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Downgrades Kill the Euro with More to Come

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TODAY'S BIGGEST PERCENTAGE MOVERS

THE STORIES IN THE CURRENCY MARKET

EXPECTATIONS FOR UPCOMING FED MEETINGS

CURRENT US INTEREST RATE: 0.25%
12/13 Meeting 01/25 Meeting
NO CHANGE 64.0% 53.8%
CUT TO 0BP 36.0% 40.5%
HIKE TO 50BP 0.0% 5.7%
CUT TO 75BP 0.0% 0.0%

DOWNGRADES KILL THE EURO

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**Early publication

Thin liquidity has meant quite a bit of volatility for the EUR/USD today. The euro fell steeply during the European trading session, recovered during the first half of the shortened North American only to plunge near the close following news that S&P downgraded Belgium. Short squeezes rarely last on thin volumes days and this is particularly true when fundamentals factors are stacked high against a rally in the euro. Over the past 48 hours, we have heard nothing but bad news out of Europe. S&P downgraded Belgium, Fitch downgraded Portugal, Moody's downgraded Hungary and Italy's bond auction was a dismal failure that drove 10 year Italian bond yields to a record high and the EUR/USD to its lowest level in 7 weeks. This morning, Italy sold six month bills at a record yield of 6.5 percent and zero coupon bonds at an average yield of 7.814 percent. In response, 10 year Italian bond yields rose high of 7.322 percent, a painfully expensive level for Italy to borrow. We have warned that one of the most immediate consequences of rapidly rising bond yields are downgrades by rating agencies. We already saw how much damage lower ratings for smaller countries such as Greece, Belgium, Portugal and Hungary can have on euro. A downgrade of Italy or France would surely drive the EUR/USD below 1.30. European officials need to act quickly if they want to prevent Spanish yields from rising to Italian levels and to save Italy from paying more than 8 percent to borrow. Italian bond yields are moving into very dangerous territory and if nothing is done to reverse the rise in borrowing costs, we could get fall into a vicious cycle where borrowing costs rise, triggering more downgrades which then cause yields to increase further and the euro to slide deeper into negative territory.

Eurobonds: Quick Solution?

There is a "quick fix" according to ECB member Paramo, through the issuance of Eurobonds but we all know how Germany feels about the idea. Not only is it impossible under the current EU Treaty which is not as much of problem, since Germany and France are open to Treaty changes but the Germans vehemently oppose jointly guaranteed Eurobonds which would drive their borrowing costs significantly higher as Eurozone debt is collectivized. German Chancellor Merkel has been unwavering in her opposition to the bonds even after a failed auction earlier this week. She may have no choice in the matter if the crisis escalates but if Germany agrees to the issuance of the bonds, it would only be with strict rules imposed on EZ nations to limit their debt and deficit and impose sanctions if they do not meet the requirements. In the meantime, we believe the Germans would more readily support increasing their EFSF commitments before issuing Eurobonds.

Like the U.S., Germany also has a number of important economic releases on the calendar next week including confidence numbers, retail sales and employment but the headlines will be what matters. A number of European officials are speaking next week while EU Finance Ministers meeting in Brussels to discuss ways to end the crisis.

USD: BEIGE BOOK AND PAYROLLS

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It has been a great week to be long dollars with the U.S. dollar ended the week higher against all of the major currencies. Unfortunately as much as Americans would like to see their currency strengthen because it brings greater purchasing power internationally, the appreciation of greenback reflects more risk than relief. It is no secret that the dollar is only trading as a risk currency and even though there is quite a bit of U.S. economic data on the calendar next week this is not likely to change in the near future. Europe's troubles are worsening by the day and the consequences are too severe for investors to care about anything else. Even if this week's U.S. economic reports are strong, if the crisis in Europe escalates, wrecking havoc on the financial markets, the Federal Reserve could need to increase stimulus to protect the U.S. economy from future weakness. With that in mind however, the Federal Reserve's Beige Book report and the monthly non-farm payrolls report will be important to watch. Since the last FOMC meeting, there have been both improvements and deterioration in the U.S. economy. The lack of consistency will make it important to see what parts of their local economies the various Fed districts are emphasizing for growth and weakness. Non-farm payrolls are always important and with jobless claims below 400k for the past 3 weeks, improvement is expected in the labor market. The forecast for NFP is currently 120k compared to a rise of 80k the prior month. Like many countries around the world, the U.S. government has been forced to rein in its debt and one of the ways that it is doing so is cutting government spending which means government jobs. The payrolls report is expected to show losses in public sector jobs but relatively healthy growth in the private sector. Whether this improvement last remains to be seen because banks have laid off employees left and right and these job losses, though small in relation to the monthly change in payrolls are still notable. Aside from the Beige Book report and NFPs, new and pending home sales are also scheduled for release along with consumer confidence, Chicago PMI and the ISM manufacturing reports.

