My EURUSD forecast for week ending 8 Nov

The most significant econ data of the week is the US Q3 advance GDP which at +3.5% beat estimates of +3.2%. This is largely a positive for risk sentiment as it marks the bottom of the economy and within the reading’s components; indications were of broad based recovery.

Looking into the details, household spending actually rose 3.4% even as household income fell 3.4%. It seems that instead of de-leveraging, families are returning to spending quite quickly (namely durable goods) and that suggests that this increase in spending might not be sustainable. That number can be largely attributed to cash for clunkers (new cars purchases with a government grant) which just expired.

Meanwhile, residential investment increased for the 1st time in 3.5 years as prices stabilized with help of 1st time home buyers tax credit (again, more government grants) helping real residential investment to rise an astonishing 23.4% after a drop of a similar magnitude in the 2nd quarter. Hence, Q3 will mark the turnaround in the housing market after the subprime crisis. Its sustainability is also questioned but to a lesser extent as the federal govt is likely to continue with the tax credit program until late 2010.

Prior to the release of the GDP data, we saw some risk aversion in the market during which Goldman Sachs downgraded GDP to +2.7%. EURUSD broke below 1.50 firmly and USDJPY came close to breaking the 90 support level as investors pared carry trade.

An observation is that the yen is coming back as the main funding currency now instead of the dollar as short term yields on the dollar at close to 1% is proving very attractive vis a vis yen assets, giving USDJPY support this week (which kept above 90 for the most part). But I the feel the main pair to watch for dollar direction is the EURUSD, the fact that it is now trading below 1.50 for 4 running days goes to show that mkt has been pricing an eventual recovery in the US economy which was confirmed by the GDP release and by extension, the unemployment rate.

Recently there has also been market talk in the WSJ and FT about the fed preparing to change its ‘extended period’ language and the suspicious may think this was induced by some in the fed to prepare the market for an eventual change in language.

In the FOMC meeting next week however, I think the fed will still keep its ‘extended period language’ because recovery is in its early stages and to do otherwise would be disruptive. But they will put more weight and words describing the recovery of the economy and maybe suggest more winding down of securities purchases in light of better corporate funding and financial conditions. QE has ended and would be a thing of the past. All these are dollar supportive as these have to take place before removal of the ‘extended period’ phrase. So even if PMI data and earnings in the earlier part of the week are good, any dollar sell off would be contained. Rangey trading is expected.

My expected range for EURUSD next week (ending 8 Nov): 1.4650 (50 day moving average) - 1.50 (I doubt the market is willing to take on risks before the outcomes of the FOMC on Wed and NFP on Friday.