April 2009 German ZEW Survey

The German ZEW investor confidence survey improved for the sixth consecutive month in April, with the index jumping to a two-year high of 13.0 from -3.5 in the previous month however, the current outlook for the economy slipped to -91.6 from -89.4, which is the lowest since September 2003, as the region faces its worst economic downturn in over half a century. The data suggests investors are holding an improved outlook for the future as policymakers take unprecedented steps to shore up the ailing economy and at the same time, the European Central Bank is expected lower the overnight lending rate to a record-low in May as growth and inflation falter. Meanwhile, the ECB is also anticipated to adopt unconventional measures to manage monetary policy beyond the interest rate to shore up the euro-region however, as the Governing Council fails to meet on common ground, the lack of decisive action could weigh on the outlook for future policy.

March 2009 German ZEW Survey

Investor sentiment in Germany unexpectedly rose to its highest level in nearly two-years as the ZEW survey increased to -3.5 from -5.8 in February. Meanwhile, the gauge which evaluates the current situation of the economy fell to -89.4 from -86.2 in the previous month, and conditions may get worse as Europe’s largest economy faces a deepening recession. As the European Central Bank forecasts the annual rate of growth for the euro-region to contract 2.7% this year, and expects economic activity to remain subdued in 2010, the governing board is anticipated to lower the benchmark interest rate further in an effort to stem the downside risks for growth and inflation. As a result, investors are pricing another 25bp rate cut by the ECB next month however, as President Trichet remains reluctant to overshoot the interest rate, the central bank may adopt additional policy tools as the economic downturn intensifies.

EUR/USD: Trading the German ZEW Investor Confidence Survey

The German ZEW investor confidence survey is expected to improve for the seventh consecutive month in May as economists forecast the index to increase to 20.0 from 13.0 in the previous month however, as the current outlook for the economy is expected to hold near its lowest level since 2003, fears of a deepening downturn could weigh on the exchange rate as region faces its worst recession in over half a century.

Fundamental Outlook for US Dollar: Bullish

Following up on a period of fundamental abundance with dramatic market events (the Fed Stress Test) and high-level economic indicators (non-farm payrolls), the dollar was put through its staid phase this past week. A round of indicators that included the April retail sales and May University of Michigan consumer confidence survey have put the focus back on the supposed ‘green shoots’ that so many policy officials and market commentators have noted recently. This will be the primary concern for dollar traders next week: is the United States leading the gradual economic recovery? However, this broad and speculative fundamental driver will only be able to guide price action if it is not interrupted by a more immediate concern – like a sharp rise or plunge in risk appetite.

Working with the forecast that there will be no unforeseen event that sweeps over the market and stirs sentiment, we will have a series of indicators and meetings that could guide the measured race for establishing the leader of the global economic recovery. As it stands, most of the major, industrial powerhouses are mired in recession; and the immediate outlook is far from promising. However, the currency market is a relative one and speculators are willing to look well into the future to discount the macro trends. So far, the US has shown signs that the pace of deterioration in employment, factory activity, consumer spending, confidence and the housing market are slowing. It should be noted that these trends are not positive, just less aggressive in their decline. And, these cautious ‘improvements’ have put the market at large on watch for ‘green shoots.’ We will see whether the Fed sees the same signs of hope with the minutes from the Federal Open Market Committee’s (FOMC) last policy meeting over April 28-29th. In previously released statements, the group has maintained its forecast for a contraction through the rest of the year and a slow recovery through the first half of 2010. If perhaps the central bankers are more encouraged by recent data, and they project perhaps a recovery sometime before the turn of the year, it would be a big vote for the US outpacing Japan, the UK and perhaps even the Euro Zone.

As for economic indicators, there are no key releases that promise heavy volatility; but there are those that will have their hand in guiding general growth forecasts. The Leading Indicators composite is typically overlooked; but the components of this indicator are exactly what is needed for projecting a true recovery. If there is any theme that can be derived from the docket, it will be the health of the housing market. The NAHB Housing Market Index for May and housing starts and permits data for April will cross the wires Monday and Tuesday. The sector indicator is expected to push an 8-month high (still far from positive territory) and the construction activity gauge is seen ticking higher (through from record lows). This was the area of the economy that triggered the recession. Can it be the source of the recovery?

