The risk trade is on! - thanks to a sharp rise in pending home sales and moves by central banks in Asia. The extension of the housing tax credit has helped to boost pending home sales by 3.7 percent, the strongest increase on record. Given that the housing and manufacturing sectors were the hardest hit in the global slowdown, as long as both sectors continue to recover, risk appetite can be sustained. Manufacturing ISM fell short of expectations but so far, the dip has failed to take the steam out of risk rally. The stronger numbers could help the dollar recover modestly but we do not believe that they have enough punch to take the EUR/USD back below 1.50 today and will only prevent it from making a new yearly high.
In the month of November, manufacturing ISM fell from 55.7 to 53.6. This is the fourth consecutive month that ISM is in expansionary territory. Aside from new orders, exports and imports, the rest of the underlying components of ISM all declined. However it is important to realize that new orders and exports are direct beneficiaries of a weaker dollar which suggests that the depreciation in the greenback is holding up the U.S. economy. This is the single biggest reason why the market has downplayed the Federal Reserve and Treasury's calls for a stronger dollar, because traders know that at this point in the recovery, a weak dollar helps more than it hurts the economy. The only reason why they have made conflicting comments is to appease their trade partners.
However rather than sit idly and watch the dollar fall, the Japanese attempted to take measures into their owns hands - the only problem is that they fell short. The new Democratic Party held a special meeting on the economy last night and they had the opportunity to completely turn the Yen around. Unfortunately they did not decide to intervene in the foreign exchange market and sell the Japanese Yen and instead simply increased their Quantitative Easing Program by 10 trillion. This has halted the rise in the Yen but we believe that this will only be temporary. By not intervening last night, the Japanese government has signaled to the market that at 85, USD/JPY is a threat to the economy but does not create an emergency situation that would warrant the first intervention by the Ministry of Finance in 5 years and the first by the DPJ. Yet the bottom line is that the government increased stimulus which should help to spur the recovery. As for Reserve Bank of Australia, their decision to raise interest rates 3 months in a row is a clear vote of confidence on the economy and the reason why traders continue to buy the commodity currencies.
Looking ahead, the countdown begins for non-farm payrolls, which is due for release on Friday. The employment component of manufacturing ISM fell from 53.1 to 50.8, which is marginally above the 50 boom/bust line and suggests that the pace of improvement in manufacturing payrolls has slowed. Based upon the jobless claims figures, we expect non-farm payrolls to fall less in November than in October. Traders will be looking to the ADP and service sector ISM report for more confirmation over the next 48 hours. Expectations for a stronger NFP number could help to sustain the risk rally even though a push to new a yearly high in the EUR/USD may have to wait.
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