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The U.K. housing market continues to deteriorate, as mortgage approvals fell to 73,000, near their lowest level in nine years. F

Fundamental Headlines

•    GBPUSD  –    The U.K. housing market continues to deteriorate, as mortgage approvals fell to 73,000, near their lowest level in nine years. Falling home prices have also led to homeowners withdrawing less equity from their homes to purchase cars and vacations, which will weigh on future growth. The tight credit markets have seen banks hold onto to cash despite the BoE’s recent rates cuts. The lack of liquidity is stalling the housing market and preventing business from getting the capital they need for projects. This has adversity affected construction which saw activity contract for the first time in six years. Speculation has increased that the BoE will need to cut rates at their next meeting by 50points to give banks an incentive  to lend.  Discuss the topic and your trade ideas in the GBP/USD Forum.
•    EURUSD – European factory gate prices rose 0.6% as expected pulling the year over year increase to 5.3%. Record oil prices and increasing demand fro commodities have exacted price pressures throughout out the production process.  Inflation in the region has accelerated to its fastest pace in 16 years, with the recent CPI estimate measuring at 3.5%. The runaway inflation has prevented the ECB from cutting rates in an effort to stem the slowing growth in the region. Many expect that the central bank will need to cut rates in the near term as the contraction in the U.S. spreads through out the global economy. Discuss the topic and your trade ideas in the EUR/USD Forum.
 
•    Stocks Surge As Two Major Banks Advance Turnaround Plans (link) – Wall Street Journal
•    Toyota Feels Pinch Along With Big 3 As Sales Dive  (link) – Wall Street Journal
•    Rush To Restrict Trade In Basic Foods (link) – Financial Times
•    Bernanke Faces Scrutiny In Congress Over Bear Stearns Buyout  (link) – Bloomberg
•    IMF Cuts World Forecast on Worst Crisis Since 1930’s  (link) – Bloomberg

Talking Points

•    Japanese Yen:  remains near 102.00 as equities supportive
•    Euro:  Back above 1.5600 as bargain hunters come in PPI hot
•    Pound: PMI Construction misses badly
•    Swiss Franc: still weak off UBS news
•    US Dollar: ADP on tap

A relatively quite night of trade in the FX markets as the dollar consolidated its gains of the past several days. The EURUSD bounced back  above the 1.5600 level as the sharp sell off of the past several days brought out some bargain hunting euro longs. The only economic event of note – EZ PPI - printed at a bit hotter than expected 0.6% and stoked the move higher.

Meanwhile,  news out of the UK continues to confirm the fact that the housing sector is rapidly contracting. The steep fall off in construction PMI which came in at 47.2 versus 52.0 forecasts indicates that housing activity will decelerate sharply as the year progresses, likely causing the BoE to begin lowering rates in earnest. The one possible offset could come from the manufacturing sector which continues to perform well due to favorable EURGBP exchange rates. Still, housing is a bigger portion of the UK economy than manufacturing and further slowdown in that arena is likely to turn UK monetary policy more dovish.

In contrast to last week, when the decoupling thesis was driving trade in the FX market especially after the better than forecast IFO, this week market players are casting a more skeptical eye towards the EZ. Last night’s horrid Retail Sales numbers along with the massive write-offs from European banks suggest that spillover effects are reaching the 17 member region. Whereas in the past EURUSD rallied off positive European data, this week the pair will only find strength if US data proves far worse than expected. In short, instead of being a test of relative strength, the trade in the EURUSD is quickly becoming a race to the bottom

Today, the ADP data, though hardly accurate in the past, could roil the markets if the number prints materially worse than expected. As we noted before only a print of –100K or worse in the NFP is likely to re-ignite the euro rally. On the other hand a mild contraction in US labor demand has already been priced in and the greenback may actually rally back to the 1.5500 level.

EURUSD 1.60 or 1.50?  Join us in EURUSD Forum

To discuss this article please contact Boris Schlossberg, Senior Curency Strategist: bschlossberg@fxcm.com

• Euro Breaks Down as Cracks Begin to Show
• British Pound: UK Manufacturing Rebounds, Prices Hit 9 Year High

Why Did the Dollar Rally?

