Economic Calendar Thin, Dollar to Take Cues from Stock Performance (Euro Open)

The US dollar sold off against the Euro and the British Pound to start the trading week. With minimal event risk on the economic calendar, near term forex price action looks likely to fall in with stock market performance.

Key Overnight Developments

• UK House Prices Falling At Fastest Rate in 6 Years, Says Rightmove
• Australian Producer Prices Hit Record High on Sticky Oil Costs

Critical Levels

The Euro rallied to open the week, pushing nearly 100 pips higher to challenge the 1.35 level. The British Pound followed suit, coming within a hear of 1.74 late into the overnight session.


Asia Session Highlights

UK real estate values continued to slide as Rightmove House Prices shrank -4.9% in the year to October, the worst in 6 years. Rightmove’s commercial director Miles Shipside describes the current situation bluntly, saying “from an economic point of view, we've stared into the abyss.” Shipside continued to say rising unemployment will see the situation deteriorate further, forecasting “a lot of repossessions about to happen. The situation is going to get more severe.'' The pace of economic growth slowed to nil from the first to the second quarter, and the UK is widely expected to formally enter into recession by the end of this year. Companies have started to trim expenditure dramatically ahead of the leaner period ahead, pushing unemployment to 8-year highs. For the Bank of England, all of this invariably means interest rate cuts. Indeed, the market is currently pricing in at least 125 basis points in monetary easing over the next 12 months, exerting considerable downward pressure on the British Pound.

Australian Producer Prices rose to a record 5.6% in the year to the third quarter, the highest in at least 9 years. The increase was driven by a whopping 9.5% jump in the price of imported crude materials (mostly oil). Firms using oil-based goods as production inputs typically enter into long-term contracts with their suppliers to lock in the price, thereby fixing a portion of their manufacturing costs and limiting uncertainty from daily exposure to price fluctuations. This means it can take some time before currently standing agreements expire, allowing for adjustment to current (and substantially lower) oil prices. Also, it is important to note that Australia releases PPI figures on a quarterly rather than a monthly basis, meaning that the third quarter metric includes July’s crude oil price peak at over $147/barrel. On balance, the Reserve Bank of Australia will be undeterred in their campaign to slash borrowing costs in spite of today’s result. RBA chief Glenn Stevens issued a hefty 100-basis-point rate cut earlier this month, saying that price growth “is likely to show an increase [in the second half of this year]...but the Bank remains of the view that inflation will start to decline in 2009.” The markets are currently pricing in a 0.50% rate cut when policy makers meet again on November 4th, with at least 125 basis points in easing over the next 12 months.

Euro Session: What to Expect

The economic calendar is tame going into Monday’s European session, with German Producer Prices the only notable item on the docket. The report is expected to show price growth slowing to 7.5% in the year to September, down from 8.1% in the preceding month. By contrast with the aforementioned Australian PPI reading, the narrower monthly (rather than quarterly) time horizon of this release means that September’s -9.9% drop in crude prices is sure to be reflected. Indeed, this is likely to be the key driving force pushing price growth lower. Easing inflationary pressure will give the ECB room to continue easing interest rates after participation in the coordinated 50-basis-point cut to bolster credit markets. The market is pricing in at least 125 basis points in cuts over the next 12 months, with a 0.25% cut expected at the next meeting on November 6th.

With no significant US economic news to spook the market in late trading, the only event risk on the docket is Chairman Ben Bernanke’s testimony at the US House of Representative’s Budget Committee. The Fed chief will be summing up the general state of the economy at present, with traders looking for clues about the magnitude of upcoming interest rate cut at the October 29th FOMC meeting. Looking at Fed Funds futures contracts, traders are pricing in a 62% chance of a 25bps cut, while the odds of a 50bps are seen at 38%.

Stock performance may also offer a directional catalyst: Asian shares added an average of 3.5% while US stock index futures are up about 1.5%. EURUSD shows an 84% correlation with the MSCI Index of global equities. Just over a week ago, we saw EURUSD show an -84% inverse correlation with 30-year US Treasury bonds. This suggests traders are betting on normalizing credit market conditions as LIBOR lending rates decline, with capital flowing out of bonds and US dollars into equity markets. This would support our technical outlook favoring near-term dollar weakness as the greenback has apparently met resistance against an average of six top currencies.

To contact Ilya regarding this or other articles he has authored, please email him at ispivak@dailyfx.com.