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Severity of Dollar Weakness

Last updated 5/22/2009 4:55 PM ET (GMT -5) 5 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• SEVERITY OF DOLLAR WEAKNESS
• EUR/USD: NEARING VERBAL INTERVENTION LEVELS?
• GBP/USD: IS THE RECESSION ALMOST OVER?
• USD/CAD: RETAIL SALES RISES FOR THIRD STRAIGHT MONTH
• AUD/USD: GOLD PRICES UP $80 THIS MONTH
• NZD/USD: HITS 7 MONTH HIGHS
• USD/JPY: NO RISK OF INTERVENTION

EXPECTATIONS FOR UPCOMING FED MEETINGS

SEVERITY OF DOLLAR WEAKNESS

Over the past few weeks, we went to talking about the prospect of further dollar weakness in the short and long term to the market’s complete distaste for U.S. dollars .  This new trend of dollar weakness is supported by fundamentals, technicals and momentum.  Ahead of the 3 day weekend in the U.S. and the U.K., currency traders continued to bail out of U.S. dollars, driving the EUR/USD above 1.40, USD/JPY below 94 intraday and the GBP/USD towards 1.60.   Although the lack of U.S. and U.K. participants in the market on Monday should lead to thin and quiet trading, that has not always been true.   Between 2006 and 2008, the range in EUR/USD on Memorial Day Monday was no more than 50 pips, but in 2005, the intraday range in the EUR/USD was 115 pips and in 2004, it was more than 200 pips.  With that in mind however, it has been an usually active trading week and currency traders may use this opportunity to reassess their positions in light of the credit risks.  

Speculation about Credit Worthiness Raises the Need for Diversificatio n

We along with everyone else have spent much time talking about whether the U.S. government will actually lose its AAA credit rating.  Some people like Bill Gross of PIMCO believe that it is inevitable while others such as the Bruce Kasman, the Chief Economist of JPMorgan believe that the risk is very low.   Being downgraded is of course the step that comes after a rating agency cuts the credit outlook for a country.  Regardless of what actually happens, the one concrete take away from the events of this week is the need for diversification.  Based upon the debt loads of the G20 nations , many countries could see the outlook of their credit rating cut.  If that happens, investors will be scrambling for alternative places to park their money.  Rather than waiting for Standard and Poor’s to make announcements, we should see more and more diversification by private investors as well as sovereign wealth funds out of U.S. dollars.  

How Much Has the Dollar Weakened ?

The following chart illustrates the degree of U.S. dollar weakness over the past month.  As you can see, the dollar depreciated the most against the commodity currencies and the least against the Japanese Yen.  The losses in the dollar and gains in the other currencies this month pretty much represents the entire year to date moves for most of the major currency pairs.  The Japanese Yen is still trading lower than where it started in January, but a close below the 94 level would the open door up for a move down to 88.   Interestingly enough, even though the euro appreciated less than the British pound this month, it is actually more overvalued on a purchasing power parity basis (calculated using consumer prices).  Currencies can trade well above or below their PPP levels for some time, but this suggests that going forward, the euro could underperform currencies such as the British pound and Canadian dollars.  

* Source: Bloomberg, as of 5/22/09

Outlook for Week Ahea d

It will take a lot to ease the market’s concern about credit worthiness in the coming week and it can probably only be achieved by comments from U.S. government officials.  In the shortened trading week ahead, the U.S. economic calendar is fairly busy.  There are no U.S. economic data on Monday, but consumer confidence is due on Tuesday followed by housing market reports on Wednesday and Thursday.  Durable goods orders are also on calendar along with first quarter GDP and Chicago PMI numbers on Friday.  Since the consumer confidence reports were most likely taken before the latest threat to the U.S. AAA rating, consumer confidence should see signs of improvement thanks to the recovery in U.S. equities.  The contraction in GDP should have also slowed in the first quarter as retail sales rebound and the trade deficit narrowed. 

EUR/USD: NEARING VERBAL INTERVENTION LEVELS?

The Euro broke the psychologically important 1.40 level against the dollar as U.S. traders continued to dump the greenback at the NY open.  The rally in the EUR/USD this past week has been nothing short of impressive and the next stop for the currency pair could be 1.42.  There was no major Eurozone economic data released today but ECB members continued to remind euro traders that the current level of interest rates is appropriate.  As the EUR/USD extends its gains, the biggest question on the minds of traders is whether there will be verbal intervention from the ECB.  The Eurogroup’s Chairman Jean-Claude Juncker in an interview today said that the rising euro could pose a threat to an economic recovery. However, since Juncker is not an ECB member, his comments do not hold as much weight. The last time the ECB verbally intervened was back in 2004, when ECB President Trichet called the EUR/USD& #8217;s move to 1.3667 (the high at the time) “brutal.”  Since then however the uncle point in the exchange rate for the ECB has changed.  The last time we heard complaints from the ECB was in March 2008, when the EUR/USD was trading around 1.57.  As a result, we don’t believe that ECB officials are concerned about the euro’s current level.  

