Daily Forex Report - USD on the defensive, stocks and commodities surge

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• USD: Lower, pressured by improving risk appetite and a surge in commodity prices, ISM beats expectation
• JPY: Higher, tracking broad USD weakness versus the majors
• EUR: Higher, manufacturing PMI rose to 21 month high, investor confidence at best level since June 2008
• GBP: Higher, UK manufacturing PMI and mortgage approvals beat expectations, debt worries limit gains
• CHF: Higher, EUR/CHF near multi-month low, Swiss manufacturing PMI remains above 50
• CAD and AUD: AUD & CAD higher, China may use FX reserves to buy commodities, PMI at 20 month high

Overview  
USD traded lower to start the year pressured by firmer equity market trade and a surge in commodity prices. Strong PMI data from China and Europe contributed to equity market gains and demand for commodities. China’s manufacturing PMI rose to its highest level since April 2004. The improvement in China’s PMI data suggests that China’s economy may grow by 10% in early 2010. There are reports that China may use FX reserves to buy oil and commodities. Crude traded above $80 a barrel and metals prices surged. The surge in commodity prices sparked demand for growth led currencies like the CAD and AUD. GBP underperformed pressured by selling in cross trade as UK Chancellor Darling warns that cutting the deficit too quickly could hurt the UK economy. In addition, Pimco says it will cut holdings of UK bonds because of increased borrowing. USD started the year higher in Asian trade supported by speculation that improving US economic data will lead to an earlier Fed rate hike and in reaction to a statement from Fed Chairman Bernanke that all options are open for interest rates. There was limited reaction to a UBS report which says the USD may firm in 2010 as US investors cut foreign holdings with US investors are less willing to increase their foreign exposures. US economic data was mixed with construction spending declining more than expected and manufacturing ISM rising more than expected. USD remained on the defensive post release of the ISM report.

The trade will be looking closely at this week’s US economic data for possible clues to Fed policy outlook. This week’s key US economic report is Friday’s release of US unemployment. The trade will be looking at the unemployment report for confirmation that the US labor market is improving. The latest estimate from Market watch is that US nonfarm payrolls rose by 10k in December ending 23 months of decline. (Consensus is nfp declined by 23k.) If the nonfarm payrolls turn positive the report will likely fuel speculation that the Fed  will raise rates sooner than forecast and demand for USD. Fed policy outlook will be a key market driver in 2010.

Today’s US data:
November construction spending declined by 0.6%, a 0.4% decline was expected. December ISM rose to 55.9, a reading of 54 was expected.

Upcoming US data:
On January 5th November factory orders, pending home sales and December auto sales will be released. Factory orders are expected at 0.5% compared to 6% last month. Pending home sales Index is expected at 111.8 compared to 114.1 last month. On January 6th December ADP employment and ISM non- manufacturing Index will be released. The ADP employment report is expected at -70k compared to -169k last month. The nonmanufacturing ISM index is expected at 50 compared to 48.7 last month. On January 7th initial jobless claims for the week ending 01/02 will be released expected at 545k compared to 432k last week. On January 8th December nonfarm payrolls and unemployment will be released. Nonfarm payrolls are expected to come in at -23k compared to -11k last month. The unemployment rate is expected to rise 0.1% to 10.1%. November consumer credit will also be released on January 8th expected at -4.40bln compared to -3.51bln last month.

JPY
JPY rebounded from a four-month low versus the USD supported by spillover from broad USD weakness against the majors. JPY was initially pressured by a statement from Fed Chairman Bernanke that the Fed will keep rate hike options open. Fed rate hike speculation was over shadowed by improving risk appetite as equity markets rally and commodity prices surge. A report that China’s manufacturing PMI rose at its fastest pace in several years fuels demand for commodity markets and equities JPY remains vulnerable to concern about Japan’s sovereign debt rating and widening of US and bond yield gap. S&P warns that Japan’s sovereign debt rating may be cut if steps aren’t taken to cut Japan’s rising debt. Last week Japan announced a record ¥92.3trln budget for fiscal 2010/ 11. For the first time since World War II Japan’s bond issuance will exceed tax revenue. US/Japan ten year bond yield spread is at its widest level in two years. Speculation that the BOJ may expand quantitative ease in early 2010 is a major risk for the JPY. The BOJ expanded its funding operations and pledged in mid-December to combat deflationary pressures in Japan.

On January 8th November preliminary leading indicators will be released expected at 2.2% compared to 2.5% last month.

Key technical levels to watch in USD/JPY include support at 91.92 the December 30th low with resistance at 94.10 the August 28th high.

EUR
EUR traded higher supported by report of improving EU manufacturing PMI and Sentix index and rising risk appetite. EU December manufacturing PMI rose to a 21 month high at 51.6 compared to 51.2 last month. The January Sentix investor confidence index improved to -3.7 from -5.5 last month. The Sentix index is at its highest level since June of 2008. Despite today’s report of improving manufacturing activity and investor confidence the ECB is expected to maintain steady policy bias. Firmer equity market trade also supported the EUR. US economic data and Fed policy outlook will be the key drivers for EUR trade this week. EUR remains vulnerable to concern about EU sovereign debt risk and Fed rate hike speculation.