GBP: OBR FORECASTS AND CHANCELLOR AUTUMN SPEECH NEXT WEEK

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For the fifth consecutive trading day, the British pound extended its losses against the U.S. dollar. No U.K. economic data was released overnight but on Thursday, third quarter GDP growth was confirmed at 0.5 percent, the slowest annualized pace since the fourth quarter of 2009, when the U.K. economy was still in recession. Private consumption, imports and exports were revised sharply lower while government spending was revised higher. Although growth accelerated on a quarterly basis in Q3, no matter how you look at it, the data shows that the recovery in the U.K. economy has been anemic at best. The latest CBI Industrial Trends survey confirms that the outlook remains grim. The CBI index fell to -19 from -18 as orders fell by the fastest pace in more than a year. According to the report, firms now expect production activity to remain weak over the next quarter, which does not bode well for Q4 GDP growth. If the European crisis deepens, the U.K. economy could be pushed into recession next year. The Office of Budget Responsibility will release its economic and fiscal forecasts in the coming week and unfortunately we expect these forecasts to be grim which could keep pressure on sterling. Aside from this release, the only other notable reports from the U.K. are Nationwide House Prices, Consumer Credit, Lending, Mortgage Approvals and manufacturing PMI. We will also be keeping an eye out for comments from U.K. Chancellor Osborne who will be delivering his Autumn Economic Statement to the House of Commons.

CAD: BUSY WEEK AHEAD

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The reversal in U.S. stocks pushed the Canadian, Australian and New Zealand dollars lower against the greenback. This week has been a tough one for the commodity currencies, especially the Australian dollar which fell nearly 3 percent percent against the greenback. Although the losses in the New Zealand and Canadian dollars were more moderate, the NZD fell to its lowest level in 8 months while the Canadian dollar slipped to a 7 week low. Throughout the week, the commodity currencies took their cue from risk appetite and unfortunately this will remain the case in the coming week. Nothing matters right now expect for Europe and good news or bad news out of the region will determine how the comm. dollars trade. However with that in mind, it will be a busy week for Canada who will be releasing current account, GDP and employment numbers. A rebound in job growth is expected in the month of November along with a smaller current account deficit in the third quarter and faster growth in September. The key release from Australia will be retail sales and manufacturing PMI, both of which have more downside than upside risks. The only releases from New Zealand will be NBNZ Business Confidence, building permits and the terms of trade for the third quarter.

JPY: CPI EASES FURTHER, BOJ RAISES CONCERNS ABOUT EUROPE

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Most of the Japanese Yen crosses ended the day higher but the reversal in U.S. stocks stripped away most of the day's gains. Weaker economic data from Japan kept pressure on the Yen with consumer prices in Tokyo falling an annualized pace of 0.8 percent in November while CPI across the nation fell 0.2 percent. Inflationary pressures in Japan have been negative for some time now and explain why the central bank has kept monetary policy so easy. On Thursday, the Cabinet revealed that Japanese banks have the greatest exposure to Italian debt among foreign banks after those of France and Germany. This is particularly disconcerting because it means that next to the Europeans, the Japanese are the most exposed to Italy's debt troubles which means that rating agencies could turn to their scrutiny to Japan. However in a separate speech, BoJ Governor Shirakawa suggested otherwise by saying that financial firms have small exposure to Europe's debt problems – regardless of which statement is true, Europe's debt crisis has already impacted Japan by driving the Yen sharply on the demand for safety. Finance Minister Azumi expressed his frustration last night when he said that it is difficult to change the market trend via intervention unless Europe provides details on how it will set up a firewall to contain the crisis. Nonetheless, they reminded the market that they are ready to respond to speculative currency moves without hesitation if necessary. Foreign demand for Japanese stocks and bonds and Japanese demand for foreign assets contracted significantly last week reflecting a general aversion to new positioning in the market. Next week will be a busy one for Japan with retail sales, jobless rate, industrial production, housing starts and manufacturing PMI scheduled for release.

USD/JPY: Currency in Play for Next 24 Hours

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Our currency pair in play for Monday is USD/JPY. Small business confidence is scheduled for release from Japan at 12:00 AM ET / 5:00 GMT which will be followed by U.S. new home sales at 10:00 AM ET or 15:00 GMT.

Even with the strong rally in USD/JPY today, the currency pair remains in the range trading zone which we determine using Bollinger Bands. Resistance is firmly at the first standard deviation Band which coincides with lows from the beginning of the month. Support on the other hand is at 77, where ew have the 50-day SMA and the lower first standard deviation Bollinger Band converging.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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