Markets Calmed After Euro Debt Auction

Portuguese Auction Gives Euro Relief

The euro found a bit of relief overnight as a much anticipated auction of Portuguese debt was fairly well subscribed.  The initial results of the auction saw the EUR spike higher against the USD through the 1.30 level, only to be sold off again to settle near the 1.30 mark at the time of writing.  This price action suggests that traders are still dubious as to the prospects for a workable solution to the European debt crisis and as a result there are ample offers in the market to sell EUR at levels above 1.30.  Bloomberg reports that plans are in the works by the EU to put together an aid package for Portugal that would guarantee lower interest rates on bailout loans.  The plan could be in the amount of 60 billion euros and would be an attempt by European lawmakers to subdue the crisis that has caused so much strife in the region.  Many market participants have been questioning the health of the Eurozone due to these debt issues and the viability of the euro as a going concern has even been brought up.  If these reports do come to fruition it would signal that the EU was being proactive in their attempts to contain the crisis rather than bail out nations after they get into trouble.  The market wants to see a concrete plan before they embrace the euro again, so until something tangible is in place we can expect to see price action similar to today’s, where any rally in the euro is met with significant selling pressure. 
M&A Talk Fuels CAD Rally
The Canadian dollar has reached a 32 month high overnight against the USD as news that Cleveland-based Cliffs Natural Resources has agreed to purchase Canadian miner Consolidated Thompson for over $4 billion in cash.  The purchase will be made in Canadian dollars, so clearly the flow will be significant enough to push the USDCAD pair to a new low in the mid 0.98 cent level.  The Loonie has been fairly quiet this week and intraday ranges have been tight as little in the way of Canadian (or international for that matter) data has been enough to knock the CAD from its current strong levels.  From a purely technical perspective the CAD is beginning to look a little overbought and has been able to withstand changes in risk sentiment over the past few weeks with little movement.  The Loonie now seems to be reacting favourably to good economic data from the US, our largest trading partner, but has also been able to withstand recent bouts of risk aversion that have seen other commodity linked currencies falter.  The question on many people’s minds right now is whether or not the Loonie can stay below par for any longer.  Data from Canada has been good but inflation is far from out of control, thanks in large part to the strong Loonie, so the Bank of Canada could be on hold in the near term.  Secondly, an overly strong dollar is far from what our government wants as it places a big strain on our manufacturing sector causing our products to become more expensive relative to the rest of the world.   For the time being it seems as if the CAD will be content to follow the news and equities in order to find direction until something tells us otherwise.  Canadian trade balance figures are released tomorrow and could have a big impact should the figure come out far from expectations.
Aussie Shows Resilience
The Australian dollar is off its recent lows against the US in the 0.98 cent region even as devastating floods continue in Queensland.  RBA board member McKibbin was on the tapes last night suggesting that the floods could wipe out as much as 1% of Australian GDP growth for this year.  This report initially caused a selloff in the AUD but it has come back on good developments in Europe this morning.  The RBA has maintained that they will be vigilant on interest rates should inflation continue to rise, and with commodity prices staying firm there is a good chance this will materialize.  This tightening bias has effectively put in a floor for the AUD for now, while data and equity market developments will continue to dictate price action.
Have a great day.

USD.CAD Trade Recommendation + More

There have not been a whole lot of developments on the fundamental front in recent trade and we will take the opportunity to go over broader price action which should hopefully do a good job of bringing you all up to speed. The Euro is now attempting to mount its first recovery rally in 2011, with the market basing out this week and jumping back above 1.3000. The fundamental driver for the recovery can be mostly attributed to all of the latest support from EU and commitments from Japan to help stabilize the region. However, we do not expect to see rallies extend much further before eventually running into some formidable offers as the overriding downside pressures remain intact. The fact of the matter is that the Eurozone is still very much in trouble and needing more time to sort itself out, while the US economy is looking more and more attractive. Market participants are finally starting to see the potential in USD buying not only as a safe-haven, but as an undervalued investment which could prove very rewarding once the Fed starts to reverse monetary policy.