On January 5th German December unemployment and CPI will be released. The German Unemployment rate is expected unchanged at 8.1%. CPI is expected at 1% compared 0.5% last month. On January 6th EU services PMI and December will be released expected 53.7 compared to 53 last month along with EU industrial new orders expected at 1% compared to 1.5% last month and November PPI expected unchanged at 0.2%. On January 7th EU December economic sentiment will be released along with November retail sales. Economic sentiment index is expected at 90 compared to 88.8 last month. Retail sales are expected to rise by 0.1% compared 0.0% last month.

The technical outlook for the EUR is mixed as the EUR traded above 1.4400. Expect EUR support at 1.4306 the December 30h low with resistance at 1.4503 the December 15th high.

CHF
CHF traded higher despite report of a drop in Swiss manufacturing PMI. Swiss December PMI declined to 54.6 from 56.9 last month. The fact that the Swiss PMI remains above 50 suggests that the Swiss manufacturing economy continues to expand. CHF gains are attributed to safe haven demand fueled by escalating geopolitical tensions as the US closes its embassy in Yemen. CHF is also supported by gains in cross trade to the EUR. EUR/CHF traded at its highest level since March 12th, 2009 and the cross hit a low of 1.4809 in overseas trade. Swiss officials have been noticeably quiet about recent CHF appreciation versus in EUR but today’s movement in the cross towards 1.4800 could inspire SNB intervention. This week’s Swiss economic calendar includes January 7th release of December CPI expected at 0.1% compared to 0.2% last month. Expect USD/CHF support at 1.0235 the December 11th with resistance at 1.0509 to December 19th high.

GBP
GBP traded mixed giving back initial gains that were inspired by report of strong UK manufacturing PMI and jump in UK mortgage approvals. UK manufacturing PMI for December rose to 54.1 from 51.8 last month. The manufacturing PMI is at its highest level since November 2007. Mortgage approvals rose to 60,518 from 57,718 last month. UK mortgage approvals are at their highest level since March 2008. UK M4 rose by 0.9%% in November. GBP continued to underperform with gains limited by concern about UK budget outlook and uncertainty about BOE monetary policy. UK Chancellor Darling warned that cutting the deficit too quickly could hurt UK economy. His comments may generate concern about UK debt rating as debt agencies have urged the UK to take action to reduce the deficit. GBP gains were also limited by report that Pimco plans to reduce holdings of UK bonds because of increased UK borrowing. BOE will hold a policy meeting Thursday and are expected to hold monetary policy and the current level of asset purchase unchanged. The improvement in UK manufacturing PMI mortgage data suggests that the UK economy is emerging from recession but the data may not be enough to encourage the BOE to change monetary policy at this time. The BOE is expected to wait to see inflation figures in February for deciding whether a pause in its asset purchase plan is justified. GBP remains vulnerable to concern about UK debt outlook and election uncertainty. The UK will hold a general election sometime after March of 2010 and before June 3rd. Latest polls show that the Conservatives could capture a 22 seat majority in parliament.

On January 6th December services PMI will be released expected unchanged at 56.6.

The technical outlook for GBP is mixed to positive as GBP rallies above 1.6100. Expect near-term support at 1.6005 with resistance at 1.6340 the December 17th high.

CAD
CAD traded sharply higher supported by firmer equity market trade and stronger commodity prices. A report that China may use some of its reserves to buy crude oil and commodities sparked significant demand for metals and crude in Monday’s trade. Gold traded over $25 higher, crude traded above $80 a barrel and copper prices traded a 16 month high. In addition, strong manufacturing PMI’s from Europe and China sparked demand for equities and growth related currencies like the CAD. There were no major Canadian economic reports released in today’s trade. CAD has outperformed with support from improving growth outlook in North America and less dovish BOC policy bias.  At the BOC policy meeting in December the BOC reaffirmed its pledge to leave interest rates at record lows through June 2010 as long as inflation remains in check. Last week BOC Governor Carney said that the BOC’s pledge to keep rates low until mid to 2010 is conditional and the BOC has flexibility to shorten the time frame for the rate commitment.

On January 5th November I PPI and RMPI will be released. These reports will give some indication of whether Canada is experiencing inflationary pressures.

The technical outlook for CAD is positive as USD/CAD trades below 1.0400. Look for near-term support at 1.0207 the October 15th low with resistance at 1.0580 the December 23rd high.

AUD
AUD traded sharply higher despite report that Australia’s manufacturing PMI declined. Australia’s December manufacturing PMI fell by 2.7 points to 48.5. AUD was supported by improving the risk appetite as equity markets surge in reaction to strong PMI data from China and a report that China may use some of its FX reserves to buy commodities. China’s manufacturing PMI was at a 20 month high. China is a major export destination for Australia. AUD had been experiencing significant selling pressure sparked by diminished RBA rate hike speculation and concern that recent RBA rate hikes have contributed to weaker than expected domestic growth in Australia. At the start of December investors were looking for the RBA to hike rates by 50 basis points in February. The trade now is looking for the RBA to pause in its tightening cycle because the sustainability of the economic recovery in Australia is less certain. AUD is supported by improving risk sentiment and positive outlook for commodity prices.

On January 6th November building approvals would be released expected at 1.5% compared to -0.6% last month. On January 7th November retail sales and November trade balance will be released. Retail sales are expected to rise by 0.6% compared to 0.3% last month. The trade balance is expected at -2.5 billion compared to -2.3 billion last month.

The technical outlook for the AUD is positive as the AUD trades above 9000. Expect AUD support at 8929 the December 31st low with resistance at 9295 the December 4th high.