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THE STORIES IN THE CURRENCY MARKET

• U.S. DOLLAR: CONSEQUENCE OF DOLLAR WEAKNESS
• GBP/USD: BEWARE OF THE QUARTERLY INFLATION REPORT
• EUR/USD: ECB WEBER SAYS NO NEED FOR MORE PURCHASES
• USD/CAD: OIL AND TRADE
• AUD/USD: STRONGER HOUSING NUMBERS
• NZD/USD: GOLD AND OIL PRICES EXTEND GAINS
• USD/JPY: EXTENDS GAINS AGAINST USD

EXPECTATIONS FOR UPCOMING FED MEETINGS

CURRENT US INTEREST RATE: 0.25%					Rates Expect to Remain Unchanged in June and August
	6/24 Meeting	8/12 Meeting
NO CHANGE	84.0%	73.5%
Cut to 0.00%	16.0%	13.5%
Increase to 0.50%	0.0%	13.0%
Increase to 0.75%	0.0%	0.0%

U.S. DOLLAR: CONSEQUENCE OF DOLLAR WEAKNESS

The rally in the U.S. dollar on Monday was indeed temporary.  The greenback sold off against every major currency and even managed to hit a new 6 week low against the Euro and 4 month low against the British pound intraday.  However despite the weakness, the dollar recovered a good portion of its earlier losses, leading some currency traders to wonder whether the greenback is nearing a bottom.  We continue to believe that the dollar is prime for a bounce but at the same time we do not believe that dollar weakness is over. In the EUR/USD for example, there is a very decent chance that the currency pair could pull back to 1.3450, but as long as it does not close below 1.34, the uptrend is still intact.  Yet the most intriguing price action has actually been in USD/JPY.  The currency pair has come under aggressive selling pressure over the past 3 trading days.  

USD/JPY: Decoupling from Equities

USD/JPY has completely decoupled from equities.  Despite today’s rally in the Dow, USD/JPY has continued to sell-off.  Since Friday, the currency pair has fallen from a high of 99.58 to an intraday low of 96.11, a move in excess of 300 pips.  Everyone is looking for a reason to explain the divergent price action in the currency pair.  In the past, USD/JPY would rally if equities rallied as the risk appetite improves.  However this relationship has broken down over the past month as the erratic price action of USD/JPY indicates that it is the lack of demand for dollars rather than risk appetite that is driving the markets. Selling by exporters is playing a large role in the weakness of USD/JPY.  Companies like Honda expect the Japanese Yen to continue to strengthen this year and are therefore increasing their hedges at current levels. A bipartisan group of U.S. lawmakers will make another attempt to punish China for manipulating its currency.  This is a dangerous game to play and one that is raft with political and economic consequences.  Senators Debbie Stabenow of Michigan and Jim Bunning of Kentucky plan on introducing the legislation tomorrow.  It has little chance of being passed at this time as policy makers have bigger fish to fry.  China and the U.S. need to work together to pull the world out of recession and it would hurt more than help the situation by bringing back the age old debate on currency manipulation.  Nonetheless, if their efforts garner any more press than it has already, the impact would be dollar negative.  

 

Bernanke Talks Currencies

In his speech last night about the results of the stress tests, Bernanke also talked about currencies.  More specifically he said that the dollar will remain the leading reserve currency for the foreseeable future and that it will stay strong because the U.S. economy is strong and because the Federal Reserve is committed to making sure that we have price stability.  If this was his attempt at verbal intervention, it is feeble at best because it had almost zero impact on the greenback.  The dollar has been falling in recent weeks because the U.S. economy is improving and it will take significant dollar weakness before it becomes concerning to the Federal Reserve.  In times of recession, a weaker currency helps to smooth the recovery. 

 

Consequence of a Weaker Dollar: Inflation

The biggest consequence of a weaker dollar is inflation.  Commodity prices have been on a tear lately and that is a direct consequence of a weaker dollar.  Producer and consumer prices are due for release this week and we expect inflation pressures to be on the rise.  Tomorrow’s import price report will be the first clue on the degree of inflation over the past month.   If commodity prices continue to rise, the threat of runaway inflation becomes more real.  Oil prices hit an intraday high of $60 a barrel.  After the PPI and CPI numbers this week, fear of inflation could become the new “theme” in the currency market.  

Retail sales are due for release and we are looking for a stronger report.  The weekly Redbook and ICSC data showed an improvement in consumer spending.  Wal-mart and Walgreens also reported stronger sales at the expense of luxury retailers.  U.S. consumers are trading down, but at least they are spending.  Higher gasoline prices should also push up gas station receipts.  

Will Inflation Threaten the Dollar?

