US Dollar: What to Expect in December

Written by Kathy Lien, Chief Strategist
• 5 Central Bank Meetings Will Make for a Busy Trading Week in the FX Market
• Euro Extends Losses Despite Strongest Consumer Price Growth Hits 6 Year High

US Dollar: What to Expect in December
We are entering the last trading month of the year which usually draws out a lot of unique factors that can affect the demand for US dollars. A few weeks ago, we published a report on the seasonality of the US dollar and we found that based on 20 years of data, the dollar has a greater tendency to fall in the month of December (see report). These risks are higher this year with problems in the financial sector still plaguing the US economy; we could see another month of volatility because options are expiring and traders across different markets are divided on what to expect from the Federal Reserve. The futures market is currently pricing in a 100 percent chance of a quarter point rate cut with 42 percent of that probability in favor of a half point cut; in other words the odds for 50bp over 25bp is quickly nearing fifty-fifty. The dollar however was stronger across the board today and the main reason for that is the expectation that the Fed will come to the market’s rescue. However over the medium term their rescue efforts should be dollar negative and regardless of what the Fed decides to do, half of the market will be surprised. For the US dollar and the currency market this means one thing and that is volatility. Fundamentally, Federal Reserve Chairman Ben Bernanke has set the tone for trading last night when he reiterated the cautionary comments made by Fed Vice Chairman Kohn earlier this week. Bernanke told the markets that the relapse of funding problems has tightened credit conditions significantly and he believes that consumer spending could be particularly vulnerable this month given higher energy prices and mortgage payments, a weak housing market, and unfavorable volatility in equities. Today’s US numbers were mixed. Personal income and personal spending growth declined but the PCE deflator and Chicago PMI accelerated. Ultimately the bad news outweighed the good which is why rate cut expectations continued to rise. The Middle East Council meeting begins on Monday read our special report on what this could entail for the US dollar.

5 Central Bank Meetings Will Make for a Busy Trading Week in the FX Market
Five central bank meetings in the coming week will make it an exceptionally busy time in the foreign exchange market. The Bank of Canada, Reserve Banks of Australia and New Zealand, the European Central bank and the Bank of England will all be convening to discuss interest rates. No one is expected to make a move, but many could surprise with one. Now more than ever the upcoming interest rate decisions require close attention by anyone who may be interested in where currencies may be headed over the next few weeks. The comments made by the central bankers after their rate decisions can and will confirm or deny current market sentiment. The biggest impact may be on carry trades, which live and die by the expectations for interest rates. The Japanese economic calendar is pretty empty with only labor cash earnings, the leading economic index and the final figures for third quarter GDP due for release. Even if there were some meaningful surprises, the data should have a minimal impact on the Japanese Yen. Last night we had what could have potentially been very market moving Japanese data, but unfortunately the mixed reports failed to lift the Yen. National consumer prices were stronger than expected due to the rise in oil prices and housing starts improved. The unemployment rate remained unchanged but the job to applicant ratio fell to 1.02, reflecting the tough conditions that the Japanese economy still faces.

Euro Extends Losses Despite Strongest Consumer Price Growth Hits 6 Year High
The Euro extended its losses today and is on its way to testing 1.45. Although we are still long term Euro bullish, the Euro could now fall to 1.44 before it rises back to 1.50. Economic data continues to support further Euro gains. Consumer prices in the Eurozone hit a 6 year high of 3 percent in November, which is the strongest pace of growth in more than 5 years. This is well above the ECB’s 2 percent target and if it were not for weakening growth, the central bank would probably be rushing to raise interest rates. Third quarter GDP was stronger than expected, but that is old news. Eurozone consumer confidence in the month of November and German retail sales for the month of October were much weaker than expected. Collectively this will force the ECB to sit on their hands next week while screaming about the need for tight monetary policy.

British Pound Continues to Weaken on Softer Consumer Confidence
With financial market turmoil taking a big toll on the UK economy, it would be surprising if consumer confidence actually held steady. In the month of November confidence plunged to a 4 year low, reflecting mortgage concerns and rising prices. The Bank of England will be meeting to decide on monetary policy next week and currently a rate cut is not expected. However it is important to be careful because the BoE is notorious for catching the market by surprise. We have seen many instances where the market did not expect a rate cut, yet the BoE delivered one anyway, so do not be surprised if the Bank of England actually cuts interest rates.

Canadian Dollar Hits Parity, Australian and New Zealand Dollars Extend Losses
The Canadian dollar fell back to parity with the US dollar after the release of their GDP numbers. Growth last month was right in line with expectations but the data was more positive than negative given strong readings in both Q2 and Q3 GDP. Business investment led the rise, but goods and industrial production weakened in September which means that the latest numbers reflect the recent deterioration in the Canadian economy. The Australian and New Zealand dollars also sold off, but that was primarily due to a broad based dollar rally and drop in commodity prices because the Australian current account balance was actually stronger than the market’s forecast.

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AUDNZD Range's Technical Appeal Looks To Fend Of Fundamental Wave

There is considerable event risk for the majors (due to heavy-hitting US data and the GCC summit), carry pairs and a number of currencies whose central banks are scheduled to release rate decisions. To balance some of this risk, we will look to range trade AUD/CAD, a pair that is comprised of two commodity exporters whose central banks have a hawkish lean. Both the RBA and BoC are scheduled to release rate decisions next week, though neither is expected to shift their benchmark target.




Trading Tip – There is considerable event risk for the majors (due to heavy-hitting US data and the GCC summit), carry pairs and a number of currencies whose central banks are scheduled to release rate decisions. To balance some of this risk, we will look to range trade AUD/CAD, a pair that is comprised of two commodity exporters whose central banks have a hawkish lean. Both the RBA and BoC are scheduled to release rate decisions next week, though neither is expected to shift their benchmark target. However, this does not guarantee low volatility as there is a relatively stocked calendar. Aside from scheduled event risk, USD/CAD’s action around parity will likely act as a good guide for AUD/CAD. The suggested strategy uses a very aggressive entry and tight stop as it can be expensive to wait out a test of 0.89 to see if it is a genuine or false break. If spot hits 0.8750 before we are entered, we will cancel the order. Additionally, we will cancel any unexecuted orders on Thursday.

Event Risk Australia and Canada

Australia – All eyes will turn to significant event risk leading up to Tuesday’s Reserve Bank of Australia interest rate decision and Gross Domestic Product report, with Trade balance and Retail Sales figures likely to influence sentiment ahead of the key releases. Analysts predict that Retail Sales grew at a 0.6 percent pace through the month of October, as a robust labor market and strong consumer sentiment boost spending. Indeed, strong wage price pressures and consumer demand were behind the Reserve Bank of Australia’s decision to raise rates to 6.50 percent through their last meeting. Though analysts expect the bank will leave rates unchanged through their upcoming December announcement, there remains a very real risk that rates will continue to rise through upcoming months. A later Gross Domestic Product figure is likewise to force noteworthy volatility across Australian dollar pairs.

Canada – Event risk for the Canadian dollar will intensify in the week ahead, with a key Bank of Canada interest rate decision to easily drive volatility through Tuesday’s trade. Outlook is very mixed for the Bank of Canada’s result, with median consensus forecasts calling for unchanged rates. Yet 12 of 27 analysts polled by Bloomberg news predict that the central bank will actually cut rates by 25 basis points to 4.25 percent. Such indecision typically makes for strong reactions to a rate announcement. Otherwise, traders will look to Friday’s Employment report to drive volatility across Canadian dollar currency pairs.
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