Relative Performance Versus USD Wednesday (As of 11:35GMT)

1. SWISSIE +0.27%
2. CAD +0.24%
3. AUSSIE +0.22%
4. YEN +0.02%
5. STERLING-0.04%
6. EURO-0.06%
7. KIWI-0.43%

For today, market participants have been primarlly focused on the Portuguese auction results. The anticipation of the auction results had generated a lot of intraday voltility in European trade, with the Euro rallying sharply on rumors of a much better result than forecast. However, this proved to be unfortunate, with the results finally coming in quite solid but well below the blowout rumors. This then forced a sharp pullback below 1.3000 from where we have since been seeing some consolidation. The actual result showed Eur1.249B raised (originally high end of estimates; blowout rumor had been over Eur5B). Also getting some secondary atention was an internal EU Commission report proposing a new stability mechanism for sovereigns that could be funded by a bank tax.

Meanwhile, price action in the Pound has been rather boring against the buck, although we have certainly seen some relative strength against all of the other major currencies. As things stand, we do see risks for more Cable upside ahead of the Bank of England rate decision on Thursday, with the market potentially extending up towards 1.5800 before eventually finding renewed offers against the Greenback. As far as the crosses are concerned, we would recommend being less aggressive selling Eur/Gbp following the latest drop, and more focused on buying the Pound against some of the more exposed commodity currencies.

If early 2011 price action is any indication of things to come, it is becoming quite clear that what might have been a rising star in 2010, could now very well be a fading light in 2011. The Australian and New Zealand Dollars have been hit rather hard in the opening days of the new year, with the Australian Dollar standing out as the big loser. Initially, fears of a slowdown in China had begun to weigh on the higher yielding antipodean, but some softer local data and a very serious flood situation have only exacerbated matters and helped to further depress the market. Technical studies have been warning of the possibility for a major trend reversal here, and it looks as though it is finally starting to play out. By virtue of its proximity and correlated economy, the New Zealand Dollar has also been liquidated of late.

Our favorite trade for 2011 is starting to look quite promising early on, with our Eur/Aud buy recommendation already in the money and potentially on the verge of really accelerating. A closer look at the daily chart below shows the early formation of a possible double bottom, with a break back above neckline resistance at 1.3330 to confirm the setup and open a move towards a measured move objective by 1.3700 over the coming days.

Although 2 of the 3 major commodity currencies have been hit hard in recent trade, we can not call it a full on commodity bloc slaughter, with the Canadian Dollar doing a very good job of separating itself from the pack, The Canadian Dollar has actually been one of the stronger currencies of late, with the relative strength coming from a resurgence in demand for US assets which benefit the neighboring Canadian economy, along with a notable divergence in commodity price correlations. Although gold prices are still quite bid, it is oil that has emerged as an outperformer in recent trade, and when breaking down the commodity bloc, it then makes perfect sense to see the oil rich Canadian Dollar benefiting from this fact. At the end of the day, Canada neighbors a recovering US economy and should benefit from this proximity, while Australia (and to a lesser extent New Zealand) are more tied to Chinese economic growth prospects which currently are in question.

Price action in the Aud/Cad cross rate (see below) certainly paints a good picture of what we have been talking about, with the market coming under some intense pressure over the past several days to trigger a major inter-day double top formation that now projects additional weakness down towards the 0.9300 area over the coming sessions. For those worried about playing a short Aussie trade through the US Dollar or Euro, this could very well be another option that eliminates Eurozone debt exposure or further accommodative US monetary policy risks.

Nevertheless, while we certainly favor being long the Canadian Dollar relative to its commodity cousins, we still contend that the relative strength versus the US Dollar is “Loony.” At this point, the justification for this belief is purely technical, as we see longer-term cyclical studies showing Usd/Cad at a major risk for a significant trend reversal over the coming months. As is always the case, we are quite confident that the fundamental catalyst is waiting around the corner and will soon reveal itself.

