Gain Capital

The USD is finishing the week mixed against other major currencies, with gains against the JPY, GBP and CAD, but lower against EUR, CHF, AUD and NZD. US stock market declines continue to overshadow all other market developments, providing one reason why the USD remains relatively rangebound. Important developments in the past week were Fed Chairman Bernanke’s downbeat economic assessment and vows to take timely and decisive action to support the economy. His comments on Thursday effectively put a lock on a 50 bp rate cut to 3.75% on Jan. 30. However, stock market losses on Friday convinced traders that there was room for even steeper rate cuts, as Fed Fund futures began pricing in nearly 40% likelihood of a 75 bp. rate cut. Against this backdrop, the USD held up remarkably well, failing to extend losses against the EUR beyond the EUR/USD highs seen after the Dec. NFP report at 1.4825.

The Bank of England (BOE) held rates steady this week, against my call for a cut, but GBP failed to sustain short-lived post-announcement gains and is limping out to end the week lower across the board. A 25 bp rate cut in February is all but assured, with the BOE likely delaying only to get the quarterly inflation report as political cover before cutting. ECB Pres. Trichet retained his hawkish outlook, confirming that the ECB holds a tightening bias, but I continue to maintain that ECB rates are not going any higher, leaving Trichet still blowing smoke. In the unlikely event that the ECB were to tighten rates, I think the EUR would ultimately suffer as European credit markets, banks, and consumers would all recoil in horror. Canadian data, most notably the Dec. employment decline (-18.7K vs. exp. +15.0K), continued to come in on the weak side, increasing the view that the Canadian economy is softening alongside the US.

China reported a drop in its trade surplus and the slowest growth in exports in two years along with the smallest increase in money supply in seven months, suggesting that slower growth is also appearing there. In recent months, the Chinese have allowed the Yuan to appreciate faster and continue to enact measures to curb bank lending, to prevent the economy from overheating. These measures finally appear to be taking hold, triggering fears that slower growth in China will ultimately lead to slower global growth. That in turn has seen oil prices and the Baltic Freight Index, a measure of transport demand linked to global growth, drop back further.

US financial markets continue to be roiled by announcements of massive write downs and losses at major US financial firms, with Citi, Chase and Merrill expected to report significant new losses next week. While losses to date have been concentrated in the financial sector, consumer related firms are also increasingly under pressure, essentially providing evidence that the housing slump has infected the broader consumption-led economy.

The USD outlook remains for weakness based on slowing growth and lower interest rates, but it also remains uneven. The slowing global growth outlook will also affect other currencies, especially those with a commodity base such as AUD and CAD, but also GBP, which faces its own unique set of challenges. EUR retains the best prospects against most, but even there the trajectory has faded. I continue to look for further range trading in EUR/USD, with the upside trigger to further gains at 1.4820 opening room back to the all-time highs at 1.4970/75. But I look for such strength to eventually fade and for a relapse back to the 1.43-1.45 area. USD/JPY looks to have the clearest path, and it should be lower, as financial market volatility keeps carry trade (JPY-cross) selling the dominant theme. Strength beyond the 110.40/50 area, the base of the Ichimoku cloud, will be needed to alter that view.