tomorrow’s heavy event risk, the European Central Bank released its monthly Survey of Professional Forecasts bulletin with a positive revision to growth. According to the report, Euro-Zone GDP is expected to contract 3.5 percent through 2009 (from a previously projection of a 4.5 percent slump) and expand 1 percent through 2010 (compared to a previous outlook of 0.3 percent). Looking ahead to Friday’s European session, we will find validity to these more optimistic forecasts in (and a much more volatile response to) the government’s first measures of 3Q growth. The most Euro Zone measures hold the greatest fundamental weight for the macro crowd; and the official consensus calls for 0.5 percent growth through the three months to officially bring the region’s recession to a close. However, the reading alone will not likely define the entire event. For volatility, the German numbers could steal the show. Scheduled for release at 7:00 GMT (a full three hours before the regional data), Europe’s largest economy is expected to have grown 0.8 percent through the period to match its fastest pace of expansion since the final quarter of 2006. Furthermore, those looking for fundamental guidance beyond just the few hours of volatility that follows the round of data will dig deeper into the performance of other members. While Germany and France have paced the global recovery, other economies like Italy and Spain (which reported a contraction of 0.3 percent today) are still struggling. 

Australian Dollar at Risk of Being Pegged Fundamentally Overbought
The Australian dollar has enjoyed its status as bullish extreme of the economic and monetary policy spectrum while risk appetite extended its impressive recovery; but what happens should sentiment cool or even retrace? Thursday’s pullback in risk appetite (though leveraging a recovery for the US dollar) left the Australian currency relatively unscathed. Speculators maintain a strong fundamental and persistently hawkish interest rate outlook that has served them well over the past eight months. However, RBA Governor Glenn Stevens has already come out saying further policy adjustments will be taken in moderation. There is reason to believe him. Consumer-based inflation was at its lowest level in a decade through the third quarter and still cooling. For growth, while the net employment change for October unexpectedly rose by 24,500 positions last night; the jobless rate still ticked up to a six-year high. With the rest of the world taking its time and fundamentals developing at a moderate pace, there is reason to believe the RBA will slow; yet the market is still pricing in an 84 percent chance of a hike on December 2nd.

Japanese Yen’s Correlation to Risk has Waning as Recovery Develops
With the dollar competing for the title of the market’s favored funding currency where does that leave the Japanese yen. While benchmarks for other asset classes (stocks, commodities, etc) have all pushed to record highs, the more risk-attuned yen crosses have actually been developing long-term, broad congestion patterns. This could be in response to island nation’s economic recovery, its ballooning deficit and debt position or simply an effect of competition; but what seems clear is that this ambiguity will not last for long. Signs of lasting deflation are rising and domestic consumption is far from healthy. When US rates start to rise later down the line, it is almost a certain that Japan’s will remain untouched.

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EUR/USD: Trading the Preliminary German GDP Report

Economic activity in Germany is expected to expand at a faster pace in the third quarter as economists forecast the growth rate to increase 0.8% after rising 0.3% during the three-months through June, and long-term expectations for higher interest rate in Europe could drive the exchange rate higher as the nation emerges from the worst recession since the post-war period.

Trading the News: German Gross Domestic Product 

What’s Expected

Time of release:        11/13/2009 7:00 GMT, 02:00 EST

Primary Pair Impact :    EURUSD

Expected:         0.8%

Previous:         0.3%

Effect the German Gross Domestic Product report had over EURUSD for the past 2 quarters

2Q 2009 German Gross Domestic Product

The preliminary GDP reading for Germany showed the economy unexpectedly emerged from the recession as the growth rate expanded 0.3% from the first-three months of the year, while the annualized rate of growth slipped 7.1% from the previous year amid expectations for a 7.6% decline. However, as the Bundesbank forecasts the unemployment rate to reach 10.5% in the following year, the slump in the labor market is likely to weigh on economic activity going forward as policy makers see a risk for a protracted recovery. As a result, the European Central Bank is likely to hold borrowing costs at the record-low and maintain its EUR 60B in covered-bond purchases to stem the downside risks for growth and inflation, and is widely expected to maintain a dovish outlook as the central bank sees price growth slipping below the 2% target over the near-term.

