The declines are widely speculated as a normal correction.  In particular, gold was due for a mild correction as the commodity rallied wholeheartedly by 5.5% since the Federal Reserve commitment for looser monetary policy.  The selloff has some technicians eyeing the next round of support which is expected to loom over the $1,700 figure in the short term.

Nonetheless, the commodity declines are forcing both the Australian and Canadian dollars lower against the greenback.  At midday in New York, the Australian dollar is trading at 1.0733, down by 0.16% – and falling from key resistance at the 1.0800 short term technical barrier.  Canadian dollar losses have been approximately on par with the Aussie, falling by 0.16% against the US dollar.  The loonie currently trades at an exchange rate of 0.9960.

Tonight’s central bank decision by the RBA is adding to the overall sell sentiment – with many traders in the market expecting a rate cut of 25 basis points.  The sentiment has been heightened – increasing the probability of a cut a bit over the 50% mark – following worse than anticipated retail sales figures in the overnight.

According to the construction sector survey, index readings dipped to a 51.4 in January – below the December 53.2 mark.  Although this is the 13th consecutive month of gains, the figure stands as the weakest reading in 4 months and compounds fears that the recession isn’t just over yet.  Notably, however, today’s survey findings still portend to a thin silver lining for Europe’s second largest economy.  According to subcomponent readings, confidence among construction companies and business leaders continues to be optimistic – although the same companies are unlikely to add to current payrolls.

The recent round of optimism seems to have been spurred on by improving month to month comparisons in recent weeks.  Notably, manufacturing sector activity improved to an 8-month high, while confidence among consumers recovered to the highest in almost the same time period.

Given the overwhelming and rising optimistic sentiment, today’s results may be temporary as traders begin to shift their sentiment to a potential turnaround in the UK economy.  This should support the current sterling momentum – if at least for another session or two.

Economic Pessimism

Pure fundamental reasoning for the recent downturn has some in the market convinced that further dollar weakness is sure to come.  Although the European economy is down in the dumps as well, the masses seem to be focusing on the growing twin deficits currently held by the U.S.  The same concerns helped to support a higher Euro valuation just five years ago, when estimates had calculated a fiscal shortfall of $700 billion.  Chump change to what experts are now shuddering at when considering the plethora of programs that have been approved by the current administration.  Participants of the era will also scarcely remember falling employment as well.  All in all, current budget deficits will have to be funded by an increasing number of Treasury debt issuance, adding to an already bloated credit bill that is surely to decrease the confidence in U.S. based debt.

Carry Trade Bandwagon

It used to be the Japanese yen that was the butt of all carry trades in the last two to three years.  However, now it seems that the greenback is the funding currency of choice.  It makes perfect sense as the Federal Reserve has made significant cuts to the benchmark interest rates over the last 20 months in order to accommodate the underlying credit markets.  But at what cost?  With benchmark rates at the record low of 0.25 percent, traders will continue to sell the U.S. dollar short, helping out the Euro.  Making it even worse is the fact that U.S. rates aren’t expected to be raised until after all of the other G7 central banks have their turn.  Although expectations were hovering around a 40 percent chance of a 25 basis point increase by the Fed in the fourth quarter, those estimates have dwindled and placed a higher likelihood of that happening at the tailend of the first half 2010.

Dollar Doldrums: Central Banks Want Out

Additionally, central banks have played their part in rumors and threats as entities in all parts of the world have begun to talk the dollar down.  Earlier this summer, BRIC nations complained about their exposure to the dollar with Russia leading the way for a supranational currency or preferential trading of special drawing rights backed by the World Bank.  All of this talk of currency conversion has done nothing but increase already nascent speculation that a massive Euro conversion may happen as nations attempt to diversify out of U.S. dollar based assets.  This is of particular interest as three of the five aforementioned nations have risen up the currency reserve ladder (#1 China, #3 Russia, #5 India), with the fourth (#8 Brazil) not too far behind.  As long as there remains the underlying discomfort between the greenback and these nations, there will be a supported preference for anything other than U.S. currency.

The Monkey Wrench

Given the recent facts and trends, Euro strength looks to be here to stay.  Even if European Central Bank President Jean Claude Trichet begins his dutiful jawboning of the detrimental effects of a stronger currency, speculators are likely to keep pressing the currency higher.  The only caveat seems to be in the form of an earlier economic assessment of the Euro region.  Given the fact that interest rates remained relatively high in the area, economic growth may be slow to come.  The slower growth will likely keep European nations behind the current recovery and force policy makers to drag heels when it comes to raising rates in the near future.  Should this economic stalling actually take place, the current euro momentum may be placed in jeopardy.