GBP/USD: IS THE RECESSION ALMOST OVER?

The British pound rallied against the U.S. dollar every single day this week, but there are signs that the rally could be losing momentum as it nears the critical 1.60 level.  The first quarter GDP numbers failed to surprise anyone as it met expectations.   Annualized GDP showed a contraction of -4.10%, while quarterly growth fell by -1.90%. Even though these numbers did not necessitate a strong market move, it is still worth examining the health of the underlying numbers. The 1.9% decline in QoQ GDP fell by the most since 1979 on broad based weakness in investments, exports, household spending, and inventories. However, it is important to keep in mind that this report tracks conditions in the first 3 months of the year, and therefore does not crush any recovery optimism. In fact, David Blanchflower, a BoE Policymaker, announced the very real possibility that the recession is about “three quarters” through the cycle. Even though positive estimates like this sharply contradict the actions and comments made by the bank, it is reassuring. The schedule for UK releases next week is unusually light. With the Spring Bank Holiday in swing for the beginning of the week, the only scheduled event will be the Gfk Consumer Confidence Survey on Thursday.

USD/CAD: RETAIL SALES RISES FOR THIRD STRAIGHT MONTH

The Australian, New Zealand, and Canadian Dollars continued to strengthen against the greenback, ending a spectacular week for all 3 commodity currencies. The Canadian Dollar rallied against the greenback for the fifth consecutive day climbing to a level last seen in October of 2008 as retail sales printed a positive figure for third straight month. Canadian Retail Sales rose by 0.3% in March coming just under the forecasted 0.5%, thanks to an increase in the sale of cars as dealers offered large discounts. The sole economic release for Canada in the coming week is Current Account. Therefore, expect the loonie to be highly influenced by risk appetite, oil prices and the state of U.S. economy. The Australian and New Zealand Dollars also hit seven month highs against the greenback led by a rise in commodity prices. The appeal for alternative investments pushed the price of gold to its highest level since March.  Over the past month, gold prices have increased close to $80 an ounce.  Meanwhile, optimistic remarks from Glenn Stevens about a recovery toward the end of the year contributed to this week’s advancement.  Next week, Westpac and Conference Board Leading Indexes will be released shining more light on the state of the Australian economy.  New Zealand has its Trade Balance and Business Confidence reports due for release.  

USD/JPY: NO RISK OF INTERVENTION

USD/JPY fell to a 2 month low of 93.85 before recovering to end the U.S. trading session virtually unchanged.  The greenback has been particularly weak against the Japanese Yen and there are a multitude of reasons why the currency pair has sold off aggressively, which we covered about in our special report on What is Driving USD/JPY Lower? .  As expected, the Bank of Japan left their target interest rate unchanged at 0.10% but to the surprise of the market, they raised their growth forecasts for the first time since 2006. The BoJ statement noted the benefits from the stabilization of production and exports and their belief that the worst is now behind them. BoJ Governor Shirakawa said that, “It looks like we’re coming out of the freefall stage.” Looking forward for BoJ monetary policies, it is becoming more unlikely that the bank will find that an addition to asset purchase plans is required, making the meeting almost a non-event for FX traders. However, the risks are still high for the economy. If Q2 growth and economic data is unable to meet the now elevated expectations, the health of the economy will once again be highly uncertain. Economic data today was mixed and showed that the Coincident Index and Supermarket Sales were improving, while the Leading Index continues to worsen. There are a lot of economic data due for release from Japan next week including consumer prices, trade balance, retail sales and the jobless rate.  Despite the recent strength of the Yen, the Japanese government has no intention of intervening according to the Finance Minister.  Japan knows that intervention at this point is useless because their recovery is contingent upon the recovery of the U.S. Also they have made it an unofficial policy to avoid intervention at all costs with the larger goal of getting China to revalue their currency.

EUR/USD: Currency in Play for Next 24 Hours

EUR/USD will be the currency in play for Monday. Even though US markets will be closed because of Memorial Day, the Europeans will release the influential IFO Surveys. The reports are broken down into the Business Climate, Current Assessment, and Expectations and will be released at 4:00 am ET or 8:00 GMT.

