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U.S. Dollar: Think Strategically

Last updated 9/25/2009 5:15 PM ET (GMT -5) 4 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• U.S. DOLLAR: THINK STRATEGICALLY
• GBP/USD: U.K. OFFICIALS HAVE DOLLAR ENVY
• EUR/USD: BIG WEEK AHEAD
• USD/CAD: CARNEY TO MULL OVER QE
• NZD/USD: TRADE DEFICIT NARROWS, BUT EXPORTS PLUNGE
• AUD/USD: BIG WEEK AHEAD
• USD/JPY: WHEN WILL THE BOJ INTERVENE?

EXPECTATIONS FOR UPCOMING FED MEETINGS

U.S. DOLLAR: THINK STRATEGICALLY

For the first time since the beginning of the month, the U.S. dollar index ended the week in positive territory. There is finally hope for the dollar bulls that may be looking for some sort of respite after what must have felt like a losing battle. Yet it is far too early to become over optimistic since the dollar only traded higher against the British pound and Canadian dollar on Friday and instead lost value against the Japanese Yen, euro Australian and New Zealand dollars.  On an intraday basis, there has been a tremendous amount of volatility in the major currency pairs, reflecting indecision in the foreign exchange market.  The rollercoaster like price action in the following chart of the EUR/USD is the type of moves that we have become accustomed to over the past few trading days.

Although the wild intraday swings may be viewed as opportunity to some traders, others may be confused and frustrated by the quick moves.  One minute the dollar is rising aggressively and the next minute it is giving up all of its gains and then some.  For the most part, the EUR/USD is moving in lockstep with equities but that may not be true for other currency pairs such as USD/JPY and the GBP/USD.  Therefore rather than trying to make sense of such erratic intraday price action, this is the type of market environment where it may be more fruitful for traders to think strategically.  Think beyond what could happen in the next 2 hours to what could happen in the next few weeks or even months.  Although not everyone may be interested in the longer term trend of a currency pair, it is important to understand where the path of least resistance is because it can help us determine the currency pair’s trend and allow us to be more selective in the pairs that we choose to trade on both a short or longer term basis.  Generally speaking, the currencies that should perform the worst are the ones whose central banks are reluctant to tighten monetary policy and those that may perform the best are the ones that are more likely to.  One way to think about this is to look at unemployment.  The following chart compares the latest unemployment rate for all of the major countries with that of its 17 year average (which is as far back as our data goes).  The unemployment rate in the U.S. as of August 2009 is 9.7 percent compared to an average unemployment rate over the past 17 years of 5.5 percent.  The difference of 4.2 percent suggests that there is a lot of additional slack in the U.S. economy.  In contrast, the average unemployment rate in Germany is 9.83 percent compared to a current unemployment rate of 8.3 percent.   This suggests that over the past 17 years, more people have accumulated jobs in Germany.  The same is true for Australia and New Zealand who benefitted materially from China’s rapid development China over the past 2 decades.  Therefore we have good reasons to believe that the countries with the greatest excess capacity and the highest differential between the current unemployment rate and that of the 17 year average is most likely to keep interest rates on hold for the longest period of time.  In contrast, for the countries where are the unemployment is below the average, the central bank may be itching to raise interest rates.  Perhaps this helps to explain the European Central Bank’s lack of concern about the euro’s strength.  

Source: FX360.com   

Big Week Ahead – FOMC and GDP

This context may come in handy in the coming week with a busy global economic calendar that will most likely boost the volatility in the currency market.  Judging from the price action, we could see a further rebound in the buck next week even though we still believe the overall trend for the dollar is down.  The marquee release from the U.S. will be Friday’s non-farm payrolls report, but before the number comes out, there will be consumer confidence, the final release of second quarter GDP, Chicago PMI, ISM Manufacturing and the usual leading indicators for payrolls.  This morning’s economic reports were mixed – even though consumer confidence improved, durable goods fell sharply while new home sales rose at a slower pace.  The EUR/USD and AUD/USD barely budged because of the less dovish nature of those central banks, but the British pound and Canadian dollar fell aggressively.  USD/JPY also slipped below 90 for the first time since February which suggests that traders are nervous.  According to the latest futures report from the CFTC, currency traders increased their dollar short positions against every major currency except for the British pound and Canadian dollar.  Instead traders boosted their net short positions in the GBP and cut their long CAD exposure.