GBP/USD: BEWARE OF THE QUARTERLY INFLATION REPORT

Many people have criticized the U.K. government’s response to the financial crisis and recession but U.K. officials may be having the last laugh. The latest string of economic data has been surprisingly strong with signs of stabilization in both the housing and labor markets. According to the RICS House price balance, new buyer inquiries were the strongest in 10 years. The BRC retail sales monitor also jumped 4.6 percent. As a leading indicator for the broader retail sales index, the data suggests that consumer spending improved materially in the month April. The early release of the employment numbers helps to explain why consumer spending has picked up. Although the unemployment rate hit a 10 year high, the number of people claiming unemployment benefits has decreased significantly while earnings saw a smaller than expected decline. The reason why the report was released a day early was because parts of the report were leaked which may have contributed to the sharp rally in the GBP/USD during the European trading session.  The Bank of England will be delivering its Quarterly Inflation report tomorrow. A more negative tone is expected given the BoE's comments following the last monetary policy decision. This could lead to a correction in the GBP/USD which should most likely be a retracement within the uptrend.

 U.K. Retail Sales Rise in April

EUR/USD: ECB WEBER SAYS NO NEED FOR MORE PURCHASES

Only days after ECB President Trichet announced a EUR 60billion asset purchase program, ECB officials are downplaying the program.  ECB member Weber, who is the head of the German Bundesbank said that current interest rates are appropriate and there is no need for more purchases of private debt.  Even though he believes that the German economy won’t bottom out quickly and that growth will return until 2010, he is already talking about an exit strategy.  Weber along with ECB member Orphamides has pressed the central bank to keep its response to the financial crisis and recession in check.  He said that the ECB will drain money after the crisis as quickly as possible to counter inflation risks at an early stage.  These types of comments come in sharp contrast to that of other central banks who have pledged to keep monetary policy “easy” for some time.  German consumer prices remained unchanged in the month of April while German wholesale prices increased for the first time in nine months.  French business sentiment rose for the second time this year, hinting of a possible turnaround in the industrial sector.  Meanwhile Swiss National Bank member Jordan forecasted positive growth by mid-2010 for Switzerland.  It is worth noting that many central banks have forecasted positive growth next year.   

EU Plans Stress Tests

USD/CAD: OIL AND TRADE

The rally in equities, the sell-off in the U.S. dollar and the rise in commodity prices have drive the Canadian, Australian and New Zealand dollars higher.  For the first time since November, oil prices have rose above $60 a barrel intraday.  The correlation between the Canadian dollar and oil prices has been particularly strong in recent weeks.  Canada also reported a larger than expected trade surplus for a second month in a row with the trade balance rising from CAD$1.1B to CAD$0.5 billion in March.  Exports and imports both declined, but the surplus increased as imports fell more than exports. Tomorrow, Canadian motor vehicles sales will be released.  The highly volatile index is expected to rebound after falling 2.2 percent the prior month.  Meanwhile housing market data from Australia was also better than expected, which has contributed to the rally in the Australian dollar.  The larger than expected budget deficit failed to stifle the AUD/USD& #8217;s rally.  Food prices decreased in New Zealand but house sales increased in the month of April, suggesting that low interest rates is helping the housing market.  

USD/JPY: EXTENDS GAINS AGAINST USD

The Japanese Yen gave back its earlier gains as equities rallied towards the end of the U.S. trading session. The most interesting development from Japan other than the continued decline of USD/JPY were the comments from Nakagawa, the Chief Finance Spokesman for the Democratic Party in Japan.  He told the BBC that he is concerned about the value of the dollar and if his party was to replace the ruling Liberal Party, they may only want to buy U.S. bonds that are denominated in Yen.  Despite the current party’s lack of popularity, there is little chance that the Democratic Party will win the next election.  However his comments represent growing discontent amongst the Japanese about the weakness of the U.S. dollar.  The Current Account and Trade Balance figures are due for a release later in the day. Japan’s economy has been largely affected by a slack in global demand. The trade numbers are expected to improve modestly thanks to the Yen’s weakness against the EUR during the month of March.  It held steady against the U.S. dollar.  

USD/JPY: Currency in Play for Next 24 Hours

USD/JPY will be the currency in play for the upcoming 24 hours. Japan’s Trade Balance and Current Account will be released later in the day at 23:50GMT or 7:50PM EST. The U.S. will release Advance Retail Sales at 12:30GMT or 8:30AM EST. After rallying in the beginning of the year, USD/JPY reversed and pushed lower and is currently attempting to enter the Sell Zone, which we determine using Bollinger Bands. A lack of decisive trend rendered the pair to be within a triangle formation, upon a break of which could structure a more prominent trend. If the pair continues to drift lower and bypasses the triangle formation, the next level of support will be 100-day SMA at 95.00. However, if the pair advances the next level of resistance is 78.6% retracement of this year’s high and low at 98.00.

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.