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May 10, 2007

Unwinding of Carry Trade Part II
by Ashraf Laidi

Has the FOMC statement overlooked the US consumer? We mentioned in our early afternoon note that today's (Thursday) equity market sell-off reflected a sharp reduction in risk appetite triggered by dismal figures from the nation's top retailers, which raise fears of a correction in US consumer demand and prompt a hard landing in the economy. US retailers posted their biggest sales decline on record in April - a 2.3% decline as reported by the International Council of Shopping Centers. The report prompts worries that Friday's release of April retail sales will come in negative, in which case will begin to weigh on the US dollar on resurfacing expectations of a Fed easing. This slowdown-driven sell-off occurs one day after the Federal Reserve failed to recognize the weakness in April payrolls, March consumer expenditures and cooling in inflation.

February 27 Repeat?

Unlike the Feb 27 global slide which started from falling Chinese equities, today's market slide originated from poor reports on individual US retailers, which fuelled nervousness of an overstretched US consumer unable to prolong the momentum in equities. Consequently, US equities became the first casualty in what we expect to prolong into a global sell-off in Friday Asian and European trade. In the event that Friday's US retail sales come in negative, the effect will become more dollar specific.

But it 's important to note that next week's US data schedule will include a vital concentration of figures, including CPI, TICS, industrial production, Housing Market Index, housing starts and Philly Fed survey. The combination of market volatility and concentration of such important figures does remind us of the week of Monday February 26, when the array of US data and equity selloffs created a bitter recipe to investors.

Unwinding of Carry Trade Part II

In the event Asian markets extend the US sell-off - as we anticipate - then we should expect prolonged declines in USDJPY (119.30, 118.80), GBPUSD (1.9650), AUDUSD (0.8180), AUDEUR (0.6095). We expect EURUSD to stabilize at the 3-month trend line support of 1.3465-70, backed by foundation at 1.3420. The pair should accumulate momentum towards the 1.3530s in the event of a negative retail sales figure.

We also anticipate further gains in USDCAD towards the 1.1170s and 1.1220s in the event that US retail sales (8.30 am EST) come in flat, but more importantly the Canadian jobs report (7 am EST) expected to show net employment weaken to 18K in April from 54K, with the unemployment rate remaining steady at 6.1%. With the bias currently in favor of USDCAD, the path towards 1.12 is that of lesser resistance.

Ashraf Laidi
CMC Markets NA

Ashraf Laidi is the Chief FX Analyst at CMC Markets NA.

This publication is intended to be used for information purposes only and does not constitute investment advice. CMC Markets (US) LLC is registered as a Futures Commission Merchant with the Commodity Futures Trading Commission and is a member of the National Futures Association.

Copyright © 2006-2008 Ashraf Laidi

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