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US Dollar: The Stress Test Question

Last updated 4/22/2009 4:38 PM ET (GMT -5) 0 Comments - Add your comment

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• US DOLLAR: THE STRESS TEST QUESTION
• EUR/USD: EXPORT DEPENDENCE IS GERMANY’S ACHILLES HEEL
• GBP/USD: DARLING’S SOLUTION IS TO RAISE TAXES
• AUD/USD: CONSUMER PRICES DISAPPOINT
• USD/CAD: LEADING INDICATOR SHOW LIMITED GROWTH POTENTIAL
• NZD/USD: FALLS 2.0% AGAINST YEN
• USD/JPY: JAPANS EXPORTS IMPROVE

EXPECTATIONS FOR UPCOMING FED MEETINGS

US DOLLAR: THE STRESS TEST QUESTION

This week’s primary influence has been deeply rooted in speculation over stress test results as well as the flood of earnings reports that, so far, indicate that profits are on the rise. These mixed signals have been too much for the Dow to bear. The index was sent back and forth between positive and negative territories. Within the last hour of the trading day, the Dow plummeted off of 60 point gains to end the day down more than 80. Nevertheless, the market may remain range bound until the entire earnings season has played out and all stress tests have been made public. Until this time we may be subject to a constrained trading pattern. The currency markets choose the pound to be the big loser of the day. Otherwise, the dollar rallied against the commodities currencies but fell against the yen and euro.

Road to Stress Test Transparency

Day by day we are learning more and more about the proposed stress test schedule and methodology. At this point it seems that the banks will be notified of their results as early as this Friday, while an outline of how the tests were conducted will be released to the public. Within the first week of May, the government should start to unveil these critical reports to the markets.  The Wall Street journal reported today that they have confirmed the highly secretive metrics used to rate bank survivability. The stress tests are conducted as scenarios based on assumptions about a worst-case situation for the economy. This worst case scenario is defined by the WSJ as “10.3% unemployment rate at the end of 2010, banks having to calculate two-year losses of up to 8.5% on their first-lien mortgage portfolios, 11% on home-equity lines of credit, 8% on commercial and industrial loans, 12% on commercial real-estate loans and 20% on credit-card portfolios”. Unfortunately, this situation that the government constructed is harsher than expected. This may result in mass hysteria when reports are released that show many banks are unable to sustain themselves in light of the situation the Treasury has outlined. There is also still the risk that investors will be dissatisfied by the lack of detail they received in the government release. The only good thing to come out of the tests will hopefully be provisions on how the “best performers” will be able to pay back their TARP liability.

Earnings Take a Turn for the Wors t

It has been a big confidence booster as of late that financial earnings have consistently shown improvement. The inevitable shake to market confidence came today in the form of Morgan Stanley and Capital One. Morgan Stanley reported that earnings were much worse than expected. EPS showed a loss of 57 cents while estimates were for an 8 cent gain. This terrible report also showed that the company is going to cut its quarterly dividend. Furthermore, Capital One Financial showed a $111.9 million loss and also announced they were beefing up their reserves to protect against further credit losses. Even though it appears that the worst of the credit struggle has ended, Capital One’s report shows an upward shift in credit card delinquencies. Even though economic data was light today, there are still some reports worth noting. Mortgage Applications came in above expectations, mainly on an increase in refinancing applications. Another report showed that home prices were on the rise in February.

EUR/USD: EXPORT DEPENDENCE IS GERMANY’S ACHILLES HEEL

The euro continues to gain some ground, rallying for the second day in a row after a five day spurt to the downside. EUR/GBP is higher by about 1.75%, reflecting a more concentrated shift to pound pessimism. ECB Member and Bundesbank President Axel Weber added to the latest of ECB comments. Mr. Weber, who remains adamantly opposed to bringing the target rate below 1.0%, expresses his concern over the countries dependence on exports. As recently discussed, the global recession has greatly reduced Germany’s trade industry, in effect greatly hindering economic output. In addition, Weber expressed his sentiment that a quick and forceful recovery is merely a fantasy considering the state of economic affairs. Aside from the release of EZ Debt to GDP ratio, which unsurprisingly indicated that countries were taking on more debt, today’s economic schedule remained limited. More is on the way for tomorrow in the form of the Current Account and Composite PMI. Even though Weber suggests that too much focus has been diverted to manufacturing conditions, the report still represents a glimpse into growth opportunities for the Euro-Zone. March PMI rose over prior figures for the first time since August.

