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Making Sense of Dollar and Equity Strength

Last updated 9/28/2009 5:12 PM ET (GMT -5) 4 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• MAKING SENSE OF DOLLAR AND EQUITY STRENGTH
• EUR: ECB BACKS STRONG DOLLAR POLICY
• GBP/USD EXTENDS LOSSES BELOW 1.60
• AUD/USD: STEVENS RENEWS HAWKISHNESS
• USD/CAD: CARNEY WORRIED ABOUT CURRENCY
• NZD/USD: OIL AND GOLD PRICES REBOUND
• USD/JPY: JAPANESE OFFICIALS STILL FEELING THEIR WAY AROUND THE YEN

EXPECTATIONS FOR UPCOMING FED MEETINGS

MAKING SENSE OF DOLLAR AND EQUITY STRENGTH

Over the past year, when U.S. equities rise, the dollar tends to fall because the improvement in risk appetite eases safe haven flows that have been parked in the U.S. dollar.  When 3 month LIBOR rates in U.S. fell below Japanese levels, the correlation between equities and currencies exacerbated as the dollar became the funding vehicle of choice for investors looking to assume risk.  This is what makes today’s price action in the currency market particularly mind boggling because the dollar actually strengthened on a day when stocks rose by the strongest amount in 5 weeks.  The greenback appreciated against all of the major currencies except for the Canadian dollar and Australian dollars which saw buying pressure offset by a mild rebound in commodity prices.  The Japanese Yen also held onto its recent gains even though it ended the U.S. trading session near its lows.

What Drove the Dollar Higher

The rally in the dollar has been primarily attributed to the comments from ECB President Trichet who said that he supports a strong dollar policy.  This was nothing new because he previously indicated that he believes the dollar should be strong as well, but with dollar short positions still at extreme levels, it apparently was enough to trigger a broad based rally in the greenback.  We still believe that the ECB is not incredibly uncomfortable with the strength of the euro (read our special report on Which Central Banks are Worried About their Currencies ) and therefore do not expect the dollar rally to last.  U.S. stocks staged a very strong rally on Monday and bond yields fell which should have been dollar bearish.  The Conference Board also reported that online help wanted ads fell by 101,800 in September, which suggests that Friday’s non-farm payrolls report may not be as healthy as everyone expects.  We believe that the strength of the dollar today is more a reflection of the anxiety and nervousness amongst currency traders.  It is also a few days before the month and quarter end when there is typically erratic volatility in the foreign exchange market.  The weakness of the dollar in the third quarter most likely helped to boost foreign earnings for U.S. corporations and therefore some of the strength in the greenback could reflect repatriation of profits to window dress balance sheets.  Therefore we don not expect the breakdown in the correlation between currencies and equities to last.  Since the beginning of 2008, the correlation between the S&P 500 and the EUR/USD has been close to 90 percent.  

Federal Reserve: Basking in Dollar Strength

Of all the major central banks, the Federal Reserve is the least worried about the recent fluctuations in its currency.  In fact, the Fed is basking in dollar weakness. The global financial crisis has driven inflationary pressures to very low levels while the recent plunge in commodity prices reduces price pressures even further, making one of the primary concerns of a weak currency obsolete.  Instead, the U.S. economy is experiencing only the benefits of a weak dollar which includes foreign demand for U.S. exports, real estate and U.S. companies.  It also helps to boost the foreign earnings of U.S. multinational corporations which could make for a particularly jolly earnings season in the third quarter.  Although the Federal Reserve and other members of the U.S. government could say that they support a strong currency, any reference would represent nothing more than lip service to the policy.

Looking ahead, the U.S. consumer confidence report from the Conference Board is due for release on Tuesday.  According to the University of Michigan, consumer sentiment rose to the highest level since January 2008in September thanks to the slowing pace of job losses and the rally in equities.  We expect the Conference Board to report a similar improvement.  

EUR: ECB BACKS STRONG DOLLAR POLICY

The sell-off in the EUR/USD actually began in the Asian trading session when risk aversion and demand for the Japanese Yen drove the euro from a high of 1.4720 to an intraday low of 1.4565.  In the European session, the EUR/USD managed to recover its gains but around the London close, the EUR/USD was sold aggressively after ECB President Trichet said for the second time today that he supports the U.S.’ strong dollar policy.   The first time he talked about backing a strong dollar was right around 11:00am and at that time, the EUR/USD barely budged, but when he finished his speech and repeated the comment on CNN, the selling exacerbated. Therefore the weakness in the currency pair today can only be partially attributed to Trichet’s comments about he dollar.  As we mentioned in the previous section of this report, Trichet has previously made similar comments but when he is seriously concerned about the euro, he talks about the single currency specifically or criticizes foreign exchange volatility (although ECB Nowotny did criticize abrupt forex fluctuations).  Instead, we believe the weakness of the euro is more likely to be attributed to his concern that the crisis is not over and that loan growth to companies remain weak.  This suggests that they are not satisfied with the results of their stimulus measures and are therefore not considering implementing an exit strategy in the near future.  As for economic data, German consumer prices fell by the sharpest amount since January which indicates that inflationary pressures are nonexistent.  Eurozone retail PMI and sentiment indicators are due for release on Tuesday.  