And, though the market has shifted its attention to the economy; there is no doubt that sentiment will continue to hold the potential influence over the dollar. The greenback is still considered a top safe haven in FX circles; but that can shift should US-specific risks arise. This means we need to not only watch the general level of sentiment in the market but the various currencies’ connection to risk as well. One concern that could easily blow up under the right conditions is the health of the financial system. The Fed’s Stress Test seemed to offer an honest assessment of the state of the country’s largest banks. However, there are many critics that think that floating losses were understated to help pad sentiment until a real recovery can form. If that is the case, an unforeseen shock can send the market’s into another crisis. We will monitor Treasury Secretary Geithner’s testimony on TARP for reasons cracks in the cautious optimism. – JK

US Dollar Rises as Stock Markets, US Index Futures Turn Lower in Asian Trading (Euro Open)

The US Dollar gained against most major currencies as stocks tumbled across Asian exchanges and US equity index futures traded down as much as 1% ahead of the opening bell in London. Overnight data saw New Zealand’s input PPI fell the most since 1976 in the first quarter while Japanese consumer confidence beat economists’ expectations in April.

Short-Term Forex Technical Outlook: EUR/GBP (Update)

The EUR/GBP has held a tight range over the last four-weeks of trading, and the pair may continue to move sideways over the remainder of the month as investors weigh the outlook for future policy.

US Equities and NZD/USD

The correlation between the New Zealand Kiwi, specifically, with the US stock market has become remarkably cut-and-dried of late, which you can see from the chart below. For carry traders, therefore, it probably makes more sense to follow stock market commentary than to track New Zealand economic data. The same economist, for example, warned “that the equities rally, which has seen the broad U.S. Standard & Poor’s 500 index climb 36% from its March low after rising another 3.4% Monday to its highest since Jan. 8, may be dissipating.”

Australian, New Zealand Currencies Benefit from Risk Aversion

Against each other, the New Zealand Kiwi and Australian Dollar have traded in a pretty tight range for the last year (except for a “blip” in the fall of 2008). This makes sense, as both currencies rise and fall in accordance with exports and interest rates.

Euro Resumes Decline After Brief Pause

The one-year chart of the EUR/USD depicts a general downward trend, punctuated with steep “blips.” Every couple of months or so, it seems traders are temporarily jarred loose from their mindset of Euro bearishness, and find an excuse to bid up the common currency. Invariably, the Euro then resumes its downward course a few weeks later.

The Euro’s recent trading activity fits this mold perfectly. The global stock market rally in March was accompanied by a spike in the Euro. While equities, commodities, and even other currencies continued to rise, however, the Euro peaked after a couple weeks and has since hovered around the $1.30 mark. As one currency strategist summarized: “A breakdown of the correlation between the euro-dollar exchange rate and the S&P index indicates the currency pair ‘ has become a trade that is less about risk, a little more about euro rate specifics.’ ”In other words, the decline in risk aversion has not expanded to include the Euro. This is somewhat surprising, since EU economic indicators have rebounded in the last month. The oft-cited German IFO index “rebounded from a 26-year low,” while “retail sales declined the least in 11 months in April after government stimulus packages improved consumer confidence.” On the other hand, EU lending activity, which is more correlated with economic growth, continues to decline. “The European Central Bank Wednesday released figures showing that banks in the currency area cut their lending to both companies and households in March.”

South Africa Hikes Rates, but Interest Rate Differential is Preserved

esterday, the South African Reserve Bank (SARB) lowered its benchmark interest rate by 100 basis points to 8.5%. Since December, the Central Bank has now cut rates by 3.5%, from a high of 12%. [As an aside, the SARB uses a repo rate to conduct policy, as opposed to a discount rate. In theory, a repo rate is slightly unique in that it reflects the rate at which the Central Bank will repurchase government securities from commercial banks. The Federal Funds Rate, in contrast, "is the interest rate at which private depository institutions (mostly banks) lend balances (federal funds) at the Federal Reserve to other depository institutions." In practice, both rates function as modulators of liquidity in the financial system.]

“The outlook for domestic economic growth remains subdued, with no indications of a quick recovery,” offered the SARB as a rationale for the rate cuts. Activity in manufacturing and mining, two of the cornerstones of the South African economy, have plummeted since the inception of the credit crisis, along with exports and retail sales. As a result, “Central bank Governor Tito Mboweni said April 7 he would ‘not be surprised‘ if the nation’s economy shrank for a second consecutive quarter in the three months through March, following a 1.8 percent contraction in the fourth quarter.” Meanwhile, South Africa’s producer price index (PPI) has declined for seven consecutive months. Coupled with a moderation in food and energy prices, inflation is no longer perceived as a serious problem.

The South African Rand actually rose on the news of the rate cut, as part of a trend that has seen the currency rise nearly 40% since touching a low of 11.7 Rand/Dollar in October. In April alone, “South Africa’s rand, the laggard of 27 major world and emerging-market currencies last year, rallied 12 percent against the dollar.” This reversal of fortune is due largely to the recovery of risk appetite and consequent return of investors to the carry trade.