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EUR/USD: Third Time The Charm?

Last updated 5/26/2009 5:31 PM ET (GMT -5) 2 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• EUR/USD: THIRD TIME THE CHARM?
• U.S. DOLLAR SELLS OFF AS INVESTOR CONFIDENCE IMPROVES
• GBP/USD: CONSOLIDATING BELOW 1.60
• AUD/USD: HITS FRESH 7 MONTH HIGH
• USD/CAD: OIL CONTINUES TO PRESS HIGHER
• NZD/USD: TRADE SURPLUS NARROWS
• USD/JPY: SHIRAKAWA CALLS ON BANKS TOO CUT EQUITY HOLDINGS

EXPECTATIONS FOR UPCOMING FED MEETINGS

EUR/USD: THIRD TIME THE CHARM?

For the third time in a row, the EUR/USD has tested the 1.40 level.  Over the past 3 trading days, the currency pair has failed to close materially above the 1.40 mark, leading many currency traders to wonder whether the third time is the charm.   Eurozone economic data was hardly impressive with the current account deficit shrinking but new industrial orders deteriorating.  German consumer confidence held steady while first quarter GDP was unrevised at -3.8 percent.  The EUR/USD actually started the U.S. trading session significantly lower as North Korea’s Kim Jong-il challenges the world and specifically the Obama Administration once again.  However just as Obama has quickly shifted focus onto his new Supreme Court nominee, currency traders shifted their focus to the sharp improvement in U.S. consumer confidence.  Nearly all of the major currency pairs made a U-turn following the U.S. economic report.  Yet it is worth noting that the euro was the only currency (aside from the Japanese Yen) that failed to end the U.S. trading session in positive territory.  Last week, we warned that the EUR/USD was overvalued on a purchasing power parity basis and we have previously talked about how speculators are already very short dollars and long euros.  Based upon last week’s IMM data, long EUR/USD positions are the highest since July 22, 2008. This means that the traders who want to be long are already getting long, leaving fewer buyers on the sidelines.  Yet, the rally in oil prices will help the EUR/USD and the only things that could prevent the currency pair from piercing the 1.40 level and moving higher is a more serious threat to the credit worthiness of the U.S. or another madman firing missiles.  

Oil Shakes Recession Gloom

U.S. DOLLAR SELLS OFF AS INVESTOR CONFIDENCE IMPROVES

Improving consumer confidence has boosted investor confidence, translating into further weakness for the U.S dollar.  The dollar did not start the U.S. trading day weak and  in fact had surged to a high of 1.3860 against the Euro and 1.5779 against the British pound before a taking an abrupt U-turn that caused the currency to give back nearly all of its previous gains.  The stronger consumer confidence report was the primary trigger for the rise in equities and corresponding sell-off in the U.S. dollar but the real reason why the dollar weakened was because investors haven’t given up on U.S. assets.  This sentiment is confirmed by the rally in the dollar against the Japanese Yen and the Swiss Franc.  

Investors Have Not Given Up on U.S. assets

Last week, the big story that triggered the sharp sell-off in the U.S. dollar was fear that the U.S. could face the same downgrade on its credit outlook as the U.K.  However based upon the latest Treasury auction results and the strong recovery in U.S. equities, investors have not given up on dollar denominated assets. The average bid to cover ratio over the past year for 2 year auctions is 2.43 and today’s auction came in at an astounding 2.94 bid/cover ratio.  This means that for every bid that was accepted, 2.94 bids were received.  U.S. equities also rose more than 2 percent while gold prices fell $5.  The demand suggests that the fear of the U.S. losing its AAA rating is easing.  

Economic Data Review and Preview

Consumer confidence has improved dramatically in May with the Conference Board index surging from 40.8 to 54.9, the highest level since September. With equities recovering, jobless claims easing and the Obama Administration rolling out more changes to benefit the average American, consumers have grown more optimistic.  However based upon the Case/Shiller index, there is no relief in the housing market as prices fall 2.2 percent month over month and 18.7 percent year over year. We are a bit more optimistic about housing not only because the data is from March, but in order for homes to sell in this type of market, prices need to come down. The housing bubble inflated real estate prices to levels that most Americans could not comfortably afford. Prices are now correcting which is helping to re-energize the housing market. We still expect an improvement in tomorrow’s existing home sales, but the sales will most have occurred at lower prices

GBP/USD: CONSOLIDATING BELOW 1.60

U.K. traders are back from their 3 day weekend but unfortunately their participation in the currency market has not led to any interesting price action in the British pound.  The GBP/USD has been consolidating below the 1.60 level for the past 3 trading days and appears prime for a breakout.  The British pound is holding near its 6 month highs against the U.S. dollar and appears poised to hit a 3 month high against the euro.  There is a very good chance that we could see a further decline in EUR/GBP because long positions in the British pound remain limited compared to the euro.  There was no economic data released from the U.K. last night.  The British Bankers Association will be releasing their report on mortgage approvals tomorrow.  We are beginning to see signs of a bottom in U.K. house prices and so the BBA loans data will go a long way in providing more detail on whether the improvement in house prices is matched by an increase in mortgages.  

