Can EUR/USD Rally Last?

Last updated 6/23/2009 5:19 PM ET (GMT -5) 3 Comments

Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• CAN EUR/USD RALLY LAST?
• U.S. DOLLAR: FOMC PREVIEW
• GBP/USD: TRAILS BEHIND THE EURO
• USD/CAD: IMMUNE TO CARNEY COMMENTS
• AUD/USD: MOODY’S WARNS ABOUT OUTLOOK FOR BANKS
• NZD/USD: OIL AND GOLD PRICES RECOVER
• USD/JPY: EXTENDS LOSSES FOR THIRD DAY

EXPECTATIONS FOR UPCOMING FED MEETINGS

CAN EUR/USD RALLY LAST?

The breakouts that we have been waiting for in the currency market are beginning to occur. The dollar sold off aggressively against the Euro, driving the currency pair out of its recent consolidation to an intraday high above 1.41. The more than 200 pip move in the EUR/USD was the strongest since May 8th. Although the U.S. dollar weakened across the board, the EUR/USD and USD/JPY were the only major currency pairs to stage a meaningful breakout. The GBP/USD for example is still trading within its weeklong range and the same is true for the AUD/USD and NZD/USD. Interestingly enough, most of the action was in the currency market today as equities, bonds and commodities ended the U.S. trading session virtually unchanged. The lack of correlated movements is a bit worrisome because it reflects the conviction of traders in other markets.

What Triggered the Breakout in the EUR/USD?

On Friday, we posed the question of What Can Break the Range in the Dollar . At that time, we talked about how the breakout would most likely be triggered by exogenous events as we have a very light U.S. economic calendar this week. With that in mind, it was actually a combination of exogenous events and regularly scheduled economic data that drove the dollar sharply lower against the euro today. The first of the massive U.S. Treasury auction was exceptionally well received with a bid to cover ratio of 3.19 which means that for every 1 bid received, there were 3.19 offers. This was well above the average of 2.48 for the past 10 auctions. Although the strong demand suggests that investors are not afraid of holding dollar denominated assets, it also drove bond prices higher and yields lower. Flight to safety flows eased after President Obama said that a second stimulus package isn’t needed at this time even though the unemployment rate will probably continue to rise. The Federal Reserve is also expected to reiterate that interest rates will remain at extremely low levels for some time, downplaying the possibility of a rate hike before the end of the year. Economic data from the U.S. was mixed with existing home sales rising, but less than the market had anticipated. Eurozone economic data on the other hand was surprisingly strong and comments from ECB member Weber added fuel to the fire.

2 Year Auction Results

ECB Used Up its Room to Cut Interest Rates

The initial rally in the EUR/USD was triggered by stronger German consumer confidence and the highest Eurozone composite PMI reading in 9 months. The pace of contraction is slowing which is a trend that has become global. In an unabashedly Euro bullish tone, ECB member Weber also said the central bank has "used" up its room to cut interest rates and there is currently no need for further stimulus measures. As the head of the German Bundesbank, his comments have particular sway on the currency markets. ECB member Quaden was cautiously optimistic citing that the unemployment rate could still rise with a recovery. However the comments from ECB President Trichet is what matters the most and yesterday, he said that policy makers must remain alert despite signs that the slump is decelerating because “there are still risks of a sudden emergence of unexpected financial turbulence.”

Can the EUR/USD Rally Last?

Looking ahead, the most pressing question on the minds of EUR/USD traders is whether the rally can last. Such a strong breakout can usually have follow through but there are 2 main hurdles that the EUR/USD has to overcome in the next 24 hours. The first is the 12 month ECB refinancing that we talked about on Monday. The refinancing is seen by bond traders as a quasi quantitative easing effort by the ECB because the operations are most likely going to be collateralized by government bonds which can then be posted as collateral to the ECB for funding. Weber even noted that “no additional policy steps are needed” after tomorrow’s refinancing. The second is the Federal Reserve’s monetary policy announcement. We do not expect any fireworks but EUR/USD traders will be closely watching the degree of the central bank’s optimism or cautiousness. In the meantime, before the rate decision, the Eurozone will release its current account figures for the month of April and we expect the region’s deficit to widen because of a similar expansion in Germany.

U.S. DOLLAR: FOMC PREVIEW

The U.S. dollar is trading lower ahead of the Federal Reserve’s interest rate decision. There is no question that the U.S. economy has improved since the last meeting. The housing market has stabilized, the equity markets are higher and the pace of job losses has slowed, bolstering consumer confidence (Table Comparing Change in Economic Indicators Since Last Fed Meeting ). There are of course still areas of weakness as the recovery remains fragile. The unemployment rate climbed to a quarter century high while oil and gas prices tick higher. Inflationary pressures are nonexistent and the economy is getting better so there are no major reasons for the Fed to change the size and scope of their asset purchase program. However the FOMC statement could still impact the EUR/USD because if the central bank stresses the improvements in the economy over the need for an extended period of easy monetary policy, we could see risk appetite drive the EUR/USD higher. If they stress the risks to the recovery and the need for interest rates to remain low for a long period of time over the improvements in the economy, the EUR/USD could give back its gains. Meanwhile U.S. economic data was mixed with existing home sales rising less than the expected and manufacturing conditions in Richmond improving. Durable goods and new home sales are due for release before the Fed meeting on Wednesday and the tepid increase in existing home sales suggest a similar rise in new home sales. Durable goods orders should remain weak as consumers limit their purchases of big ticket items.