The first day of trading in the second quarter has been positive for both the US equity market and the US dollar. Investors that have cut back on dollar denominated holdings in the Q1 are jumping back in force with Lehman Brothers raising $4 billion from a stock sale to calm investors and UBS announcing a similar plan to replenish capital. The US dollar is up across the board while the Dow Jones Industrial Average surged close to 400 points. On a percentage basis, this is the strongest start to the second quarter in 70 years and the improvement in risk appetite is the main reason for the dollar’s recovery. Manufacturing sector ISM was stronger than expected, but it remained in contractionary levels, which means that the data does alone would not have triggered today’s dollar rally. Prices paid surged to the highest level in 2 years, which is the only other reason for dollar strength. Inflation is roaring its ugly head with gas prices hitting a record high and rice prices estimated to rise by 55 percent this year according to the World Bank. This leaves Bernanke in a tough spot ahead of tomorrow’s testimony before the Joint Economic Committee. Although Big Ben will most certainly face tough criticism about the current state of the US economy, he has to decide whether greater emphasis should be placed on growth or inflation. How much longer can he turn a blind eye? Growth in the US is still a serious problem, but the continual rise in food prices also puts pressure on the pocketbooks of US consumers. The dollar should resume its slide if Bernanke puts a greater emphasis on growth, but if he stresses the need to balance inflation with growth, the odds for a 25bp rate cut will increase significantly, extending the dollar’s rise. The futures market is currently pricing in an 80 percent chance that the Federal Reserve will only cut interest rates by 25bp at the end of the month compared to a 20 percent chance of a 50bp cut. In addition to Bernanke’s speech, we are also expecting the ADP Employment and the Challenger Layoff reports. These numbers will help to determine if March will be another month of weak non-farm payrolls growth.

Euro Breaks Down as Cracks Begin to Show

The Euro dropped over 200 pips today following a much weaker than expected German retail sales report. For the past few months, the EUR/USD has rallied on hawkish comments from the ECB and economic data supporting the central bank’s stance. However today the cracks are seriously beginning to show which has many traders wondering whether we could see a more meaningful sell-off in the Euro. Consumer spending in Germany dropped by the largest amount in 13 months as rising food and energy prices cut spending. Although manufacturing PMI in Germany increased, the same numbers for France and Italy fell more materially. The continual improvement in the German labor market failed to offset the disappointing consumer spending numbers. Meanwhile Deutsche Bank, Germany’s largest bank announced that they will write down $3.9 billion. This number pales in comparison to UBS’ $11.9 billion loss which is why EURCHF rallied over 150 pips today. On top of the big UBS announcement, service sector PMI was also weaker than expected, reflecting deteriorating conditions in Switzerland.

British Pound: UK Manufacturing Rebounds, Prices Hit 9 Year High

Despite the gloomy outlook for the UK economy, manufacturing activity accelerated in the month of March. The US dollar has weakened significantly against the British pound over the past few months but the pound’s weakness against the Euro has helped to offset the slowdown in US demand. Employment increased modestly but prices hit a 9 year high indicating that manufacturers are passing on their costs to consumers. This explains why the Bank of England is so concerned about inflation. Another rate cut this month will be a close call as inflationary pressures bump heads with deteriorating growth; Consumer prices are well above the Bank of England’s 2 percent target while house prices are at 12 year lows.

Australian Dollar Plummets, New Zealand and Canadian Dollars Recover

The Canadian and New Zealand dollars recovered on the back of today’s improvement in risk appetite. Canadian raw material and industrial product prices were weaker than expected, but these numbers were not particularly market moving. The Australian dollar should have also recovered but dovish comments from the Reserve Bank kept the currency under pressure throughout the day. The RBA left interest rates unchanged at 7.25 percent, which was no surprise, but Stevens said that the central bank’s monetary policy will cool demand growth which will help ease inflation. Although prices have climbed significantly over the past few weeks, Stevens expects prices to fall over time.