Finally, we continue to see significant underperformance in the Swiss Franc going forward and it is actually quite fascinating and quite rare to have short Swiss Franc and short Aussie recommendations at the top of our list, with the two currencies traditionally so inversely correlated. We had established a short Swiss position through the Euro on Tuesday and things have paid off quite nicely already with the Eur/Chf cross surging towards key resistance by 1.2730. A break and close back above this level will officially confirm an inverse head & shoulders pattern formation (triple bottom) and accelerate gains to a measured move objective by 1.3000 over the coming days. The ability for global equity markets to stay well bid have certainly helped the trade, but we see the market racing higher no matter what happens in equities from here with technical studies so overwhelmingly stretched and due for a major upside correction. We are long from 1.2550 with an open objective and stop-loss at break-even after booking some quick profits on Tuesday.

Looking ahead to North America, US mortgage applications are out at 12:00GMT, followed by US import prices (1.2% expected) and Canada new house prices (178.0k expected) at 13:30GMT. US IBD/TIPP economic optimism (47.0 expected) is due at 15:00GMT, with oil and gas inventory shortly after at 15:30GMT. Later in the day, the US monthly budget statement (-$80B expected) is due alongside the Fed Beige Book at 19:00GMT. On the official circuit, Treasury Secretary Geithner speaks on the topic of China at 13:30GMT, while Fed Fisher (hawkish) is slated to speak at 18:00GMT on monetary policy. US equity futures and commodities prices are tracking moderately higher ahead of the US open.

TECHNICAL OUTLOOK

EUR/USD:The market remains under some intense pressure, with the latest break below key support by 1.2970 confirming a medium-term lower top by 1.3500 and opening a fresh downside extension towards next key support by 1.2585 over the coming days. Despite the latest drop, daily studies are still not quite oversold and show plenty of room for additional weakness before even considering a material bounce. As such, we expect any intraday rallies to be well capped ahead of 1.3300. Back under 1.2875 accelerates.

USD/JPY: The market appears to be locked in some consolidation with clear directional boas not easily determined. The latest rally has stalled out by the Ichimoku cloud top to suggest that the pressure still remains on the downside for now. Back below 82.00 should accelerate declines and expose the multi-year lows from 2010 just ahead of 80.00, while back above 83.70 will relieve downside pressures and shift structure back to the topside.

GBP/USD: The market remains under pressure and now seems poised for a retest of the platform base from early September at 1.5295. Daily studies are however in neutral territory so we would not rule out the possibility for more of a bounce towards the 1.5800 area over the coming sessions from where a fresh lower top will be sought out ahead of an eventual drop to challenge and break 1.5295. In the interim, we remain sidelined and await a clearer signal.

USD/CHF: Overall price action is certainly concerning for our longer-term basing outlook with the market dropping to fresh record lows by 0.9300 thus far. However, cyclical studies are showing oversold and any additional declines below 0.9300 are not seen as sustainable. The latest bounce back above 0.9600 is certainly encouraging and the rally has also triggered the break of the previous weekly high to set up a bullish reversal week. Look for continued acceleration of gains back above parity over the coming sessions, with any setbacks expected to be well supported above 0.9500 on a close basis.

FLOWS

US Funds have been repeat buyers of Eur/Usd along with a macro account , talk of a large LHS flow through the course of the day in Eur/Gbp, Asian reserve account selling in Cable buy orders from a UK corporate for a reported dividend payment.

TRADE OF THE DAY

USD/CAD:The market has been under some intense pressure and after managing to match the 2010 lows from April on the final day of the year, has now extended declines to fresh multi-month lows into the 0.9800’s. But daily studies are starting to look a little stretched, and this in conjunction with longer-term cyclical studies which warn of a major base, leave us looking for opportunities to buy rather then selling into the downtrend. Look for a weekly close back above 1.0100 to officially relieve downside pressure and open the door for a bullish reversal. In the interim, we see setbacks well supported ahead of 0.9800 on Wednesday and will implement our ATR analysis to isolate an ideal counter-trend entry point. Should the trade trigger, hourly studies will also be well oversold which ultimately should limit any additional downside risk for the day. STRATEGY: BUY @O.9835 FOR AN OPEN OBJECTIVE; STOP 0.9685. RECOMMENDATION TO BE REMOVED IF NOT TRIGGERED BY NY CLOSE (5PM NY TIME) ON WEDNESDAY.