EUR/USD is continuing its string of stellar performance, cementing its position in the Bollinger band buy zone. Resistance can be found by drawing Fibonacci levels from the mid-July 2008 highs to the October low. This gives us the 50% retracement right at the psychological 1.4200 level. Support is in place at the prior high placed on March 19th at 1.3740. This level is very close to the 38.2% retracement from the Fibonacci levels. Even though markets will be quiet on Monday, the importance of the IFO report may result in the testing of one of these significant levels.

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Comments (5)

Brian

May 23, 2009 at 02:56 AM ET

Hello Kathy, I don't have a comment but some observations that I would like your opinion. I have just recently starting following fundamentals and I find it very frustrating. It appears that since early March when the treasury department announced QE and the improvement in risk appetite the the dollar has taken a dive in my opinion not justified. Other countries such as the Uk has implemented QE and the Eurozone has mentioned that they will impose some of the same but why is the dollar suffering the most when the other countries are in the same condition when the dollar is suppose to be a safehaven currency.

Another observation, the dollar was moving in the opposite direction of the US stock market, when the market was up the dollar was down and visa versa, but lately I noticed a change, the stock market would fall and the dollar would fall as well but when the stock market rose the dollar would still fall . Not sure what's really going on but it simply appears that the dollar cannot win regardless.

I find it really difficult to follow sentiment and fundamentals in this current environment, to me neither is making any since.

Help

FxFundamentalist

May 24, 2009 at 04:50 AM ET

Hi Brian, I apologize that this question was directed to Kathy, however, I feel that I do have some points which can satisfy - 1) QE done by Fed is in excess of $1 Trillion, compared with 125 Bln pounds from UK and 60 BLN Euros from EZ. 2) Kindly note that QE was first of all initiated by US and immediate consideration any rational trader have after a central bank's decision to print money would be lowering the value of currency. Later on QEs adopted by other central banks were judged in comparision to US QE efforts and thus QE from other central banks do have immediate effect but no big implications there after. 3) Also, note that as safehaven currency shines when economy is lack luster, From March, there is considerable evidences from fundamentals from both US and EZ claiming there recession is easing or at the least economy is not in free fall. As far as you mind to correlate S&P and USD, you do need to take Risk appetite/aversion ( and lately credit concerns ) into picture. 1) If there are positive news either from US or from Euro zone about important inflation, spending, growth or policy, S&P or DAX responds to it by a rally along with a rally from EuroUsd. 2) If you see some good Quarterly results from Finance,Energy or Tech company in S&P then it would lead to rally in equity and by risk appetite implies a rally to EuroUsd ( towards high yielding ). 3) Lately I have found, if S&P does bad and it's not related to risk appetite ( for example credit concern of US ), you will still find a rally in EuroUsd. So when do you expect EuroUsd to go down on fundamental basis - 1) If credit risk looms around EuroZone which already has Spain, Portugal, Ireland and Greece downgraded and EuroZone Debt to GDP is 70%, this situation cannot be ruled out. 2) If we get some news from white house or from bigger officials from fed ruling out or at the least explaining their way to clear the budget deficient or it's concern. 3) Oil prices dive. 4) Euro zone shows terribly bad results in couple of it's important data. Seeing the correlation not holding at the moment between USD and risk aversion lately, my strategy would be - 1) To go long for both GBP or Euro in case UK or EZ data comes out better than expected. I don't trust it's flip side at the moment, so if the data is bad, then I would keep myself out. 2) I won't trade any of the US numbers as the correlation is yet to be established. 3) I would also monitor credit concerns for Euro Zone. Sorry Brian, I made the answer excessively long but it's some kind of fun for me to explain the things. he he he :)

klien

May 26, 2009 at 01:35 PM ET

FxFundamentalist is spot on. Hopefully that answers your Q Brian!

jet

May 24, 2009 at 02:13 PM ET

I have only been trading the fx markets for about 4 year and reading comments on the demise of the dollar the entire time with only temporrary set back - "the usd is dead" that's what everyone was saying - I even bought a black suit for the funeral hehehe - but so far you can't beat the money management of the united state and in the end the usd will rule again as it should. Asia keeps talking about moving away from the usd but tak is cheap they just invreased the amount of us debt purchased again this month. HMMM and as for the dollar losing is peg to commodities come on what will we replace it with the euro? Please it will cease to exist before it reaches it's 20 aniversary if not well before that the EZ and GB the last I saw had MORE debt not less then the US The S&P said the chances of the US losing it AAA rating was UNLIKELY but made no such satement about GB . The moves this week in the currency markets have been rediculas and WAY over done - In my opinion i'd be VERY careful shorting the usd here - but that's just my opinion -

klien

May 26, 2009 at 01:36 PM ET

When growth becomes the focus again and everyone is comparing which countries are growing faster, then the dollar will rise again

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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.