Encouraging nfp numbers on Friday did not have the desired effect in the short term as yesterday both the euro and pound finally reacted to the closing doji candles.
The big news today is the Fed interest rate decision and the issue is whether the cut will be 25 or 50 points. The consensus appears to suggest that given Friday’s numbers the Fed will only need to reduce rates by 25 points, just enough to placate Wall Street and a small Christmas gift to the consumer to encourage spending. Any more than 25 points also seems unnecessary as the US government has formulated a rescue plan to help the victims of the sub prime crisis.
Any rate cut will also boost share prices and this will be reflected in the usual carry trade as the appetite for risk returns. Nzd yen and euro yen both look poised to make positive upward moves today.
While the euro too will derive a short term boost to the announcement, the situation with the pound is complicated by release of the trade balance figures which are expected to show increasing deterioration and an increase to the record deficit posted for September.
Although markets have not been particularly sensitive to trade data over the past few months, it is worth noting that most UK economic cycles have ended with a sudden loss of Sterling confidence as the trade situation has deteriorated. It is also important to note that the US trade deficit has shown evidence of improvement while the UK deficit has continued to widen. This is not surprising given dollar weakness.
The import side will also be watched closely as any increase could signal continuing consumer spending which would help offset the negative impact on Sterling of a wider trade deficit.
Sterling’s initial reaction will still be determined by the headline figure and the pound should gain some near-term relief if the deficit is below GBP7.5bn. In contrast, any increase in the deficit above the GBP7.8bn recorded last time would trigger initial Sterling losses while a shortfall above GBP8.5bn would trigger sharper selling.
The impact would be magnified if there is weakness in both exports and imports as this would suggest a deteriorating economy while strong readings for exports and imports would help support cable.
The above is, of course, reflected in the chart as the rate hovers close to 2.05. Favourable trade data will allow cable to bounce off this level and possibly make its way back to 2.07. We can only wait and see.