1Q 2009 German Gross Domestic Product

Economic activity in Germany contracted at a record pace during the first three-months of the year, with the growth rate tumbling 3.8% from the fourth quarter of 2008, while the annualized rate plunged 6.7% from the previous year amid expectations for a 6.5% drop. The bigger-than-expected decline reinforces a dour outlook for future growth as policy makers anticipate GDP to weaken at an annual pace of 6% this year, and the government may take further steps to shore up Europe’s largest economy as the outlook for global growth remains bleak. Nevertheless, as Chancellor Angela Merkel pledges EUR 82B in public spending to jump-start the ailing economy, with the European Central Bank lowering borrowing costs to a record-low of 1.00% and commiting EUR 60B in covered-bond purchases, the extraordinary efforts taken on by the government should help to stem the downside risks for growth and inflation.

What To Look For Before The Release

Traders with access to market depth information via the FXCM Active Trader Platform may use it to gauge the potency of the economic data release as well as to shed some light on the market’s directional bias. Increasing volume ahead of the announcement will telegraph likely follow-through behind whatever move is to materialize, while an imbalance in available liquidity on the Bid versus the Offer side of the market will tell us the direction major institutions are likely favoring ahead of the announcement:

Bullish Scenario: If we see substantially deeper available liquidity on the Bid side of the market, this tells us that major price providers in the market are looking to buy the Euro against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bullish bias on EURUSD ahead of the data release.

Bearish Scenario: If we see substantially deeper available liquidity on the Offer side of the market, this tells us that major price providers in the market are looking to sell the Euro against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bearish bias on EURUSD ahead of the data release.

How To Trade This Event Risk 

Economic activity in Germany is expected to expand at a faster pace in the third quarter as economists forecast the growth rate to increase 0.8% after rising 0.3% during the three-months through June, and long-term expectations for higher interest rate in Europe could drive the exchange rate higher as the nation emerges from the worst recession since the post-war period. Business confidence in the region jumped to a 13-month high in October, with industrial outputs increasing 2.7% after rising 1.8% in August, and the data reinforces an improved outlook for future growth as trade conditions improve. A report by the Federal Statistics Office showed the trade surplus widened to 10.6B from 8.1B in August as exports jumped 3.8%, while the Federal Labor Agency said unemployment slipped 26K in October after falling 15K in the previous month, leading the jobless rate to fall back to 8.1% from 8.2% in previous month, and conditions are likely to improve going into the following year as the government forecasts economic activity to expand at an annual rate of1.2% in 2010 after contracting 0.5% this year. At the same time, retail spending unexpectedly declined 0.5% in September after tumbling 1.8% in the previous month, while the GfK consumer confidence survey slipped to 4.0 from a revised reading of 4.2 in October amid expectations for a rise to 4.5, and the ongoing weakness in the domestic economy may weigh on the outlook for growth as policy makers see a risk for a protracted recovery. Bundesbank President Axel Weber said that “the general economic trend is pointing upward” and expects the growth rate to expand 0.75% in the third quarter, but went onto say that the economy “continues to rely on support from fiscal and monetary policies” and argued that the stimulus “shouldn’t be withdrawn too quickly” as the recovery remains weak. In addition, the central bank head remained “concerned that unemployment may rise in the course of next year,” which would hamper the outlook for private spending, and Mr. Weber continued to see a risk for GDP to remain below last year’s level until 2013 as growth prospects remain subdued. Moreover, the International Monetary Fund anticipates the recovery to be “slow and fragile” as the group forecasts GDP to grow at an annual rate of 0.3% in 2010, and the European Central Bank may keep the benchmark interest rate at the record-low throughout the first-half of the following year in order to encourage a sustainable recovery throughout the euro-region. Nevertheless, as risk trends continue to drive price action in the foreign exchange market, a rise in risk appetite could support the euro higher as market participants move into higher risk/reward investments.

Trading the given event risk favors a bullish outlook for the single-currency as market participants anticipate economic activity in Germany to expand for the second consecutive quarter, and price action following the release could set the stage for a long euro trade as policy makers hold an improved outlook for future growth. Therefore, if the growth rate expands 0.8% or greater from the second quarter, we will look for a green, five-minute candle subsequent to the release to confirm a buy entry on two-lots of EUR/USD. If these conditions are met, we will place our initial stop at the nearby swing low or a reasonable distance taking volatility into account, and this risk will generate our first target. Our second objective will be based on discretion, and we will move the stop on the second lot to breakeven once the first trade reaches its target in an effort to preserve our profits. 

In contrast, the slump in household spending paired with tightened credit conditions are likely to weigh on the economy, and a dismal GDP reading is likely to stoke increased selling pressures on the single-currency as investors weigh the prospects for a sustainable recovery in the region. As a result, if GDP expands 0.4% or less, we will favor a bearish outlook for the EUR/USD, and will follow the same strategy for a short euro-dollar trade as the long position mentioned above, just in reverse.

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