Current Currency Rates

Currency Unit	USD per Unit	Units per USD
	USD United States Dollars	1.0000000000	1.0000000000
	EUR Euro	1.2967476828	0.7711600439
	GBP United Kingdom Pounds	1.5601019997	0.6409837307
	CAD Canada Dollars	1.0096014882	0.9904898237
	AUD Australia Dollars	0.9870978490	1.0130707923
	JPY Japan Yen	0.0120125593	83.2462069209
	INR India Rupees	0.0221459424	45.1549987793
	NZD New Zealand Dollars	0.7601408312	1.3155456975
	CHF Switzerland Francs	1.0260920634	0.9745714207
	ZAR South Africa Rand	0.1453567802	6.8796240462

European Tension Escalates

Euro Stabilizes on Intervention, Japanese Vote of Confidence

Panicked selling of Portuguese government debt drove the European Central Bank to intervene in the secondary bond markets yesterday, alleviating strain and putting a temporary floor under the euro. Later in the session, the euro moved up against the yen but exhibited surprisingly little movement against the other crosses after Japanese Finance Minister Yoshihiko Noda said that his country would use some of its foreign exchange reserves to buy European debt.
A Portuguese bailout mounted via the European Financial Stability Facility has become a near certainty in the market's eyes. A rescue of Spain is the next possibility on the horizon, but the country’s relative fiscal strength makes such an outcome slightly less probable. Belgium is rapidly moving toward crisis, with its government paralyzed, debt levels topping 100% of gross domestic product, and bond yields on a steady upward march. 
The coming trading cycle should see another spike in volatility in the euro, in advance of the Portuguese debt auction. Spain and Italy are also due to sell securities on Thursday. Amid the uncertainty, many traders with large short positions will trim their exposures, while others will seek to place new bets on the currency's direction –leading to choppy trading conditions. Sharp reversals are common in this sort of environment, making it a good time to consider placing limit orders.
Aussie Falls on Flooding
The Australian dollar weakened against all of its major rivals as floodwaters threatened Brisbane, the country's third largest city. The currency is now sitting just above the .98 barrier against the US dollar, after topping 1.0225 only two weeks ago. 
According to numbers released yesterday, November's trade surplus contracted as coal shipments declined in value and imports rose. Exports contribute roughly 20% of Australia's gross domestic product. Traders expect a further contraction in the weeks ahead as flooding damages mining and transportation infrastructure across Queensland state. Depending on the extent and duration of the economic damage, weakness in the Aussie may not last long, as there is little indication that this unfortunate event will substantially affect longer term growth prospects. 
Interest Rate Momentum Sustaining Canadian Dollar
Canada's dollar regained ground after slipping earlier in the trading cycle, trading near the .9930 mark once more as commodities provided support and domestic bond yields continued to march higher. Traders are steadily moving benchmark interest rate hike expectations forward as conditions in the country's largest export market improve and domestic lending continues to grow. 
A third of Canada's gross domestic product is generated through exports, approximately 73% of which go directly to the United States. US growth forecasts from the major banks and government bodies have been aggressively upgraded in recent months, raising hopes that Canada’s exports will gear up accordingly.   
Deputy Governor of the Bank of Canada Agathe Côté was the latest in a line of policymakers to warn about consumer debt risk, highlighting the 170% growth in home equity loans over the last ten years as a particular area of concern in a speech yesterday. Home equity loans tend to be indexed to floating interest rates, making them particularly sensitive when rates rise sharply – an echo of the adjustable rate mortgages that caused so much havoc in the US economy two years ago. 
The central bank raised benchmark rates in an effort to slow lending last year, and clearly remains motivated to put the brakes on further debt increases. Whether the Bank will hike rates in the face of a strong dollar and uncertain export conditions remains to be seen, but rising yield differentials are providing support for the currency at the moment. This is reminiscent of the dynamic seen early last year, which bolstered the exchange rate for almost six months before interest rates were actually increased.  

