It may seem like a bit of a dull day on the markets. The second week of the month is usually full of second tier data releases, and after Friday’s whopper of an NFP number, it is natural for the dollar to take a breather.
However, don’t write off the dollar too fast, the recent recoveries in the USDJPY, EURUSD and GBPUSD look like they are built on shaky ground, and could be some profit-taking ahead of the next leg higher for the dollar.
Is Germany worrying itself into recession?
The German economy has become the latest problem for the Eurozone. It looks like geopolitical fears combined with a slowdown in China have come to bite Germany’s mighty manufacturing sector.
Firstly the services sector PMI report for September fell into contraction territory below 50, then factory orders fell 5.7% for August, and today industrial production fell 4% in August, the largest monthly fall since 2009. So, are we back in crisis territory for the Eurozone, or are the German’s actually worrying themselves into recession?
The latter point is worth noting, geopolitical fears have died down, although exports to Russia are likely to remain weak. Chinese growth has been slowing, but it is managing to stay above water, and the EUR has fallen 6% on a trade-weighted basis since March this year, which should be good for German exports. Added to that, other sectors of the German economy remain strong.
The service sector makes up 70% of German growth, and German retail sales expanded at a healthy 2.5% rate for August, at the same time as the industrial sector was on its knees.
Unemployment is also at its lowest level since reunification at 6.7%. Nearly 30% of the German workforce are employed in the industrial sector, but so far falling orders has not translated to job losses. One reason could be because the late closure of some German factories for the summer holidays, which could have negatively impacted the German data, thus we may see a bounce back in the September figures.
If, as we believe, the German economy is not as bad as the headline economic data suggests then there is less impetus for the ECB to add sovereign QE to its menu. We don’t expect sovereign QE from the ECB even if Germany’s economy slips back into recession in the coming months, not least because of political resistance from Berlin.
France could be the big winner from a weak Germany
If the German economy does slip up in Q3, we will get the first Q3 estimate on 14th November, then the pressure could start to build on Angela Merkel to loosen the fiscal screws to help support the consumer. The knock on effect of looser fiscal policy in Germany, could be loser fiscal policy for the rest of the Eurozone.
France has already said that it won’t meet its fiscal targets, if there is a move away from tough fiscal targets that could be good news for the French economy. Thus, bad news for Germany could be good news for France and the rest of the currency bloc.
IMF remains downbeat
The slowdown in the currency bloc is also threatening the global economy, so says the IMF. Its latest global growth forecasts revised down the estimate for 2015 global GDP to 3.8% from 4% on a weaker outlook for the Euro-area, Brazil and Russia. It also said that the currency bloc has a 30% chance of falling into recession in the next 6 months.
This is uncomfortably high for the ECB and governments of the currency bloc who are still intent on enforcing strict fiscal rules. However, if the economy continues to slide, outside pressure could build to boost pro-growth measures.
The market outlook
From a market perspective, the mini recovery in EURUSD has hit a road block after reaching as high as 1.2675 on Monday. It fell back on the German data; however, it is managing to hold on above 1.2600, for now.
Although the fundamental picture is deteriorating for the single currency, the decline in the EUR could be stemmed from a technical perspective, as the dollar enters a period of consolidation.
After a surge higher, the dollar could be pausing for breath. It has run into some resistance at 110.00 in USDJPY, and for EURUSD and GBPUSD support has come in at 1.25 and 1.60 respectively. This is to be expected after such a strong USD performance in September.
Key support for USDJPY lies at 108.00, if a deeper correction is on the cards then this pair could fall back to 106.70 – the 38.2% Fib retracement of the July – September advance. Likewise, resistance for EURUSD lies at 1.2675, a deeper pullback could see back to 1.3073 – the 38.2% retracement of the May – October decline.
Will Dudley weigh on the buck?
Whether or not the dollar manages to get back into rallying mode could depend on William Dudley, the head of the Federal Reserve Bank of New York, who is speaking on the economy later this evening.
He is notable for two things:
1) His closeness to Fed President Yellen
2) His stance as an uber-dove.
In a recent speech Dudley said that he was concerned about prices, which looked like they peaked in May.
He said he would like to see the economy run hot for a while, before thinking about raising interest rates. I will be watching to see if he continues to sound concern about the prospect of disinflation in the US and what this could mean for FOMC action.
Thus, in the next 24 hours we could see the outlook for EURUSD shift from weak German economic data to dovish comments from Dudley. If Dudley does sound concerned about prices then we could see another day of consolidation for the buck.
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