US Dollar to Extend Gains on Economic Data, Falling Stock Markets

The US Dollar added to gains in overnight trading as investors dumped risky assets on persistent fears of the deepening global recession.

Another dollop of dour economic data threatens confidence and US stock index futures hint at further losses, slipping over -1.6% ahead of the opening bell in Europe.

The US Dollar added to gains against the Euro and the British Pound (down as much as -1.3% and -0.8%, respectively) in overnight trading as investors dumped risky assets on persistent fears that deepening global recession will hurt trade and weigh on earnings. The MSCI Asia Pacific index dropped -3.0% while US index futures slipped -1.6% ahead of the opening bell in Europe.

Japan’s Tertiary Index showed service demand shrank -1.6% in December, the second consecutive month in negative territory. Dwindling export demand has pushed Japanese companies to cut back production capacity and boosted unemployment, weighing on consumption (including that of services) and depressing economic growth. Indeed, data released yesterday saw Japan’s Gross Domestic Product shrank an annual rate of -12.7% in the fourth quarter, confirming the world’s second-largest economy is mired in the worst recession since the 1974 oil crisis.

Minutes from the last policy meeting of the Reserve Bank of Australia offered little that had not been revealed when Governor Glenn Stevens announced the latest in massive interest rate cuts earlier this month. As before, the RBA expects monetary easing as well as substantial fiscal stimulus to “help to cushion the economy from the contractionary forces coming from abroad.” This comparatively rosy sentiment was tempered with a disclaimer warning that the promised boost “would take time to be effective and could be expected to have only a modest effect on the near-term outlook.” Looking at overnight index swaps, the markets are pricing in at least a 0.50% rate cut in March and 75-100 basis points in total easing over the next 12 months.

UK inflation is likely to continue to slow with the Consumer Price Index set to print at 2.7% in the year to January, the lowest in 10 months. Although the easing in the pace of price growth gives the Bank of England scope to continue cutting interest rates as the economy sinks into deepening recession, priced-in market expectations suggest policymakers will remain on hold when Mervyn King and company convene in March. Importantly, this is unlikely to give the British Pound any meaningful lift: recent comments by the BOE chief suggest further rate cuts “may well be required” as the economy slogs in a “deep recession” and CPI falls below the central bank’s target of 2% by end of May. Expectations of further easing put the sterling at a long-term disadvantage against those currencies where up is the only way left for yields to go, suggesting particularly weakness against the US Dollar as traders bet the Federal Reserve will begin to raise borrowing costs by the first quarter of next year. The DCLG House Price Index is expected to lose -10.1% in the year to December, the lowest since record-keeping began in February 2003.

Germany’s ZEW Survey of investor sentiment is expected to rise to -25 in February from -31 in the preceding month. While this is an improvement in mathematical terms, the negative reading continues to show suggest that a minority of respondents expect the economy to improve over the next 6 months. The marginal up-tick in the headline figure will likely owe to an increasing number of respondents who expect conditions to remain the same, a verdict which still supposes the economy will shrink albeit not an increasing pace. A survey of economists conducted by Bloomberg expects German GDP to shed -2.45% through 2009, the worst performance in at least 34 years.

The Euro Zone Trade Balance report is expected to show a -6.7 billion euro deficit in December, amounting to a -67.5% decline in trading terms from one year before. The export sector has been hard-hit by dwindling global demand, widening the shortfall. Meanwhile, the US trade gap has considerably narrowed, with December result showing the smallest monthly deficit in nearly 5 years. The implications for the single currency are quite clear: if imports increasingly outpace exports for the Euro Zone while the reverse is true for the US, this implies a net outflow of money from the regional bloc and into the States, making for long-term downward pressure on the EURUSD exchange rate.

Swiss Retail Sales have room for a bit of an improvement: traders saw the SECO measure of consumer confidence rebounded from record lows last week as inflation came to a near-standstill, boosting Swiss consumers’ purchasing power. Importantly, a print in positive territory is unlikely to be anything more a temporary up-tick: unemployment has risen to a 2-year high of 3.3% and will weigh on disposable incomes as well as prompt precautionary saving; further, the fallout in price growth will work against consumption if inflation turns negative (a reasonable proposition considering CPI printed at just 0.1% in January), for if consumers expect prices to fall in the future they will perpetually put off purchases to get the best possible deal, putting the brakes on spending altogether.