U.S. Dollar: Can The Gains Be Sustained?

Last updated 10/9/2009 5:29 PM ET (GMT -5) 3 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• U.S. DOLLAR: CAN THE GAINS BE SUSTAINED?
• EUR/USD: TIDE SHIFT FROM GERMAN TO FRENCH STRENGTH
• GBP/USD: MAJOR REVERSAL
• USD/CAD: HITS 13 MONTH HIGH HIGH ON BLOWOUT EMPLOYMENT NUMBERS
• AUD/USD: HOLDS ONTO GAINS DESPITE USD STRENGTH
• NZD/USD: GOLD PRICES LOWER, OIL PRICES HIGHER
• USD/JPY: UP MOST SINCE AUGUST

EXPECTATIONS FOR UPCOMING FED MEETINGS

U.S. DOLLAR: CAN THE GAINS BE SUSTAINED?

The U.S. dollar strengthened dramatically on Friday, leaving many currency traders to wonder whether the dollar has finally hit a bottom. USD/JPY rose 1.6 percent, the strongest percentage gain in 2 months. The GBP/USD also sold off aggressively, paving the way for further losses. However in order to consider whether the gains can be sustained, we have to first understand the drivers behind the sharp rally in the dollar. Over the past few weeks, the dollar came under severe selling pressure and even hit fresh year to date lows against some currencies. In that type of environment, it doesn’t take much to turn things around. Comments from Fed Chairman Ben Bernanke triggered profit taking in the dollar after he suggested that the Fed will be prepared to tighten when the economy improves. Granted this is a relatively obvious statement, the timing was perfect for the dollar. We have been talking all week about “Where the Fed Fits In” on the global easing and tightening scale and up to now, Fed officials only expressed their reluctance to implement an exit strategy. Even though we still do not believe that the Fed is close to removing their ultra easy unconventional monetary policies, they are strategically moving themselves closer to their peers or could be attempting to indirectly prop up the dollar.

Can the Gains in the Dollar be Sustained?

However if you look beyond the price of USD/JPY and the GBP/USD, the greenback is still struggling to recover. For example, the EUR/USD sold off by less than 100 pips while the Canadian dollar extended its gains against the greenback. The Australian and New Zealand dollars are still holding near their highs. The trade deficit narrowed in the month of August, but the mild improvement is hardly enough to trigger a bottom in the dollar. Yet we are walking into a very busy data week that will allow investors to compare the current state of the U.S. economy with that of its peers. We already know that Australia, New Zealand and Canada are outperforming the U.S. economy (data-wise) but there is a good chance that the U.S. could play catch-up in the coming week which may actually be dollar positive. The releases to watch on the U.S. calendar include retail sales, the minutes from the most recent FOMC meeting, consumer prices and the Treasury International Capital flow report. Although economists expect a sharp drop in consumer spending following the expiration of the cash for clunkers program, the rise in the ICSC and Redbook retail sales reports suggests that the contraction in spending may not be as bad as expected. Given the latest comments from Bernanke and the recent trend of U.S. data, we anticipate optimism from the members of the monetary policy committee. As for inflation, the rise in commodity prices should bolster price pressure. The TIC report which measures foreign demand for U.S. Treasuries on the other hand is a bit of a wildcard. Talk of reserve diversification and the weakness of the dollar have traders fearing that foreigners have become less willing to buy dollars. However demand by foreign central banks is not that volatile and could therefore surprise to the upside. So overall, we believe that the odds are skewed towards stronger reports next week and we may finally see the dollar rally on good data. On top of that, White House Economist Romer repeated the Obama Administration’s support for the strong dollar.

Dollar Short Positions Increase

According to the latest CFTC report, forex positioning in the futures market is nearing extreme levels. For example, net short positions in the British pound rose against the dollar to the highest level ever while long positions in the euro rose to the highest since January 2008. Long positions in the Canadian dollar also doubled while long Australian dollar positions remained near 1 year highs. The only currency that traders trimmed their positions in was USD/JPY, but even then short USD/JPY positions remained near 1 year highs. This confirms our belief that the short dollar trade has become very overcrowded and because of that, the dollar is setting up for a rally. Next week’s economic reports could provide the necessary catalyst. In the meantime, Canadian and Japanese markets are closed on Monday for holidays. It will also be a Bank Holiday in the U.S. but the equity and currency markets will be open for trading.

EUR/USD: TIDE SHIFT FROM GERMAN TO FRENCH STRENGTH

The euro is suffering today thanks to Bernanke’s hawkish comments and some tepid German economic releases. First there was Consumer Prices, which on a harmonized basis, were unable to keep up with expectations. This renewed some deflationary concerns in the region as Germany’s growth in Q2 has not been enough to circumvent these threats. There was also the German Trade Balance which showed that their surplus narrowed thanks to weak exports and a boost in imports. Germany’s international shipments fell for the first time since July and were down 20% on an annualized basis. This begs the question of whether or not euro strength is starting to have an impact on the critical export sector. If so, the region may have to renew their distaste for a rapidly appreciating currency in an effort to ensure growth in the largest Euro-zone nation. However, in a day that showed a sluggish Germany also managed to reveal strength in France and Italy. Both countries reported better than expected Industrial Production. France, in particular, showed that output rose 1.8%, far exceeding last month’s gain of only 0.10%. Italian output on the other hand rose by the most in about two decades. However the true strength of these reports is somewhat distorted by massive government stimulus programs including their equivalent of the cash for clunkers. For next week, keep an eye on Tuesday’s ZEW Economic Sentiment Index, Thursday’s Consumer Prices, and Friday’s Trade Balance.