GBP/USD: DARLING’S SOLUTION IS TO RAISE TAXES

The pound quickly reversed all of yesterday’s gains in a day filled with telling economic announcements. Perhaps the most important on the list was Chancellor of Exchequer Alistair Darling comments regarding the budget. In order to pay for all of the funds spent during the past seven months, the Chancellor will dramatically raise taxes to 50.0% for individuals earning in excess of £100,000. In addition, further taxes will be levied upon motorists and smokers. Even with this added revenue, which will arguably put an even more burdensome strain on the economy, the government will have to borrow £269 billion more than previously forecast. What this adds up to is an economy that is strained by fiscal deficits that totals more than 12% of GDP. Nevertheless, Darling still insists that growth will return by the end of this year. In instantaneous fashion the pound dropped severely, as Darlings estimates appear to be overly optimistic. The economy’s rebound period seems to be pushed further and further into the future. Economic data that was released today showed that Jobless Claims rose only by 73.7K, beating estimates by a long shot. Unfortunately, after learning that incomes will be taxed more heavily, the impact may be negligible. Average Hourly Earnings came in below prior figures at 3.2%. Public Finances increased to 28.4B from 4.4B. The Bank of England’s Minutes were released today only to maintain the status quo for UK monetary policy.

AUD/USD: CONSUMER PRICES DISAPPOINT

Commodity currencies are primarily lower in today’s trading session, as the decline in equities ate away at risk appetite. Australia reported that Consumer Prices slowed drastically form 3.70% to 2.50% on a yearly basis. The weakest inflation levels in about a year and a half indicate that problems are mounting for the once well-positioned economy. Nevertheless, lower inflation rates will give the RBA more breathing room when considering more monetary easing as CPI heads closer and closer to the banks lower inflation band of 2.00%. The continuous stream of negative economic announcements may nonetheless force the central bank to take some kind of action.  Australia will report New Motor Vehicle Sales in tomorrow’s session. Canadian Leading Indicators fell from -1.10% to -1.30%; this supports the BoC’s decision to cut growth forecasts to -3.0%. Nevertheless, Canadian Finance Minister Jim Flaherty manages to relieve some of the pain through his optimism. Flaherty says that the signs of stabilization are becoming clearer as confidence rises. Canadian Retail Sales are expected for tomorrow. Once again things remain relatively quiet in New Zealand with no economic new scheduled for the rest of the week.

USD/JPY: JAPANS EXPORTS IMPROVE

USD/JPY is facing modest downside pressure, rallying off of earlier lows. Crosses headed down as well, with NZD/JPY facing a loss of more than 300 pips. GBP/JPY on the other hand was off by more than 2.0%. Japan reported that the slide in exports slowed, declining 45.6% versus last month’s reduction of almost 50%. The modest improvement was very largely the result of USD/JPY& #8217;s rallies in February and March. Nevertheless, the one inherent weakness still remains that the Japanese economy is too dependent on exports, and as a result, currency movement. Since the yen has so far strengthened in the month of April, it is possible that last month’s improvement will be reversed. However, with the Japanese and Chinese stimulus plans and temporary reversals in international markets, Japan may be able to maintain a constant trade balance even if the yen appreciates further. Speaking of stimulus plans, the Japanese Parliament approved measures that would consist of government purchases into the shares of large non-financial companies. Japanese Supermarket Sales also came in better than expected. Economic data on the horizon for tomorrow night include the All Industry Activity Index and the Corporate Service Price Index.

EUR/USD: Currency in Play for Next 24 Hours

EUR/USD will be the currency pair in play for tomorrow. The Euro-zone will be releasing Manufacturing, Services, and Composite PMI at 4:00 am ET or 8:00 GMT. EZ Current Account will also be released at the same time. Even though data is still relatively light for the US, we will see Jobless Claims at 12:30 am ET and Existing Home Sales at 10:00 am ET or 14:00 GMT.

Even after two days of consecutive gains, an event not experienced for more than a week, EUR/USD still finds itself buried in the Bollinger Band sell zone. Resistance at this point looks to be the 1.3097 level which is the 50% retracement of the March 4th lows to March 20th highs. This level has been previously successful in repelling price action. In addition, the one standard deviation Bollinger band will be encountered only slightly below. Support is defined as the low placed on March 20th at 1.2888. Today’s lows reached this level only to quickly change course. Nevertheless, since the pair is in a fairly well defined downtrend, it may not take long for this level to be tested a third time.

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.