Inflation Back?
After meetings in Switzerland, the traditionally inflation sensitive European Central Bank President Jean-Claude Trichet put the subject back on policymaker agendas, saying; “This is no time for complacency and the solid anchoring of inflation expectations is considered something that is important by all of us”. Trichet is remembered for hiking rates the last time that prices were rising sharply just prior to the financial crisis. He called for central bankers to maintain vigilance, saying "We have to deliver price stability and need to be credible in this delivery".
While prices are not moving as quickly as they did in 2008, inflation indicators are steadily ticking up around the planet, as economies improve and commodity prices rally. Central banks created massive amounts of new money in the wake of the financial crisis, and much of this liquidity has sloshed into the real economy over time. As Warren Buffett said in 2009; “Economic medicine that was previously meted out by the cupful has recently been dispensed by the barrel. These once unthinkable dosages will almost certainly bring on unwelcome after-effects. Their precise nature is anyone's guess, though one likely consequence is an onslaught of inflation”. 
Prices have skyrocketed in much of the emerging world, and annualised increases are already well above central bank comfort levels in the United Kingdom and Europe. At the same time, deflationary conditions remain entrenched in the United States and Japan. 
History suggests that relatively high inflation rates tend to cause exchange rates to depreciate. When prices rise more quickly, a country’s goods become less competitive and export revenues fall. Demand for the currency drops as fewer foreign buyers purchase it, and domestic consumers sell it to buy foreign goods. 
As always, markets act on expectations. High inflation expectations often lead to downward adjustments in exchange rates as traders act in anticipation of future conditions. 
The seventies and eighties were marked by wide variations in inflation rates, which drove extensive dislocations in foreign exchange rates. It is difficult to know whether the modern central banking system will successfully calibrate stable inflation paths in the years ahead, but it is very likely that price expectations will once again become a large influence on global currency markets. Something to keep an eye on – particularly for corporate treasurers with dual, correlated exposures to interest rates and currencies. 

Happy trading!

Major Head and Shoulders Possibility

Despite some early downside pressure in Asian trade on Monday, the Euro managed to quickly shrug off the multi-month low by 1.2875 before bouncing impressively back above 1.2900. The bounce was impressive because late Sunday headlines in which France and Germany were seen putting pressure on Portugal to apply for EU/IMF aid, could have weighed much more substantially on the major currency in Monday trade. However, reports of ECB bond buying and comments from Japanese FinMin Noda of Japanese interest in Euro bonds, quickly came to the rescue and helped to prop the market, while denials from Germany’s Merkel and FinMin Schaeuble of the Sunday headlines also helped to diffuse the situation somewhat. Also out denying such rumors of a Portuguese bailout was Portugal’s PM himself who said that such talk is only helping speculators and reiterating that the country will not be applying for aid. Key short-term levels to watch above and below in the Euro now come in by 1.3025 and 1.2875 respectively. A close back above 1.3025 will relieve downside pressures, while back below 1.2875 accelerates declines.

Relative Performance Versus USD Tuesday (As of 12:00GMT)

1. CAD+0.17%
2. EURO +0.06%
3. STERLING+0.03%
4. SWISSIE-0.05%
5. YEN-0.36%
6. KIWI-0.69%
7. AUSSIE-0.90%

In the end, we would suggest that the risk is still very much to the downside in the Euro even in the event of any intraday rallies, with the Eurozone peripheral problems still very much alive and not likely to fade away anytime soon. Meanwhile, it is also worth paying attention to Monday’s US equity close, with the weakness in the DJIA potentially warning of some form of a top in global stocks for now. This would be a risk negative event and could very well accelerate broad based Euro declines. Much like the Greenback had been very sensitive to any negative developments while it was under intense pressure in previous years, the Euro now is in a similar position and seems very vulnerable and exposed to any hiccups within the domestic and global economy.

On the data front, the Australian trade balance came in at a surplus but slightly less than was expected. This data proved to weigh significantly on the antipodean, which has already been under pressure as the costs and damages associated with the local flood continue to escalate. In New Zealand, data was actually quite solid, with both building consents and NZIER business confidence exceeding expectations. But while Kiwi has managed to outperform its cousin on the day, the single currency remains under pressure against the USD as broader market forces dominate. Elsewhere, UK BRC retail sales fell for the first time in 8 months as bad weather wreaked havoc with consumers during the holiday period.

