CHOPPY DAY FOR FORE WITH WARNINGS FROM ALL CORNERS

By Andrew Wilkinson, Senior Market Analyst, Interactive Brokers

The dollar moved ahead despite a weaker than forecast headline number for fourth quarter GDP as analysts focused on an ex-inventory number showing the world’s largest economy rose at its fastest pace in 26 years. The dollar had weakened earlier after Moody’s threw its cards on the table sending a warning to lawmakers over further expansion of the budget deficit. The revenue shortfall is in danger of becoming greater rather than smaller as everyone seems to agree it needs. The ratings agent warns that the government is running out of time in the event it wants to avoid a downgrade.

U.S. Dollar – Fourth quarter GDP rose at 3.2% driven by a surge in spending from an increasingly optimistic consumer. We’ll find out later today whether the University of Michigan’s consumer confidence series expanded from a December reading of 72.7. Within today’s growth report consumers spending 4.4% more in the final quarter than in the prior quarter. And although the headline reading fell short of predictions by a touch, it is a healthy reading that confirms the revival of the consumer-driven economy. The pace of growth jumped from a third quarter rate of 2.6%. Stripping out inventories the economy surged by 7.1%, which is the fastest pace since 1984. The dollar index, which was lower for most of the morning, rebounded following the report. Weighing on the dollar earlier was a warning from Moody’s that the United States was running out of time in reducing its budget deficit on account of risks associated with spending cuts and the recent extension of tax cuts.

Japanese yen – Earlier in the week the Governor of the Bank of Japan reiterated his stance that the economy would soon emerge from a period of recession characterized by falling prices. Mr. Shirakawa appeared vindicated in a slew of data out at the end of the week including an unexpected decline in the rate of unemployment to 4.9% to end the year. That was the first drop in three months. A decline of 0.4% in the consumer price index (excluding food and energy costs) marked the smallest decline in two years helping somewhat reinforce the Bank’s latest prediction for a return to an annual rise in consumer prices through the next fiscal year end in March 2012. The yen reversed Thursday’s decline inspired by a downgrade to its sovereign credit rating from S&P and gains were accelerated on news that the dollar faced a similar fate if it failed to get its house in order. Following the U.S. GDP report the yen remains higher on the day at ¥82.36. It’s also firmer against the euro, which buys ¥112.85.

Euro – One can’t help but think that the ever-tighter daily trading ranges for the euro might mean that it’s running out of rungs to climb. The single currency wasn’t able to capitalize even on the headline weakness in the U.S. report on Friday, with an immediate spike confined to $1.3735. The euro was earlier bolstered by a speech from ECB member Gertrude Tumpel-Gugerell who reminded lawmakers that the ECB was charged purely with price stability and that it could only promote stability of the euro-bloc if member states maintained sound and healthy finances. Tumpel-Gugerell said that there was no flaw in the initial concept of monetary union but said there is “weakness in the implementation of the concept.” The rousing speech possibly inspired bulls to rally around the euro earlier, but the rest of us are still waiting for some meat on the bones to fall from the dinner tables in Brussels. The euro last traded at $1.3692 and is heading towards a new low on the session.

British pound – An earlier slip in the dollar helped the pound recover to $1.5967 even after the sharpest slip in 20 years for a confidence index reported by GfK. Consumer confidence declined by eight points to -29 for January from -21 earlier. Trade body CBI also confirmed retail sales weakness with a drop in its measure from 56 to 37. The pound is now lower on the day at $1.5911 following words from Davos, Switzerland at the World Economic Forum by Prime Minister Cameron who reiterated that investors had been repeatedly warned that the voyage to recovery would never be anything but choppy. His reference to shockingly poor British growth data reflects on an unexpected economic contraction in the final quarter of 2010.

Aussie dollar – The imposition of a levy on middle-to-higher income earners in order to help flood-damaged regions of the country rebuild has chipped away confidence that the central bank will again raise interest rates. Prime Minister Julia Gillard’s taxing initiative is likely to cause a second-half drag on consumer spending and force the RBA to rethink its policy. The Aussie weakened overnight, but has snapped a three-day decline following the words of Treasurer Wayne Swan. He predicted that labor markets would become further stretched and that consumer prices would rise in response to the flooding estimated today to be A$5.6 billion. Swan said that in the first quarter he estimated consumer prices to be 0.25% higher and growth to be 0.50% lower than without the flooding. The Aussie jumped to buy 99.87 U.S. cents in early morning New York trading and has pared gains lately to buy 99.61 cents.

Canadian dollar – Also speaking in Davos, Switzerland at the World Economic Forum by was Bank of Canada Governor Mark Carney who warned over the threat to economic growth from a persistently strong Canadian dollar. He welcomed signs of U.S. economic recovery as “very welcome” and supportive of further output expansion in Canada. But he also served up warning that emerging market governments must continue to act against expansion through raising monetary policy further. Mr. Carney warned that the expansions in some venues was likely to be unsustainable thereby posing a threat to the global economy. The Canadian unit is lagging the greenback today at $1.0050 U.S. cents.

Andrew Wilkinson Senior Market Analyst