U.S. Dollar: G8 Summit vs. Data

Last updated 7/3/2009 4:54 PM ET (GMT -5) 1 Comments

Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• U.S. DOLLAR: G8 SUMMIT VS. DATA
• EUR: REBOUNDS DESPITE WEAK RETAIL SALES REPORT
• GBP/USD: BANK OF ENGLAND MEETING NEXT WEEK
• AUD/USD: SERVICE SECTOR ACTIVITY BACK IN EXPANSIONARY TERRITORY
• USD/CAD: IVEY PMI AND EMPLOYMENT NUMBERS NEXT WEEK
• NZD/USD: NO MAJOR ECONOMIC DATA ON TAP
• USD/JPY: 95 LEVEL CRITICAL FOR COMING WEEK

EXPECTATIONS FOR UPCOMING FED MEETINGS

U.S. DOLLAR: G8 SUMMIT VS. DATA

With U.S. traders out celebrating the July 4 ^th holiday, recovery and consolidation was the theme in the currency markets today. The euro and commodity currencies rebounded against the U.S. dollar while the British pound and Japanese Yen edged modestly lower. The EUR/USD had a slightly wider than expected July 4 ^th holiday trading range of 100 pips but the trading range for USD/JPY was less than 50 pips.

In the week ahead, the U.S. economic calendar is extremely light. The only pieces of potentially market moving data will be the service sector ISM index on Monday and the U.S. trade balance on Friday. However there will be interest rate decisions from Australia and the U.K. along with the G8 Summit in Italy beginning on Wednesday. In light of that, the lack of U.S. economic data next week could lead to a further rally in the dollar as bears take profits on short positions. After Thursday’s weak non-farm payrolls report, traders need a very good reason to buy stocks and sell dollars. Unfortunately there may not be many reasons for investors to turn optimistic in the coming week. The only hope is for strong earnings from Alcoa or an escalation of reserve diversification talk around the G8 meeting. However in all likelihood, China’s flip flopping threats about the dollar will amount to more bark than bite. G8 leaders have no interest in talking down the dollar at this point and at best it may only be mentioned in their outreach talks with the emerging economies. This is not the time or place to be talking about reserve diversification as European leaders may adamantly oppose any measures that could further strengthen their currencies. Therefore China’s request won’t amount to anything and instead the G8 leaders will focus on discussing the state of the global economy, the need for greater financial regulation, climate change, trade and development. The markets also rarely react to the outcome of the G8 Summit as specific financial announcements are usually left to the Finance Ministers meeting.

Using Currencies to Forecast Earnings

Meanwhile when traders return on Monday, their focus will shift to earnings season. Many equity analysts believe that Q2 earnings will be stronger for the nonfinancial sectors because of cost cutting, the rally in equity markets, the improvement in consumer confidence, government stimulus programs and the slower pace of contraction in manufacturing indices. However, we believe that the weakness of the U.S. dollar has also played a large role in corporate profitability between April and June just as the dollar’s strength in the first 3 months of the year bit into earnings. In the second quarter, the U.S. dollar weakened across the board. This will benefit the companies that export abroad, have foreign operations or large account receivables denominated in foreign currencies. In general, the industries with the greatest foreign sales exposure are energy, technology and consumer staples. Google for example reported in the first quarter that foreign currency fluctuations shaved 7.8 percent off from their revenues. Considering that the dollar only strengthened 5.16 percent against the euro and 1.85 percent against the British pound in the first 3 months of the year, we can only imagine the positive impact that a 14 percent appreciation of the British pound and close to 6 percent appreciation of the euro will do to earnings in the second quarter. Some analysts estimate that Google, who makes more than 50 percent of their money internationally, will see a 20 cent contribution to earnings purely from FX flows. Companies that produce commodities could also benefit as the weaker dollar drives commodity prices higher. Therefore equity traders may find it useful to use currency fluctuations to forecast earnings.

EUR: REBOUNDS DESPITE WEAK RETAIL SALES REPORT

Despite sharp selling in Asia yesterday, the EUR/USD ended the U.S. trading session virtually unchanged. Eurozone economic data was mixed with the final service sector PMI data revised marginally higher from 44.5 to 44.7. Retail sales were weak with consumer spending falling 0.4 percent. This drop was not entirely surprising considering the sharp decline in spending in France and the slower pace of growth in Germany. Looking ahead the big question for the EUR/USD next week is whether or not it will test the monthly low of 1.3750. Even though the Eurozone economic calendar is busier than the U.S., there may not be any major surprises. The only meaningful releases on the calendar are the final figures for first quarter GDP, industrial production and the German trade balance. Manufacturing activity is improving globally and therefore we expect to see evidence of this recovery in the industrial production and factory orders report. Therefore the chance of consolidation is greater than a test of the monthly high or low. Consumer prices were released from Switzerland today. The market was looking for CPI to ease but it held steady which is mildly positive for the Franc. Employment data is due for release next week and like many other countries around the world, the jobless rate is expected to rise.

