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Bailing Out of U.S. Dollars

Last updated 5/21/2009 5:05 PM ET (GMT -5) 2 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• BAILING OUT OF U.S. DOLLARS
• GBP/USD: UNFAZED BY S&P OUTLOOK CUT
• EUR/USD: CLOSING IN ON 1.40
• NZD/USD: RALLY GETTING TIRED?
• USD/CAD: STRONGER ECONOMIC DATA
• AUD/USD: CHINESE TRADE AGREEMENT TO BE A BIG GDP BOOSTER
• USD/JPY: HITS 2 MONTH LOWS

EXPECTATIONS FOR UPCOMING FED MEETINGS

BAILING OUT OF U.S. DOLLARS

The U.S. dollar has weakened across the board as investors bail out of dollar denominated assets. Rating agency Standard & Poor’s put the U.K. on credit watch, spurring fears that the outlook for U.S. government debt could also be cut from stable to negative.  A week ago, the Financial Times carried an Op-Ed piece about how America could lose its AAA rating and now PIMCO’s Chief Investor Officer Bill Gross is issuing the same warning.  The U.S. fiscal situation in many ways is just as bad if not worse than that of the U.K., but downgrading U.S. debt has severe global consequences.  Investors are not taking any chances and are adjusting their positions in case the U.S. is put on credit watch.  This liquidation of dollars has driven the EUR/USD to 4 month high, the GBP/USD to a 6 month high and USD/JPY to a 2 month low.  We could see more selling into the holiday weekend but it is important to note that the major currency pairs are nearing critical levels.

Currencies, Equities, Bonds and Commodities: All Telling the Same Story

The most worrisome aspect of today’s moves is the fact that currency, equity, bond and commodity traders all feel the same about U.S. assets – which is that they don’t want to own them.  Traders dumped the U.S. dollar, stocks and government bonds and bought gold.  It has been a while since we have seen such a cohesive move across the financial markets and unfortunately when that happens, it also suggests that there could be continuation.  Based upon the IMF’s projections of U.K. versus U.S. debt load, there is no reason why the U.K. should have its credit rating outlook cut to negative and the U.S. not.  In April, the IMF released a report that projects U.K. debt load to reach 66.9 percent of GDP compared to 70.4 percent for the U.S.  Both countries are spending aggressively and therefore both fiscal imbalances will deteriorate.  However, the U.S. dollar is a global reserve currency and Standard & Poor’s may be hesitant to be the first to say that “Emperor has no clothes.”  So even if they put the U.S. on credit watch, they may not actually follow through with a downgrade.  Yet the threat of a downgrade is all investors may need to send the dollar and U.S. equities lower.  This would also be the perfect excuse for central banks to start increasing their holdings of other currencies at the expense of the U.S. dollar.  

Bill Gross: US Could Lose AAA Rating

Gold – The Big Winner

The biggest winner out of all this should be gold.  From a credit worthiness perspective, S&P may start to review other countries with high and growing debt to GDP ratios such as the U.S., Germany, France, Italy and possibly even Japan. This leaves few places to hide for investors outside of the only asset whose credit and value will never be questioned – gold.  Also, the latest FOMC and Bank of England minutes revealed that both central banks are considering more Quantitative Easing, which could further erode the value of their currencies. A weaker currency will reduce deflationary pressures and possibly resurrect inflation fears and at that time it is important remember that gold is frequently perceived as an inflation hedge.  Now that gold prices are above $950 an ounce, the next step may be $1000. 

U.S. markets are closed for Memorial Day on Monday and in anticipation of the holiday weekend, no U.S. economic data will be released on Friday.  This morning’s reports were disappointing with jobless claims retreating less than expected and continuing claims climbing to a record high of 6.66 million. The 4 week moving average declined by 20k, but until jobless claims dips below 600k and continuing claims start to decrease, the U.S. economy will still report negative job growth.  Leading indicators rose 1.0 percent, which was stronger than forecasted and the first upbeat reading in 7 months, but the manufacturing sector in Philadelphia region only saw a mild improvement. Following the sharp rebound in the Empire State manufacturing survey, everyone was looking for a healthy jump in the Philly Fed index, but instead it only rose from -24.4 to -22.6. The underlying components were a bit better but in order to reverse the negative sentiment in the financial markets today, we needed very strong numbers.  