Moving on, Goldman Sachs is back in the news, with GSAM chairman O’Neil saying in the FT that the US could make a big comeback in 2011. O’Neil goes on to say that he believes by virtue of this fact that the US will avoid a Japanese style lost decade. While the comments could certainly help to bolster equities a bit, they also may serve the USD well, as any signs of recovery in the US will likely narrow yield differentials back in favor of the Dollar. Finally, a NY Times article entitled “Euro’s architect warns about currency’s future", has been getting some attention as Ex-ECB member Issing warns that the “Euro’s existence could be compromised unless countries find a way to impose tougher spending curbs on one another and develop a consistent fiscal policy.”

Looking ahead, the economic calendar is quite light into North America. US NFIB small business optimism (94.5 expected) is due at 12:30GMT, followed by Canada housing starts (180.0k expected) at 13:15GMT. US wholesale inventories (1.0% expected) are then out at 15:00GMT. On the official circuit, Fed Plosser speaks on the outlook for the economy at 13:30GMT, while Fed Kocherlakota takes to the stage later on in the day at 19:00GMT. US equity futures have recovered a bit and currently point to a firmer open. Commodities are also bid with gold leading.

TECHNICAL OUTLOOK

EUR/USD:The market remains under some intense pressure, with the latest break below key support by 1.2970 confirming a medium-term lower top by 1.3500 and opening a fresh downside extension towards next key support by 1.2585 over the coming days. Despite the latest drop, daily studies are still not quite oversold and show plenty of room for additional weakness before even considering a material bounce. As such, we expect any intraday rallies to be well capped ahead of 1.3300. Back under 1.2875 accelerates.

USD/JPY: The market appears to be locked in some consolidation with clear directional boas not easily determined. The latest rally has stalled out by the Ichimoku cloud top to suggest that the pressure still remains on the downside for now. Back below 82.00 should accelerate declines and expose the multi-year lows from 2010 just ahead of 80.00, while back above 83.70 will relieve downside pressures and shift structure back to the topside.

GBP/USD: The market remains under pressure and now seems poised for a retest of the platform base from early September at 1.5295. Daily studies are however in neutral territory so we would not rule out the possibility for more of a bounce towards the 1.5700 area over the coming sessions from where a fresh lower top will be sought out ahead of an eventual drop to challenge and break 1.5295. In the interim, we remain sidelined and await a clearer signal.

USD/CHF: Overall price action is certainly concerning for our longer-term basing outlook with the market dropping to fresh record lows by 0.9300 thus far. However, cyclical studies are showing oversold and any additional declines below 0.9300 are not seen as sustainable. The latest bounce back above 0.9600 is certainly encouraging and the rally has also triggered the break of the previous weekly high to set up a bullish reversal week. Look for continued acceleration of gains back above parity over the coming sessions, with any setbacks expected to be well supported above 0.9500 on a close basis.

FLOWS

A well followed investment bank is said to have offers in the 1.3000 zone in Eur/Usd, Eastern European names were noted dip buyers earlier and a Middle Eastern account sales have been seen. An ACB is winning out against reported supply in Cable, a UK clearer was among the sellers. A real money account has been a noted buyer in Usd/Chf this morning to little lasting impact.

TRADE OF THE DAY

EUR/CHF:While I recognize that the entry on this trade is somewhat unconventional, I am a big fan of the trade and am really liking the way price action is unfolding here. The market had come back under some intense pressure since breaking back below 1.3000, with the declines resulting in a drop to fresh record lows below the September 1.2765 bottom to 1.2400 ahead of the latest minor bounce. However, given the intensity of the drop, we still retain a longer-term constructive outlook, and with daily studies once again showing oversold, any additional declines below 1.2400 are not expected to be sustained. The market actually looks to be carving an inverse head & shoulders baseon the hourly chart that should accelerate gains towards 1.3000 on a break back above the 1.2730 neckline over the coming sessions. The recovery back above 1.2500 and ability for the market to now consolidate the recent gains is encouraging for our reversal outlook and as such, we have established a fresh long position in anticipation of the neckline break over the coming sessions. Our stop is just under the record low.POSITION: LONG @1.2550 FOR AN OPEN OBJECTIVE; STOP 1.2390. (We are aware that risk is a little larger here in terms of points. As such, some miight be more comfortable trading the position at 0.75x leverage. For example, a $10,000 account would take a 7.5k position size here instead of a 10k position)