According to this morning’s Bank of England minutes, central bankers voted unanimously to hold interest rates at a record low of 0.5 percent.  As “recent developments were not sufficiently compelling to justify” a change in current monetary policy, the BoE saw nothing in justifying any rate increases as well as an expansion of the Quantitative Easing program.  The plan is currently set at 175 billion pounds.  Although the report was stable and expected, any further momentum higher in the currency will likely be dependant on the November 5^th meeting.  During this time, central bankers will review growth forecasts in order to better assess the current economic situation.  Forecasters have already noted that the UK economy may have very well exited the recession back in the third quarter with a 0.7 percent tick higher.  However, any visible weakness in the GDP figure may prompt another 25 billion pound increase in the asset purchase program, giving the underlying pound a bearish tone.

Notably, Governor Mervyn King was quoted in an individual article saying that interest rates in the U.K. will likely rise in the future “at some point”.  He also cautioned that “it would be wise to take this into account”.  Not only does this signal a potential shift in monetary policy, but also a shift in personal attitude as it seems that the UK monetary authority may see some signs of a stable economic foundation.  The statement also helps to fodder a sentiment that interest rates may be set to rise in the broader market, leaving the U.S. as the last player that will consider the option.  On this ticket, the British pound skyrocketed higher from the 1.6384 close yesterday in New York, to trade as high 1.6598.  Although a medium term pullback is highly likely, the sentiment may give plenty of support for anti-dollar buying throughout the day.

Now granted, this figure does not guarantee every employee that works at the bulge bracket bank this amount.  However, it does raise some eyebrows when considering the institution borrowed taxpayer funds in order to buffer itself from one of the worst financial crises in history.  Even more patronizing are the rumors that have suggested a $1 billion charitable donation by the investment bank.  The idea is enough to draw attention from the bonus hoopla – if only temporarily.

Nonetheless, Wall Street bonuses are set to rise at a time when unemployment has risen to double digit figures and productivity has slowed to a crawl.  How can this be?

• Bonuses for 2009 are expected to be higher due to lower bonuses offered to top players in 2008.  Companies involved in the last year’s meltdown were unlikely to pay high bonuses due to the wrangling that went on at the end of the year.  Now with the structures back in place and institutions on the mend, management is set to offer payouts which are going to be higher than last year.  For the record, compensation in 2008 was approximately 10 percent less than in 2007.

• Bonus structures have been revamped to accommodate the individual rather than the department.  As a result, higher payouts are likely required in order for groups to retain top talent.  Should an individual see a rather unappreciative boss, they may be more inclined to switch – taking their business down the street or overseas.

• Growth has been extraordinarily rich for the surviving investment banks.  With some earnings being boosted by recent acquisitions (Bank of America/Merrill Lynch and JP Morgan Chase/Bear Stearns), firm revenues are expected to be supported well past 2007’s big numbers.  A record $345 billion was recorded by Wall Street firms.  The number is being compared to this year’s figures for total revenue – which are already expected to come in at the high end of $440 billion.

However, all this talk may be for nothing as most of the recently printed figures are all estimations and hearsay.  The biggest consideration of all may come in the form of an announcement by Kenneth Feinberg this week.  The Pay Czar is schedule to issue statements on compensation packages at seven financial firms that receive federal funding, including well known bulge bracket banks.  Should compensation cause Feinberg to step back a little, be sure that the current administration will have something to say about it.

What remains worrisome is the current trend of a strong underlying Loonie.  The greenback has already lost close to 20 percent against the Canadian counter since the end of March 2009.  Further appreciation in the currency may choke off early signs of growth as well cause further damage to expansionary possibilities in the medium term.  Nonetheless, speculators will likely toss aside recent comments as prospects for the CAD continue rise, a trend that has been preferred since the summer months.

U.S. initial jobless claims surprised the masses as first time claimers of unemployment benefits fell last week to a level not seen since the beginning of the year.  For the week, applications dropped by an impressive 33,000 to 521,000 – significantly lower than the 540,000 that was predicted by analysts.  Today’s weekly Labor Department report conflicts with last week’s non-farm payrolls figure, giving some hope that there is now stabilization in the broader labor market.  Subsequently, the four week moving average has now dropped a haircut below 540,000, setting up for another interesting employment release next month.

As expected both the European Central Bank and the Bank of England have kept their interest rates steady following announcements this morning.  However, key elements have now sparked some speculation to the downside, which may help the greenback gain some traction against both the Euro and pound sterling.