GBP/USD: U.K. OFFICIALS HAVE DOLLAR ENVY

Over the past 48 hours, the British pound has fallen more than 430 pips against the U.S. dollar and 200 pips against the euro.  The market has primarily focused on dollar weakness but that should not draw away from the fact that over the past month, the British pound has actually performed worse than the U.S. dollar. On a percentage basis, the pound has fallen more than the dollar against the other major currencies.  The problem is that U.K. officials are sending out mixed messages which currency traders are not very happy about.  Yesterday, BoE Governor King talked about the merits of a weak sterling which suggests that he supports one.  Today, Finance Minister Darling tried to temper the weakness in the pound by saying that King’s comments were directed at exporters and the U.K.’s policy on the pound is unchanged.  However the more they try to backtrack on their comments, the more convinced we are that U.K. officials have dollar envy.  The weakness of the dollar is keeping the U.S. recovery on track and if the pound weakened as well, it could reduce the need for further stimulus.  There was no major U.K. economic data released today, but next week the calendar heats up with the final release of second quarter GDP, the current account balance, mortgage approvals, housing market reports, manufacturing and construction sector PMI.  Technically, the GBP/USD looks poised for more losses.  The neckline of the head and shoulders pattern that dates back to June has been broken and as a result, there is no meaningful support for the currency pair until 1.55.   

EUR/USD: BIG WEEK AHEAD

The EUR/USD ended the U.S. trading session virtually unchanged but not before the tremendous amount of volatility that mentioned in the dollar portion of our report. Official comments ruled the day, with some influential statements from the ECB’s Yves Mersch and German Finance Minister Peer Steinbreueck. At the Group of Twenty meeting in Philadelphia, Yves Mersch said that the ECB needed to count on “timely preparations” for the removal of stimulus in the form of low rates and unconventional liquidity initiatives. Even though this is nothing completely groundbreaking, the comments from today were distinctly cautious. This calls for an adjustment to everyone’s expectations of when a hike will come, an event that seems to be slipping further and further into the future. Adding to the cautionary sentiment was Peer Steinbreueck who warned that “imbalances” in trade and investments could derail recovery efforts. Despite the cause for concern that these comments may have left, today is still a good day for confidence. German GFK Consumer Confidence reached its highest levels since June 2008 and a gauge of economic expectations reached positive territory for the first time in more than a year. The producers of the release thanked low inflation for the lifting impact it has had on sentiment. French Confidence also improved, reaching -36 from -37. However next week could single-handedly change it all for the euro. The schedule includes German CPI for Monday, Consumer Confidence for Tuesday, German Unemployment and EZ CPI Estimate for Wednesday, retail sales and PMI for Thursday, and Eurozone producer prices on Friday.

USD/CAD: CARNEY TO MULL OVER QE

Commodity currencies were mixed but they equally shared in the substantial turbulence that hit currency markets today. USD/CAD is barely holding onto positive ground, while the aussie and loonie have been able to post minimal gains. Bank of Canada Governor Mark Carney made some substantial comments today that easily contradicts any notion that the bank was on its way to tightening. This week has seen an onslaught of similar concerns. On Wednesday Carney said the economy was not “self-sustainable”, while yesterday saw a proposal to expand mortgage buy-back programs. Today clearly tops the list. Mark Carney reiterated his concern over loonie strength as it moves away from “fundamental levels”. In order to combat this threat and others, like deflation, Carney suggests that they could revert to quantitative easing. This is a real surprise considering the fact that most banks are beginning talks about how to unwind the policies and Canada joined in the optimism no longer than 2 months ago. If Carney follows through on the plan, it may prove that they are well behind the curve, with only more weakness to come. As a double shot to the economy, oil prices have fallen 8.6% this week alone, adding to the bank’s desperation. For Canada, next week holds GDP for Wednesday. Meanwhile New Zealand reported that even though its annual trade deficit narrowed to the smallest in six years, exports plummeted to the lowest in more than two decades. In addition, imports struggled for the fifth straight month. For New Zealand next week, we are expecting reports Building Permits and Business Confidence. Australia also has a busy week with Retail Sales and the CB Leading Index due for release on Wednesday.

