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THE STORIES IN THE CURRENCY MARKET

• U.S. DOLLAR: WHERE DOES FED FIT IN PART 2
• EUR/USD: TAKEAWAY POINTS FROM ECB
• GBP/USD: BOE ON HOLD TO NOVEMBER
• USD/CAD: EMPLOYMENT NUMBERS ON TAP
• AUD/USD: STRONGEST JOB GROWTH IN 2 YEARS
• NZD/USD: AUD AND NZD HITS 14 MONTH HIGHS
• USD/JPY: 3 MONTH LIBOR SPREAD SIGNALS MORE LOSSES

EXPECTATIONS FOR UPCOMING FED MEETINGS

CURRENT US INTEREST RATE: 0.25%					Rates to Remain Unchanged Throughout 2009
	11/4 Meeting	12/16 Meeting
NO CHANGE	39.9%	46.2%
Cut to 0.00%	51.2%	44.4%
Increase to 0.50%	8.9%	6.7%
Increase to 0.75%	0.0%	0.0%

U.S. DOLLAR: WHERE DOES FED FIT IN PART 2

The U.S. dollar traded lower against all of the major currencies with the sharpest losses seen against the Australian dollar, which surged on the heels of the strongest job growth in 2 years. Earlier this week, we penned an article titled “ Where Does the Fed Fit In? ” and we truly believe that the recent price action in the currency market reflects the answer to that question. Three central banks made monetary policy announcements this week with 3 very different outcomes. The Reserve Bank of Australia hiked interest rates, the European Central Bank grew a bit more optimistic while the Bank of England left the door open for further easing. There is a good chance that all 3 of these central banks could make changes to their monetary policy before the end of the year. The Federal Reserve on the hand will most likely leave their Quantitative Easing program unchanged. They have not been in a rush to remove their unconventional measures, especially following last week’s disappointing non-farm payrolls report. This dynamic reinforces our belief that the dollar could continue to fall.

Where Does the Fed Fit In Part 2

The answer to the question of “Where Does the Fed Fit In” will also be the primary driver of the currency market over the next few months. If other central banks start to follow in the footsteps of the RBA (like New Zealand), we could see more currencies hit new highs against the U.S. dollar. There is a good chance that the RBA could also raise interest rates again before the end of the year. Even though the ECB is not expected to hike their main interest rate, they could add a spread to the December one year tender which would still be perceived as a hawkish move. The BoE is more dovish than the Fed but the pound could simply benefit from broad based dollar weakness. The following chart which is created based upon the price of options on interest rate futures, shows how close the market believes each of the major central banks are to raising interest rates and could signal the dollar's future performance against other currencies.

Earnings Season Starts off with a Bang

Earnings season has also begun and we expect a lot of positive surprises. Alcoa, PepsiCo and Marriott all reported stronger results. If equities continue to rally, the EUR/USD should as well. The following chart illustrates the correlation between the EUR/USD and the S&P 500.

Source: Bloomberg

Economic Data Preview and Review Aside from the better than expected earnings reports, the risk appetite in the market has also improved because of stronger economic data. Jobless and continuing claims have fallen while chain store sales increased 0.1 percent. In other words, the latest reports indicate that the labor market is improving and consumer spending is holding steady. The market currently expects a very sharp 2.0 percent drop in retail sales but many of the leading indicators for consumer spending including the ICSC and SpendingPulse index along with results from individual retailers suggests otherwise. The trade balance is due for release tomorrow and the weak dollar combined with the rise in the export component of manufacturing ISM indicates a recovery in trade.

EUR/USD: TAKEAWAY POINTS FROM ECB

Even though the euro ended the U.S. session higher against the dollar, there was quite a bit of intraday volatility on the heels of ECB President Trichet’s post monetary policy meeting press conference. In general, Trichet's tone was relatively upbeat which suggests that the central bank may be much closer to implementing an exit strategy than the Federal Reserve. There are signs of stabilization in the Eurozone economy and the recovery in exports should fuel growth going forward. As we expected, the second question asked by reporters was the ECB’s stance on the currency. Trichet repeated his previous comments that excess volatility and disorderly movements in exchange rates are adverse for the global economy and with that in mind, the U.S.' strong dollar policy is extremely important in present circumstances. Although no new comments were made, it was still enough to turn the EUR/USD around. Also, traders were disappointed by the fact that the ECB failed to add a spread to the one year tender in December, but with another meeting between now and then, the central bank can afford to wait. There is no urgency within the ECB to step up their degree of verbal intervention or to implement an exit strategy. In the words of Trichet "If we have anything to say on intervention, we will." He also said that monetary stimulus is providing strong support for the economy and unconventional measures will be unwound in a timely fashion when the economy improves. Overall, Trichet’s comments should be more positive than negative for the euro. Unlike the Fed, speculation that the ECB could add a spread to the one year tender in December puts the central bank closer to tightening monetary policy which is what traders should remember when they are considering the outlook for the EUR/USD. Meanwhile German industrial production rose slightly less than expected in August. The German trade and current account balance along with the final consumer price report for the month of September are due for release tomorrow.

