USD: Expect More Housing Weakness

It has been a quiet start to a busy trading week with equities consolidating after Friday’s sharp losses and the dollar trading mixed against other major currencies. The greenback strengthened against the pound, Japanese Yen, Canadian and New Zealand dollars but weakened against the euro and Australian dollar. The lack of market moving economic data explains the lack of follow through and reversals in forex market. However traders should consider this the calm before the storm because with a heavy earnings week, two testimonies by Federal Reserve Chairman Ben Bernanke and the EU stress test results set for release on Friday, it should be anything but quiet.

Expect More Weakness in Housing

At the onset of the U.S. recovery, the housing market and the manufacturing sector, which were the first to be hit by the recession were also the first to recover. However the recovery has been uneven and recent data indicates that without the government tax credit, the real estate sector would still be in the red. Many people will beg to differ and argue that the sector remains very depressed, which is true in many ways but the point that we want to make is that this week’s data will most likely show additional signs of weakness. The National Association of Home Builder confidence survey (NAHB) was the only piece of U.S. data released today and unfortunately the report showed confidence slipping to the lowest level in 15 months. Readings below 50 indicates that pessimism exceeds optimism which means this month’s reading of14 from a downwardly revised reading of 16 the previous month is exceptionally bad. According to the NAHB Chairman “We continue to see a lull in home buying activity following the expiration of the federal home buyers tax credit program as many of the sales that would have occurred this summer were likely pulled forward to meet the program’s deadline.” “In addition, builders are reporting continuing hesitancy regarding home purchases due to uncertainty in the overall economy and job markets.” The softness in housing is expected to be confirmed by tomorrow’s housing starts and building permits numbers. Even though the Obama Administration extended the home buyer tax credit to September 30 ^th , this only applies to closings. The contracts still needed to be signed by April 30 ^th .

The stability in the forex market and the rally in U.S. equities can also be attributed to optimism about this week’s earnings reports. IBM is scheduled to announce this evening followed by Apple, Yahoo, Goldman Sachs, Morgan Stanley and Pepisco on Tuesday. Coca-Cola and Ebay’s reports are scheduled for Wednesday followed by earnings from companies such as American Express, Caterpillar, AT&T, Microsoft and Amazon on Thursday. So far earnings reports have not been as weak as many had feared and so investors are optimistic ahead of these key releases.

EUR: SHRUGS OFF IRISH AND HUNGARIAN WOES

The euro extended its gains against the greenback despite a breakdown in talks between Hungary and the IMF and news that Moody’s downgraded Ireland’s debt rating from Aa1 to Aa2. The resilience of the euro in the face of weakness in other currencies suggests that hedging related exporter demand continues to support the currency. Concerns about the effectiveness of Hungary’s austerity programs caused the IMF to pull out of bailout-loan talks which have put at risk their ability to tap into the EUR20 billion rescue package negotiated in 2008. If the IMF and Hungary do not come to agreement by September, Hungary could face further downgrades. After this news broke, rating agency Moody’s said their rating for Hungary assumes an agreement later this year and this is “bad news.” They still believe that an agreement will be achieved but at least we are aware of consequences in case it doesn’t. Over in Ireland, rising debt, weaker growth and the risks in the banking sector have caused Moody’s to downgrade Irish debt. The outlook is stable which means further downgrades are not being considered at this time. Part of the reason why the market shrugged off the news is because the downgrade brings Moody’s rating in line with Standard & Poor’s and is slightly above Fitch’s levels. Considering that Moody’s rating for Italy is 2 notches higher than that of S&P, we would not be surprised if they were the next one to fall under the knife. Meanwhile the latest current account numbers showed deterioration in trade. The current account deficit rose from –EUR5.6B to –EUR5.8B with the nonseasonally adjusted deficit doubling in the month of May. Construction output also fell significantly, indicating weakness in the housing sector. German producer prices are scheduled for release tomorrow. According to Bloomberg, Hypo Real Estate Holdings in Germany is said to have failed the government’s stress test. They are expected to be the only German bank to fail, but they will not collapse because they have been taken over by the government who will not let them fail.

Impact of EU Stress Tests on Euro

For the better part of this year, the exacerbation and settling of concerns surrounding balance sheet problems in Europe has commanded the volatility in the financial markets. This Friday, it is believed the EU bank stress test results will give euro bulls the green light to take the currency above 1.30 and perhaps as high as 1.35. In fact, risk appetite in general hinges upon the outcome of the stress tests.   For currency traders, the most important question is how the results will impact the EUR/USD. The hope is that it will provide the same support to European Financial markets as the U.S. tests did for the U.S. Yet it is important to realize that the results of the U.S. bank stress tests did not help the U.S. dollar. In fact, the greenback has sold off aggressively against both the euro and Japanese Yen since May 7 ^th , 2009. Of course, the weakness of the dollar was a reflection of easing safe haven flows and not concerns about the U.S. banking sector exacerbating. In fact, the performance of U.S. stocks confirms that the stress tests were a big success. Therefore as long as the results provide sufficient answers to the top 5 questions outlined above, the EUR/USD should receive a nice boost following the announcement. However if any of the 5 questions are insufficiently addressed and we think this is a significant risk, there could be a classic buy the rumor sell the news move in the EUR/USD that causes it to give up recent gains.

Full Story: FX360.com