Current Currency Rates

Currency Unit	USD per Unit	Units per USD
	USD United States Dollars	1.0000000000	1.0000000000
	EUR Euro	1.2949749577	0.7722157050
	GBP United Kingdom Pounds	1.5577215700	0.6419632489
	CAD Canada Dollars	1.0070308328	0.9930182547
	AUD Australia Dollars	0.9958374387	1.0041799606
	JPY Japan Yen	0.0120767154	82.8039714479
	INR India Rupees	0.0220628656	45.3250279426
	NZD New Zealand Dollars	0.7635804778	1.3096196526
	CHF Switzerland Francs	1.0329236654	0.9681257517
	ZAR South Africa Rand	0.1464558513	6.8279962279

More on Payrolls

The U.S. dollar performed extremely well during the first week of 2011 thanks to stronger service and manufacturing activity and the hope that December non-farm payrolls would be strong. Unfortunately investors were sorely disappointed by the Friday's release, which showed the U.S. economy only adding 103,000 jobs last month.  With the consensus forecast at 150,000 and the whisper number ranging from 300,000 to 500,000 only a handful of traders expected such weak job growth and as a result, the dollar gave back some gains.  

The softer employment report created uncertainty in the forex market, making everyone realize that buying dollars is not a one-way trade.  Retail sales are due for release this week and the prospect of softer consumer spending could weigh on the dollar.  

Where are the Jobs?

Throughout the past year, the missing ingredient in the U.S. recovery has been jobs.  As the U.S. economy stabilized, American companies stopped cutting workers but the main problem is that there has been little hiring. Before the Federal Reserve can even consider raising interest rates, the unemployment rate needs to fall below nine percent and even with the latest decline, we are long way from that point.

What's Next?

Life after non-farm payrolls may not be so bright if the reports from retailers are accurate.  The holiday shopping season was supposed to be very strong but approximately half of the retailers reporting last week missed expectations.   This does not bode well for the New Year especially with the profit margins of retailers being squeezed by higher commodity prices.

Fed's Conundrum

There are still too many uncertainties out there to convince the Fed to tighten before the end of the year and the prospect of weaker retail sales could cause the dollar to give back its gains as investors take profits. In the December FOMC minutes, the Federal Reserve reminded us that their dual mandate is maximum employment and price stability. Maximum employment is a very high bar that will take a long time to meet which means the Federal Reserve is still not thinking about normalizing, let alone tightening monetary policy.  

Aside from the retail sales report, the trade balance, industrial production, consumer confidence and inflation numbers are also scheduled for release from the U.S. along with the Federal Reserve’s beige book report.  Continued strength in U.S. economic data could help the dollar sustain its gains, but any weakness could lead to additional profit taking.  

Beyond U.S. Borders

Outside of the U.S., it will also be a busy week down under.  You may have heard that Australia is fighting a massive flood in Queensland, the country’s coal belt.  The impact of the floods on the Australian economy has caused the Australian dollar to fall significantly along with expectations for tightening by the Reserve Bank this year.  

Last week’s economic reports were also disappointing with service and manufacturing activity slowing.  Should this week’s retail sales, trade and employment numbers also fall short of expectations, the Australian dollar could extend its slide.  The Aussie was one of the darlings of the currency markets throughout 2010 and even though we believe that the Australian dollar will regain its legs this year, the near term shock from the flood appears to be too much for the Australian dollar to handle. 

The Chart: AUD/USD

The Australian dollar / U.S. dollar currency pair is our chart of the week. See Figure 1, courtesy of GFT Dealbook. After hitting a record high on New Year’s Eve, the AUD/USD has lost more than three cents.  If the currency falls below the 50-day simple moving average (SMA) at 0.9920, then the next area of support will be around 0.9735, where we have the 100-day SMA and the 23.6% Fibonacci retracement of the May to December rally.  Should the AUD/USD start to recover, it will find resistance at parity (1.0), which is a former support turned resistance.