GBP/USD: BOE ON HOLD TO NOVEMBER

The British pound rallied against the U.S. dollar and euro after the Bank of England left the size of their asset purchase program and interest rates unchanged. The monetary policy statement was short and sweet with the central bank saying that they voted to continue with their current GBP 175 billion program of asset purchases which they expect to take another month to complete. “The scale of the program will be kept under review.” The BoE has not closed the door on further asset purchases but the market will have to wait for the minutes to see how close they are to increasing stimulus. Next month’s monetary policy announcement will be a particularly important because it comes a week before the Quarterly Inflation Report. As they prepare the report, the central bank will be thinking about the impact that the weakness in the pound and higher commodity prices will have on the economy. If economic data continues to deteriorate, the BoE may be forced to cut interest rates or ask the Chancellor for more funds. Both former Deputy Governor John Gieve and former Monetary Policy Committee member Blanchflower believe that the BoE needs to do more. The U.K. economy is clearly not out of woods and even though the BoE left monetary policy unchanged today, they have not necessarily ended their easing cycle. The central bank is still one of the most dovish on the street and for the time being, they are on hold until November. Producer prices and trade data are due for release tomorrow. On a trade weighted basis, the British pound has fallen more than 7 percent since the beginning of August which could help reduce the trade deficit. However the contribution is likely to be small since manufacturing PMI contracted.

USD/CAD: EMPLOYMENT NUMBERS ON TAP

There are a lot of economic reports due for release tomorrow but none of them are more important than Canada’s employment report. In the month of August, Canada experienced its first job gain in four months. The market expects job losses to return in September but given the sharp rise in the employment component of IVEY PMI, we believe that not only could job losses be minimal but there is a good chance that Canada experienced positive job growth for the second month in a row. A strong labor market report should add to the upside momentum in the Canadian dollar and send it a fresh 12 month high against the greenback. Although housing starts fell in September, the August data was revised sharply higher. Meanwhile the Australian and New Zealand dollars raced to fresh 14 month highs on the heels of the incredibly hot Australian employment report. A total of 40.6k Australians found new jobs last month, dropping the unemployment rate for the first time in 5 months to 5.7 from 5.8 percent. Given the rise in the employment components of the service, manufacturing and construction sector PMI reports, we were a bit surprised that economists actually expected job. In our daily report yesterday, we said there is a good chance that Australia experienced job growth but no one anticipated the strongest job growth since November 2007. The best part of the report is that most of growth occurred in full time work. The improvement in the labor market validates the Reserve Bank’s decision to hike interest rates earlier this week and confirms our belief that interest rates could be lifted again before the end of the year. The construction sector has been booming partially due to government stimulus and partially due to the recovery in the housing market. We have been looking for the AUD/USD to break 90 cents for a very long time and now expect the currency pair to rise as high as 93 cents over the next few months.

USD/JPY: 3 MONTH LIBOR SPREAD SIGNALS MORE LOSSES

USD/JPY is having a very tough time participating in the rally experienced by the other yen crosses. This of course is a reflection of the overall weakness in the U.S. dollar. The 3 month LIBOR spread between the U.S. and Japan continues to grow in the favor of the Yen which signals further losses in the currency pair. Unless the USD/JPY manages to rise back above 90, the path of least resistance is still lower with support in the currency pair at the one year low of 87.14. If the yen is only rising against the U.S. dollar, Japanese officials may not feel as compelled to intervene in the currency. Given the flip flopping comments by Finance Minister Fujii, we do not believe that the new Finance Minister is a strong advocate of intervention. He is certainly under pressure from Japanese corporations, but a break of 85 may be needed before they will step in. Meanwhile, economic data supports the recovery story in Japan. The current surplus increased more than expected in the month of August along with the Eco Watchers Survey. Bankruptcies also plunged by 18 percent while machine tool orders fell at a slower pace. The trade balance narrowed but not by as much as the market had anticipated. As long as the dollar remains the driver of the currency market, the performance of USD/JPY could continue to diverge from the other yen crosses.

USD/CAD: Currency in Play for Next 24 Hours

USD/CAD will be the currency pair in play for the next 24 hours. Canada will be releasing their employment report at 7:00am ET or 11:00 GMT and the U.S. will release its trade balance report at 8:30am ET or 12:30 GMT. USD/CAD is currently trading in the Sell Zone, which we establish using Bollinger Bands. The 1.0310 a low reached in September of last is the closest level of support. Nonetheless there may be some buying at 1.05. However below that level, there is no major support until parity. However if USD/CAD gains strength and comes out of the sell zone by breaking above 1.07, the rally could extend as far as 1.0840.

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.