GBP/USD: BANK OF ENGLAND MEETING NEXT WEEK

The British pound ended the U.S. trading session marginally lower against the U.S. dollar and euro as the service sector PMI index fell from 51.7 to 51.6 in the month of June. Although the pace of expansion slowed marginally, it is still impressive that services, which accounts for over two thirds of the economy is growing and not contracting. Despite the large drop in GDP in the first quarter, the PMI reports indicate that the U.K. economy is getting back on track. The big event for the U.K. next week will be the Bank of England interest rate decision. For the fifth month in a row, the BoE is expected to leave interest rates unchanged at 0.5 percent. However there is a lot of speculation floating around about what the central bank could do next. Some believe that they could raise their size of their asset purchase program to accelerate the recovery while others argue that they could be first to remove monetary stimulus. The latest comments from monetary policy committee members Besley and Miles suggest that the BoE is in no rush to tighten monetary policy. They said there is no specific timing to unwinding the asset purchases and that it is premature to assess the effectiveness of the Quantitative Easing program. Therefore we place the odds in favor of more dovish rather than hawkish comments from the central bank next week. In addition to the BoE decision, industrial production, the trade balance and producer prices are due for release. Improving manufacturing activity should help to narrow the trade balance while the strength of the pound may have offset higher commodity prices.

AUD/USD: SERVICE SECTOR ACTIVITY BACK IN EXPANSIONARY TERRITORY

Quiet trading has helped the Australian, New Zealand and Canadian dollars recover against the greenback. Australia was the only commodity producing country to report economic last night. Service sector PMI leaped from 39.9 to 50.2, the first month of expansion in more than a year. This healthy report confirms our belief that the Australian economy is outperforming all of its G20 counterparts. The main event risk for next week will be the Reserve Bank of Australia’s rate decision on Tuesday. The RBA’s meeting is probably one of the most anticipated central bank meetings at this point because their comments on the outlook for monetary policy and the economy could have a significant impact on the Australian dollar. Last month, the central bank warned that interest rates could still be reduced despite improvements in the economy. The economy has only strengthened further since then with retail sales rising for the third month in a row, manufacturing sector activity accelerating and the number of people falling off employment rolls decreasing. Building approvals were weak but hardly notable enough to offset the laundry list of good news. However for the RBA, there is no urgency to rush back towards tighter monetary policy. The global recovery is still fragile and strength of the Australian dollar could hurt earnings. There is more to lose if they turned hawkish one month and reverted back to dovishness the next. Therefore we expect the RBA statement to remain relatively unchanged. In addition to the RBA rate decision, Australia’s labor market report is due for release. Canada also employment numbers on Friday, but the focus in the beginning of the week will be on the IVEY PMI report. Oil prices have retraced significantly which is contributing to the weakness in the loonie. The New Zealand economic calendar on the other hand is devoid of any market moving data.

USD/JPY: 95 LEVEL CRITICAL FOR COMING WEEK

In the coming week, USD/JPY will continue to trade on risk appetite. The 95 level has been a very significant area of support and should risk aversion exacerbate we could see that level tested again. In light of the numerous reports from Japan this past week, we have learned that the corporate sector of the economy is improving but unfortunately that improvement has not trickled down to consumers. This is a major problem that Japan has had for years and one that they are clearly continuing to struggle with. Small and large business has seen improving activity thanks to demand from China but earnings continue to fall while unemployment continues to rise. Next week, Japan is set to release their leading indicators report, Eco Watchers survey and trade balance. Even though the Yen strengthened against the dollar in May, its weakness against the euro and large orders from China should help boost their trade surplus.

USD/JPY: Currency in Play for Next 24 Hours

USD/JPY will be the currency in play on Monday. Japan will be releasing its leading indicators report at 1:00am ET or 5:00 GMT while the U.S. is expected to release service sector ISM at 10:00am ET or 14:00 GMT.

Over the past 2 weeks, USD/JPY has been caught in a very tight trading range. Despite a series of higher highs and higher lows, the currency pair has been constrained between the 95 and 97 levels. Significant resistance exists right above current prices with the 10, 50 and 100 day SMA hovering around the 96.75 – 97 level. Thursday’s low of 95.70 coincides with the 200-day SMA and the 38.2 percent Fibonacci retracement of the January to April rally. Although a move below 95.60 would take USD/JPY into the “sell zone,” which we determine using Bollinger Bands, the currency pair would really need to close below 95.00 to open the door for a more meaningful sell-off. A rally above 95.70 on the other hand could pave the way for a move towards the first standard deviation Bollinger Band at 98.00.

Comments (1)

Aquiles

July 04, 2009 at 03:53 AM ET

Kathy, where do you think should be a good entering point in EUR/USD to go short?

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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.