GBP/USD: UNFAZED BY S&P OUTLOOK CUT

The resilience of the British Pound is nothing short of impressive. Normally, if a ratings agency cuts the credit outlook for a country, the currency sells off. The Pound fell victim to knee-jerk selling but it quickly recovered as 1.55 proved to be strong support in the GBP/USD. Having lowered the outlook on U.K. debt from stable to negative, Standard and Poor's believes that the country stands a 1 in 3 chance of losing its AAA rating. They are worried that the aggressive spending pattern of the U.K. could drive their debt to GDP to 100 percent in the near term.  U.K. traders were not surprised by S&P's announcement with the government spending money left and right to support the economy. By spending more, they hope to revive the economy and in turn reduce their debt burden in the future.  In reaction to S&P’s announcement, the U.K. Treasury said the budget could be halved within 5 years and therefore S&P could revise its outlook back to stable.  U.K. retail sales increased for the second month in a row, which suggests that there is light at the end of the tunnel. The results of the latest bond auction were also decent. Therefore we believe that the chance of an actual downgrade is low at this time.  First quarter GDP numbers are due for release on Friday and we anticipate stronger numbers thanks to an improvement in the trade balance and retail sales.  

UK Credit Woes

EUR/USD: CLOSING IN ON 1.40

The Euro hit a new 4 month high against the U.S. dollar as it closes in on the psychologically important 1.40 level.  As we suggested in yesterday’s Daily Currency Focus, Eurozone manufacturing and service sector PMI numbers were all better than expected.  Although both sectors remain in contractionary territory, the pace of contraction is slowing in Germany, France and in the Eurozone as a whole.  However the higher the Euro rises, the more concerned we become about the Eurozone recovery.  European exporters are only beginning to see demand improve but with the EUR/USD at 1.40, the recovery could be threatened.  A stronger currency will also increase deflationary pressures within the Eurozone.  The European Central Bank has a big decision to make next month and the level of the currency as well as its impact on inflation could pressure them to do more rather than less.  In the meantime, the proximity of the 1.40 level will make too tempting to ignore and therefore we expect the EUR/USD to test that level in the near future.  

NZD/USD: RALLY GETTING TIRED?

The Canadian, Australian and New Zealand dollars all extended their gains against the greenback, but when compared to the moves of the other major currencies the commodity currency rally appears to be getting tired.  The Canadian dollar hit a new 7 month high against the U.S. dollar, but closed above it while the Australian and New Zealand dollars consolidated its gains.  Canadian economic data was better than expected, but oil prices declined.  Foreign demand for Canadian dollar denominated assets increased in March while wholesale sales fell at a slower pace. This suggests that Canadian retail sales, which are due for release on Friday may have increased during the same month.  The big news for Australia was a report that a trade agreement with China could boost Australian GDP by A$146 billion over the next 20 years.  We have long said that Chinese demand would be the driving force behind a turnaround in the Australian economy.  There are no economic reports due from Australia or New Zealand over the next 24 hours.

USD/JPY: HITS 2 MONTH LOWS

The U.S. dollar fell to a 2 month low against the Japanese Yen as equities tumbled more than 1.5 percent today.  The weakness in the currency pair is a direct consequence of the market’s concern about the credit worthiness of the U.S. economy.  More losses are possible with no major U.S. economic data providing reason for optimism until Tuesday.  After a record setting contraction in the previous quarter, Bank of Japan is expected to leave interest rates unchanged at 10 basis points. Economists predict that the central bank will raise assessments on the economy as the global slump moderates and the stimulus package starts to help consumers.  The Eco Watchers survey and consumer confidence report suggest that sentiment in Japan is improving, albeit modestly.  Unfortunately we expect Japan to lag behind its peers in any recovery.

USD/CAD: Currency in Play for Next 24 Hours

USD/CAD will be the currency in play for the next 24 hours. Canadian Retail Sales are due for release at 12:30GMT or 8:30AM EST. USD/CAD has been selling off aggressively this week and is currently trading in the Sell Zone, which we determine using Bollinger Bands. However, the trend seems to be over extended in USD/CAD and the pair is due for a bounce in the foreseeable future. The next level of support is structured slightly below current price at 61.8% retracement September’s low and this year’s high at 1.1335. However, if support breaks the pair could continue to move downward as there is no immediate support until 1.08. The Sell Zone will be negated upon the breach of resistance which is the 1st Standard Deviation of the Bollinger Bands at 1.1590.

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Comments (2)

ChrisEccles

May 22, 2009 at 12:15 PM ET

Hold my newbie hand a little, here, Kathy !

In Para 4 of your FX360 email, under "Exporter Selling", you state that firms such as Honda and Toyota have been
responsible for aggressive selling of USD/JPY, and that they suffer greatly from a strong Yen. Surely, by going
short USD/JPY, these guys are actually providing some of the strengthening force for the Japanese currency, which
would seem to work against their interests as major exporters to the West ?

"Confused" doesn't even begin to cover it, but I presume you have a logical explanation which will allow me to
sleep this weekend ... !

;-)

Best wishes

Chris

klien

May 26, 2009 at 08:55 AM ET

If they short USD/JPY then they actually benefit from the decline in the currency. The profit from the short position would be used offset any losses on weaker revenue

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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.