PIMCO on Fed's Next Move

GBP/USD: TRAILS BEHIND THE EURO

Even though the British pound ended the U.S. trading session lower against the Euro, it still managed to benefit from dollar weakness. The only piece of U.K. economic data released this morning was BBA loans for house purchases which were stronger than expected, offsetting the decline in house prices reported on Monday. The British pound underperformed the Euro dramatically primarily because of comments made by Monetary Policy Committee member Dale who said buying gilts from foreigners can have a beneficial impact via a weak currency. He also said the central bank is still actively considering extending its operations into other corporate credit markets which suggest that that they may be expanding the scope of their Quantitative Easing program. Unlike the Federal Reserve who is expected to and has been doing “just enough,” the Bank of England has preferred to over deliver in the hopes of ensuring a recovery. The CBI distributive trades survey is due for release tomorrow which will shed some light on the state of consumer spending.

USD/CAD: IMMUNE TO CARNEY COMMENTS

Despite pessimistic remarks from Bank of Canada Governor Mark Carney, the Canadian Dollar recovered against the greenback after hitting a one month high on Monday. A reversal in the commodity prices added to the rally as oil advanced by 2.5 percent to nearly $69 a barrel, while gold rose by $3.02. USD/CAD is back below 1.15 and could see a deeper pullback towards 1.14, but as long as it holds above 1.13, the breakout remains intact, Canadian dollar traders completely shrugged off comments from Bank of Canada Governor Mark Carney who stated that the Canadian economy has slid into a recession as deep as the United States. The remarks added to speculation that the BoC is growing concerned after the sharp appreciation in the Canadian dollar since March. However, Carney also pointed out that the Canadian economy will swell at a rate twice that of the United States once the recession is over. Carney already hinted that the interest rates will remain at an all-time low of 25 basis points until June 2010 unless inflation rapidly escalates. The Australian and New Zealand Dollars also recovered significantly after yesterday’s losses as speculation of the U.S. leaving interest rates unchanged for considerable amount of time sends the dollar lower. Currency traders also shrugged off Moody’s warning about the outlook for Australian and New Zealand banks. No economic data is expected from the commodity producing countries over the next 24 hours.

USD/JPY: EXTENDS LOSSES FOR THIRD DAY

The U.S. dollar extended its losses against the Japanese Yen for the third consecutive trading day. On the economic front, the leading index fell slightly from 76.5 to 76.2. Economists predict that the world’s second largest economy may resume growth in the 3rd Quarter of the year as demand improves domestically and abroad. China’s hefty stimulus plan of 4 Trillion Yuan or approximately $590 Billion has increased the demand for Japanese goods. Increased government spending of roughly ¥25 Trillion Yen or $250 Billion continues to also benefit Japanese corporations. Therefore, next week’s Tankan Survey should confirm that the economy hit a bottom in the previous quarter. Improving economic conditions will likely negate the undermining fears of currency intervention even as USD/JPY continues to slide. Tonight, the Merchandise Trade Balance is due for release and an improvement is expected.

USD/JPY: Currency in Play for Next 24 Hours

USD/JPY will be the currency in play for the upcoming 24 hours. Tonight, Japan will release their Merchandise Trade Balance at 23:50GMT or 7:50PM EST. The U.S. will release its figures for Durable Goods Orders and New Home Sales at 12:30GMT or 8:30AM EST and 14:00GMT or 10:00AM EST, respectably. In the afternoon, the FOMC interest rate decision will be announced at 18:15GMT or 2:15PM EST.

Over the past three months, USD/JPY has been locked between the 101.00 and 94.00 price levels. However, the currency pair has recently entered the Sell Zone which we determine using Bollinger Bands. As a result, there is scope for further weakness in the currency pair. The closest level of support lingers at the 50% retracement of this year’s low and high at 94.25. If the pair breaks out of the Sell Zone, USD/JPY could begin its ascent back towards the 50-day SMA at 97.00.

Comments (3)

Les

June 23, 2009 at 06:30 PM ET

Kathy I really appreciate your comments. Re the upcomiming FOMC meeting: Do you believe that the committee stressing an improving US economy would would result in a weaker dollar? Would this not increase the desire to buy US assets? Please explain?

Thank you,
Les

Les

June 24, 2009 at 11:10 AM ET

Maby a better way of asking the question above is: Why is stressing the risks to the recovery and the need for interest rates to remain low for a long period of time over the improvements in the economy likely to cause the EUR/USD to give back its gains?

thanks,
Marv

klien

June 24, 2009 at 11:48 AM ET

This question is something that alot of traders are struggling with so I am glad you asked. The dollar is looked at as a "safe haven." The idea is that a recovery in other countries is contingent upon a recovery in the U.S. Therefore if the Fed suggests that the economic outlook is worse or still uncertain (which they may not), it would imply that a more delayed recovery for other countries, sending investors into the safety of U.S. dollars. If they are more optimistic, it would ease safe haven flows.

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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.