USD/JPY: WHEN WILL THE BOJ INTERVENE?

The U.S. dollar fell to the lowest level against the Japanese Yen in more than 7 months following the latest comments from Japanese Finance Minister Fujii who reiterated his unwillingness to intervene in the currency market unless levels become “abnormal.”  According to former MoF Chairman Eisuke Sakakibara, also known as Mr. Yen, the Japanese government may not step into the markets until USD/JPY breaks 80.  In our opinion, even though Fujii has proven to be more supportive of a stronger than weaker yen, political pressure on the new government may force them to intervene prematurely.  As soon as USD/JPY breaks its 14 year low of 87.14, we will be looking for signs of intervention.  Meanwhile, the sharp drop in USD/JPY has dragged all of the other yen crosses lower.  If there are any disappointments in economic data next week, the selling could accelerate.  Technically, there is no major support in USD/JPY until the 14 year lows.  Aside from the barrage of data from Western nations, Japan also has its share of key reports.  The most important release in the coming week will be the third quarter Tankan report - business confidence is expected to improve thanks to the global recovery.  Retail sales, small business confidence, industrial production, household spending and the jobless rate are also due for release.  

GBP/USD: Currency in Play for Next 24 Hours

The GBP/USD will be the currency in play for Monday. The U.K. jumpstarts economic releases for the next week with the Hometrack Housing Survey on Sunday night at 23:01GMT or 7:01PM ET. This will be followed by the U.S.’ Chicago Fed National Activity Index at 12:30GMT or 8:30AM ET and Dallas Fed Manufacturing Activity at 14:30GMT or 10:30AM ET. The sharp sell-off in the GBP/USD on Thursday has pushed the currency pair into the Sell Zone, which we determine using Bollinger Bands.  However more importantly, there is a very clear head and shoulders pattern and the sell-off on Friday takes the currency pair below the neckline of that pattern.  This suggests that we could see further losses if the GBP/USD fails to recover back above 1.6150.  1.55 is psychologically support in the currency pair but 1.5760 is the 38.2% retracement of March low and August high.

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Comments (4)

a_kapoor

September 26, 2009 at 01:30 PM ET

Hi Kathy,
The "think strategically" section is quite awesome ..

However, I have a question to ask.. What about USD/CHF ? Do you think UBS will intervene with CHF becoming nearly equal to the dollar.. but then what happens to the EUR/USD and USD/CHF correlation as EUR can still be expected to go higher .. or is it not ?

klien

September 28, 2009 at 11:44 AM ET

The SNB doesnt appear to be targeting a level in USDCHF but is watching EUR/CHF to make sure it doesnt break below 1.50

kbb

October 01, 2009 at 02:07 AM ET

Hi,
Great Book!! ( Day Trading the Currency Market) It, along with Brad's articles, have helped me immensely in money/risk management. Your writing style is very transparent which makes it easier to absorb especially for the fundamental analysis. Which brings me to my question(s); What do you think will happen with the NFP out on Friday and how do you think it should be traded? Will it bring any relief to the greenback, if it disappoints how far will it tumble? Which currency pair(s) would you recommend trading?

klien

October 01, 2009 at 08:37 AM ET

I will answer all of these questions in my NFP Preview today

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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.