AUD/USD: HITS FRESH 7 MONTH HIGH

The rally in the Australian, New Zealand, and Canadian Dollars are nothing short of spectacular. Both, the Aussie and Kiwi advanced to fresh 7-month highs against the greenback, while the Canadian Dollar hit a 9 month high. The proximity of the 80 cents level in the AUD/USD and the 1.10 level in USD/CAD should be too tempting for currency traders to ignore.  We believe that the currency pairs could test those levels in the near future.  Additional improvements in China, which accounts for roughly 14% of Australia’s exports, will continue to benefit the economy. Tonight, Australia will release the Westpac Leading Indicators Index.  Given that the Australian stock market rose 17 percent in the month of March, an improvement is expected.  Meanwhile, New Zealand’s trade surplus narrowed in April as demand for imports tumbled amid the worst recession in more than three decades.  On an annualized basis however the trade deficit narrowed. The Reserve Bank of New Zealand also lowered 2 year inflation expectations to 2.2% from 2.3% as the country’s demand continues to dwindle. Business Confidence will be released this evening which will provide more detail on the state of the New Zealand economy. The Canadian Dollar continued to advance despite projections that the budget deficit will being substantially larger than forecasted. There are no economic releases for Canada until the end of the week, when the Current Account will be released. Consequently, expect the Loonie to be highly affected by the prices of commodities and developments within U.S. economy.          

USD/JPY: SHIRAKAWA CALLS ON BANKS TOO CUT EQUITY HOLDINGS

Ahead of important economic releases later this evening, the Japanese Yen is trading lower.  The rally in U.S. equities is contributing to the improvement risk appetite.  The Bank of Japan’s monthly report confirmed that the Japanese government raised its outlook for the economy for the first time in 3 years signaling that the worst might be behind them.  However the Japanese recovery remains fragile and the minutes from the April 28 monetary policy meeting, which will be released this evening should confirm that.  The merchandise trade balance and small business confidence is due for release tonight and we believe that the weakness of the Yen in April should helped to improve trade.  Meanwhile, it will be interesting to see if the Nikkei starts decoupling from the Dow after Bank of Japan Governor Shirakawa urged banks to reduce their holdings of equities because the “risks associated with their stock holdings are threatening the Japanese economy the most now.”  

AUD/JPY: Currency in Play for Next 24 Hours

The currency in play for the upcoming 24 hours is AUD/JPY. Later in the evening, Japanese Merchandise Trade will be released at 23:50GMT or 7:50PM EST. Australia will release the Westpac Leading Index at 00:30GMT or 8:30PM EST. Over the course of past three months, AUD/JPY has seen an impressive rally and is currently on a verge of entering the Buy Zone which we determine using Bollinger Bands. The pierce into the zone suggests that we could see further gains in AUD/JPY.  Although 75 will be a level of contention, real resistance doesn’t come in until 77, the 38.2% retracement of September’s high and this year’s low of 77.00.  However, if the pair turns around, the next level of support hovers slightly below today’s low at 50% retracement of September’s high and this year’s low at 72.90.

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Comments (2)

Ian Middleton

May 27, 2009 at 12:54 PM ET

Kathy,
I understand how another madman would prevent EUR/USD from shooting through the 1.4000 level but could you explain why the Euro would not make that move if there is a more serious threat to the US credit worthiness?
Also your comment on oil helping the Euro?
Thanks, Ian M

klien

May 27, 2009 at 02:44 PM ET

Great question Ian. Whenever we have the threat of war, the "knee jerk" reaction would be to sell risk and buy safety. The dollar is considered a safe haven play and therefore you will see investors buy dollars and sell euros in the short term. However, if an actual war becomes a possibility, you could see the dollar make a U turn. In the months leading up to the Iraq War, the dollar sold off. The credit worthiness of the dollar is a very indirect concern. As for oil, is is 100% helping the EUR/USD. If you pull up the 2 charts together, you will see a very strong correlation.

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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.