GBP/USD: MAJOR REVERSAL

The British pound fell dramatically today despite stronger than expected economic data. Based upon the latest futures positioning from the CFTC, it appears that the short pound trade is getting just as crowded as the short dollar trade. However the momentum is on the side of pound bears along with fundamentals and technicals. Inflationary pressures are increasing based upon the latest producer price report and the trade deficit is narrowing, but compared to the rest of the world, the recovery in the U.K. has been modest. However the primary reason why the pound is underperforming is because of the dovishness of the Bank of England. Like the Fed, they are probably basking in the recent weakness of their currency but at the same time all it would take is one word from the BoE and the GBP/USD could completely reverse its decline. Until they open their mouths and either express frustration with the decline in the pound or suggest that they are not planning to increase monetary stimulus, the pound could continue to fall. In the week ahead, there is a great deal of key economic releases due for release from the U.K. including their inflation and employment reports.

USD/CAD: HITS 13 MONTH HIGH HIGH ON BLOWOUT EMPLOYMENT NUMBERS

The big story in the currency market today is the Canadian dollar which soared to a 13 month high against the greenback after the stronger than expected employment numbers. For our readers, the hot report should not be much of a surprise since we said yesterday that "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." Job growth in September was the strongest since the Spring which reflects the relative outperformance of the Canadian labor market with that of the U.S. The unemployment rate also fell for the first time in over a year from 8.7 to 8.4 percent. When you have a country like Canada experiencing larger than expected job growth and another experiencing larger than expected job losses, you can imagine what the trend of the currency pair will be going forward. However not all news was good news for Canada this morning. The trade deficit in Canada hit a record low in August as exports plunged 5 percent. Imports also fell but not as aggressively as exports. Weaker demand was seen in most products but agriculture and machinery took the biggest hit. Although we are worried about the trade numbers, we do not believe that it will erase the upside momentum in the Canadian, but we will become very worried if trade fails to recover in September. With USD/CAD trading below the 1.05 level, there is no major support until parity. Looking ahead, the most important economic releases from the commodity currencies next week include retail sales and consumer prices from New Zealand and consumer prices from Canada.

USD/JPY: UP MOST SINCE AUGUST

The dollar is finally making a break for it against the yen. The greenback took the biggest bite out of yen strength since the strong surge on August 7th. The fact of the matter is, now that expectations for a rate hike from the Fed have increased substantially, the BoJ seems to be falling behind the pack. There have been almost no inclinations that the BoJ is ready to raise rates, or stage an exit strategy for that matter. A critical weakness in the currency may have been finally realized. Nevertheless, economic data from today was pretty good. Machinery Orders rose off a record low to 0.5%. Even though this was not as much as markets had anticipated, it is still somewhat of a positive sign that spending cuts may start to subside. On a yearly basis, orders are down by 26.5%, better than the -34.8% reported last month. The main event for next week will be the Bank of Japan’s rate decision. However, after months of revealing little to excite markets, the decision is slipping into the realm of a currency market non-event. However, if they should reconcile today’s concerns by indicating that unwinding is not too far off, the yen should reverse its losses. Nevertheless, they will probably shy away from propping the yen up as, regardless of what Finance Minister Fujii says, it is becoming a destructive force for the economy.

EUR/USD: Currency in Play for Next 24 Hours

The EUR/USD will be the currency in play on Monday. German Wholesale Price Index will be released at 6:00GMT or 2:00AM EST. Abrupt and continuous rallies in EUR/USD are the thing of the past as the currency pair entered the Range Trading Zone which we determine using Bollinger Bands. At this point, the sell-off in the EUR/USD could extend to support at 1.4600, but even then the uptrend in the currency pair will not be broken. A drop below 1.4400 would be need to erase the current trend in the EUR/USD. However, if the currency pair resumes its rise back into the buy zone, resistance sits at this year’s high at 1.4840.

Comments (3)

porsche

October 11, 2009 at 05:01 AM ET

thanks u !!!!!! What do you think about USD gain and also gold gain ????

klien

October 12, 2009 at 10:12 AM ET

I've expressed my sentiment about the dollar already in the report. Possible rally but long term trend still down

DomoRoboto

October 11, 2009 at 06:52 PM ET

Your Canadian Employment prediction was a "spot-on". This isn't the first time you've issued correct predictions. I'll be reading your page regularly from now on. Thank You.

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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.