Japanese Business Confidence Hits 4 Year Low

A sharp deterioration in Japanese Business Confidence drove the Japanese Yen to a 2.5 week low against the US dollar. The triple blow of slowing US growth, rising oil prices and a strong Yen forced businesses to become even more cautious about the outlook for the Japanese economy. Goldman Sachs argues that this pace is equal to the pace that was seen in the past recession. Although growth is deteriorating, there is still a next to zero chance of a rate cut from the Bank of Japan. Interest rates are already at 0.5 percent and the BoJ does not have significant room to ease monetary policy. Looking ahead, we expect the BoJ to become even more pessimistic about the outlook for growth, but as usual that may only have a limited impact on the Japanese Yen as risk appetite remains the currency’s dominant driver.

DailyFX

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Asian Morning Update

European releases overnight:

Numbers from Europe were mixed. The manufacturing PMI numbers saw general softening with the exception of Germany which brought a flat number in the Euro-zone overall. The decline in the Swiss PMI was rather drastic while in the U.K. there still seems to be a degree of stability.

Indeed, banks are fully aware of risks as Deutsche wrote down EUR 2.5bn of losses in loans and asset backed securities for Q1. They are also slashing the value of leveraged-buyout and commercial real-estate loans and residential mortgage-backed securities.

This came on the back of UBS announcing a massive writedown of US$37bn resulting from the subprime - the largest writedown of any bank.

If any broad generalization can be made then it is that industry remains very nervous, aware of the tighter credit conditions that maintain a vulnerability to sudden shocks to the system while banks are clearly sweeping the decks to reduce exposure.

It is easy for Noyer to suggest that banks are too afraid of liquidity risk and that they should be less restrictive in lending to the market but the first prudent measures to such a situation are to reduce exposure until the full extent of the crisis are known.

Even central banks acknowledge that present conditions are likely to remain for some while to come. The fact that Deutsche is reducing the value of leveraged-buyout risk is merely recognizing that this is where the next risk lies.

Ironically though, the act of limiting exposure to LBO’s will be a likely catalyst for that next crisis to occur.

States releases overnight:

Modestly good news yet again from the States with the ISM Manufacturing and construction spending stronger than expected. It extends the string of good news - or more accurately ‘less bad news than expected’ - to ease the immediate fears of a total meltdown.

Just one day after the market was baying for the Dollar’s blood it certainly provided the impetus for the Dollar to recover and break towards the highs seen last week. The small dose of reality from Deutsche and UBS also helped curb the perception that Europe is somehow immune to the general market conditions.

Even Dollar-Yen managed to join in with the general clamor to reduce Dollar short positions and of course aided by the doom and gloom brought by the Tankan Report earlier in the day.

Certainly it should extend its gains over the remainder of the week to reach the 1.5340 support in the Euro and probably make new highs against the Pound, Swissie and Yen.

More later once the daily analysis has been done…

There following releases are due from Asia due today:

Japan March Monetary Base (YoY) +0.1% (prior)

Ian Copsey
Global Forex Trading
http://www.gftforex.com

DISCLAIMER: This forum and the information provided here should not be relied on as a substitute for extensive independent research before making your investment decisions. Global Forex Trading is merely providing this column for your general information. The views of the author are not necessarily those of Global Forex Trading, its owners, officers, agents or employees. In addition, any projections or views of the market provided by the author may not prove to be accurate. Global Forex Trading and Cornelius Luca will not be responsible for any losses incurred on investments made by readers and clients as a result of any information contained in this column. Global Forex Trading and Cornelius Luca do not render investment, legal, accounting, tax, or other professional advice. If investment, legal, tax, or other expert assistance is required, the services of a competent professional should be sought.

The Canadian and New Zealand dollars recovered on the back of today’s improvement in risk appetite.

Canadian raw material and industrial product prices were weaker than expected, but these numbers were not particularly market moving. The Australian dollar should have also recovered but dovish comments from the Reserve Bank kept the currency under pressure throughout the day. The RBA left interest rates unchanged at 7.25 percent, which was no surprise, but Stevens said that the central bank’s monetary policy will cool demand growth which will help ease inflation. Although prices have climbed significantly over the past few weeks, Stevens expects prices to fall over time.