GBP/USD EXTENDS LOSSES BELOW 1.60

For the fourth trading day in a row, the British pound lost value against the U.S. dollar.  The break of technical support on Friday opens the door for a potential test of the 1.55 level.  Mixed comments from U.K. officials continued to weigh on the pound.  Alistair Darling, Chancellor of the Exchequer announced a two-pronged initiative to start reducing the country’s massive budget deficits and the “greed and recklessness” within the banking industry. He will be meeting with banking executives to gain support for a plan to limit bank bonuses. Mr. Darling also plans on raising income taxes again on the rich, upholding his belief that the wealthiest of the population should take on the most burden. His latest comments seem to be a last ditch attempt to secure party voters at the upcoming elections which may be good for him but bad for the pound.  BoE Chief Economist Spencer Dale’s comments on the other hand were a little more uplifting. Spencer Dale said the economy appears to have stabilized and the country has weathered the worst of the storm. However, he stresses the usual concerns and says that “we are in for the long haul”. Economic data showed that the Hometrack House prices increased by the best levels in more than two years, leaving average house prices at $248,000. The 5.6% decline in yearly prices was the smallest contraction seen in a year. Nevertheless, Hometrack cautions that mortgage availability is still tight which may bring down prices in the short-run. The U.K. calendar heats up tomorrow with the final release of Q2 GDP, current and mortgage approvals due for release.  

AUD/USD: STEVENS RENEWS HAWKISHNESS

There has been a significant amount of volatility in the commodity currencies over the past 24 hours.  The New Zealand dollar fell victim to the strength of the greenback while hawkish comments from Reserve Bank of Australia Governor Stevens and higher commodity prices helped keep the Australian and Canadian dollars afloat. There was no economic data released from any of the 3 countries but Stevens renewed his hawkishness in a testimony to the Senate Economics References Committee.  Steven is confident that “both fiscal and monetary support will need to be unwound” in the near future as the economy continues to recover.   He indicated that “the bank has already signaled that interest rates, at some point, will move off of their unusually low levels.” His consistent use of the phrase “unusually low levels” indicates a clear hawkish bias. Stevens proclaims that the country is in a recovery and notes that people believe the “future is looking brighter”.  He also warned that if interest rates were kept low for too long, it would build imbalances.  Unsurprisingly this has fueled speculation of a RBA rate hike before year end.  We think this is a bit optimistic but not out of the question.  Either way, we expect the RBA to be the first major central bank to hike interest rates.   The calendar remains light over the next 24 hours with only New Zealand building permits due for release.  

I was on the Business News Network talking about the outlook for the loonie.  Link to the video  

USD/JPY: JAPANESE OFFICIALS STILL FEELING THEIR WAY AROUND THE YEN

USD/JPY has had a wild ride today, in which an almost 200 pip decline was completely reversed. On an intraday basis, the currency pair fell dangerously close to what would have been a new fourteen year high in the yen. The currency’s erratic fluctuations came on the heels of the latest comments from Finance Minister Fujii who gave the markets some mixed signals today in his strategic mission to balance both political and factual pressures. The finance minister first announced that the appreciation in the yen is not abnormal, but indicated that he does recognize that forex markets are “one-sided”. Instead of adding more emphasis over his desire not to intervene, the new party has summoned the Japanese Trade Minister to produce statistical facts to back such claims that a stronger yen hurts Japanese exporters. However, it may turn out that proof lies solely behind the fact that a strong yen is economically destructive. The Wall Street Journal reported that for every one-yen appreciation in the exchange rate, Toyota sacrifices Y25B in profits. Toyota’s sensitivity to the Yen probably reflects that of many other Japanese corporations.  Therefore it will be hard for Mr. Fujii to allow the yen to appreciate uncontrollably.  His efforts to create a country that is less dependent on external demand may be curtailed if the strong yen dents the recovery. This evening, consumer prices are due for release and they will shed more light on the inflationary / deflationary conditions in Japan.  

EUR/GBP: Currency in Play for Next 24 Hours

EUR/GBP will be the currency in play for the next 24 hours. To start things off, we will have data for the Euro-zone that includes German Unemployment at 3:55 am ET or 7:55 GMT as well as the CPI estimate for 5:00 am ET or 9:00 GMT. The U.K. will release the Index of Services at 4:30 am ET.

EUR/GBP

EUR/GBP

EUR/GBP

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Comments (4)

John Booke

September 28, 2009 at 06:26 PM ET

Kathy
You say the correlation between equities and EUR/USD has been 90%. Is that based on a day-to-day calculation or some other time frame?

klien

September 29, 2009 at 02:02 PM ET

day over day

spunky

September 29, 2009 at 09:19 AM ET

Great to see you on tv Kathy

raulsm

September 29, 2009 at 03:15 PM ET

Really appreciate your posts Kathy, clear and straighforward.

If have looked at the Brazilian Real, may I ask if you expect it to reverse course soon, or when?

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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.