Keeping interest rates at a record low of 0.50%, the Bank of England is likely waiting till November to make any real decisions regarding monetary policy.  Although confidence has edged up slightly, along with some recovery in the housing sector, things haven’t really improved in the UK economy.  Manufacturing continues to place a lag on overall productivity as labor concerns continue to swirl – last print has unemployment in the country soaring to 7.8 percent annually.  The fragility of the economy has now placed even more emphasis on any possible extension of the Quantitative Easing plan.  Already at 175 billion pounds, there is still hope that the plan will be extended another 25 billion in order to pump even more funds into the market in order to prop up the economy.  Such a move will place significant pressure on the British currency as supply will overrun demand.  As a result, look for upcoming economic data to heavily influence the central bank November decision.

European Central Bank members additionally decided to keep to their key benchmark interest rate, citing that current level of interest rates remain “appropriate” for the time being.  This decision is likely to remain for an extended period given the fact that economic growth seems choppy at best for the region.  Production has improved slightly, contrary to overall labor markets which continue to remain weak.  Should policy makers increase lending rates to soon, risks remain abound that current nascent growth will be choked off.  As a result, the ECB will likely continue to work with lenders to free tight lending markets and hope that firm stabilization will come sooner than later.  Nonetheless, the underlying currency continues to be well supported against the U.S. dollar on worrisome economic fundamentals in the world’s largest economy.

Both full and part time positions were filled, with the former gaining by an impressive 35,400 positions.  Additionally supportive for the overall positive number was the increasing demand for infrastructure positions on the rising number of governmental projects.

Nonetheless, rising for the second time in three months, tonight’s unemployment report gives Australian dollar fans plenty to be cheering about.  The recent spate of information blends well with retail sales support and rising consumer and business sentiment.  As a result, yesterday’s rate decision by the Reserve Bank of Australia seems to be justified, helping the Australian dollar gain further traction against the U.S. dollar – skyrocketing to a 13-month high at 0.9015.

Further strength can be expected in the medium term as it seems confidence in the country’s rebound prospects remain well supported compared to the economic picture of the U.S.  Expectations are already growing of another rate increase in the last two months of the year, by an additional 25 basis points.  This fact alone will help further ingrain the carry potential of the Aussie versus the greenback as the latter continues to be the “funding” currency of choice.

Proof is in the Pudding

For Australia, the choice to be the first G-7 country to increase rates, comes at a time when figures have become very promising.  According to the Governor Glenn Stevens following the rate decision, “overall, growth through 2010 looks likely to be close to trend.”  The tone is decisively more positive when compared to previous statements made during most of this year, citing that a low interest rate environment would be beneficial for the country.  Taking a look at some of the recent figures, there is ample hope of this momentum to continue.

• Job vacancies have begun to open up despite an official unemployment rate that ticked higher to 6 percent.  The rate of unemployment actually pales in comparison with other trade partners – some of which are closer to 10 percent.
• Consumer spending has returned to boost overall GDP figures.  For the record, consumer retail sales figures have been buoyed for four of the last six months by cash stimulus distributed in the first two quarters.
• Consumer sentiment has remained relatively positive along with business sentiment.  The turn to a more optimistic tone for both sectors may very well help to sustain the current momentum.
• Inflationary pressures remain subdued.  According to recent figures published by the Bureau of Statistics, the most recent quarterly rate of inflation printed a rise of just 0.5%.  Previous indications held the rate of consumer price increases to 1.5% in the second quarter, still below the benchmark target of 2-3% for the Reserve Bank.

Ranked Above The Rest

Given the recent string of positive economic data, it’s no wonder the RBA elected to increase rates.  With economic growth inching higher and unemployment and housing stabilizing, policy makers will likely turn their focus to inflationary pressures in the short term, and away from growth and recovery.  The theory was echoed through further statements by Governor Stevens.  With “the risk of serious economic contraction” dissipating, “the board’s view is that it is now prudent to begin gradually lessening the stimulus provided” and hopefully “keep inflation consistent with the target over the years ahead.”

What to Expect

The subsequent statements by the Reserve Bank of Australia have helped to support a mini rally in the underlying currency.  With the Federal Reserve likely to react last among G-7 counterparts in raising interest rates, carry trade speculators will continue to jump on the Aussie band wagon.  The sentiment has been more than supported with market participants targeting the fact of further rate increases in the near future rather than just today’s one announcement.

AUD Pairs Rise On The Day

Additional increases in the AUD overnight cash rate will widen the differential between US and Australian rate bearing instruments, making Aussie dollars more attractive.

However, the current momentum may hit a snag should sentiment surface that the RBA may have moved to soon.  New and existing homeowners who have bought into the lower rates are now paying extra per month on domestic based mortgages.  Should this increase in monthly payments deplete potential discretionary income, today’s decision may have very well choked off any further growth in the longer term.