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THE STORIES IN THE CURRENCY MARKET

• U.S. DOLLAR: CALM BEFORE THE STORM
• EUR/USD: INVESTORS ARE COMING BACK TO REALITY
• GBP/USD: RALLIES ON POSITIVE COMMENTS FROM BOE
• USD/CAD: HITS 13 MONTH LOW
• AUD/USD: BUSINESS CONFIDENCE EASES
• NZD/USD: RETAIL SALES DOUBLE EXPECTATIONS
• USD/JPY: BOJ UNLIKELY TO STIR MARKETS

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	44.5%	59.6%
Cut to 0%	48.9%	35.3%
Increase to 0.50%	6.6%	5.1%
Increase to 0.75%	0.0%	0.0%

U.S. DOLLAR: CALM BEFORE THE STORM

It has been a quiet day in the financial markets with U.S. equities oscillating in and out of positive territory. The dollar traded slightly lower against the euro and British pound but strengthened against the commodity currencies. Initially the greenback fell to a fresh 13 month low against the euro, Australian and Canadian dollars but profit taking on short dollar positions took the dollar off its lows. The lack of volatility in the currency market over the past two trading days may have been a relief after last week’s price action but that will probably come to an end tomorrow as the action is expected to heat up with U.S. retail sales and the FOMC minutes due for release.

Why is Confidence Receding?

With equities roaring to new highs, one would expect a continual recovery in consumer confidence. Yet, the only piece of U.S. economic data on the calendar today revealed that sentiment actually took a turn for the worse. In the month of October, the IBD/TIPP Economic Optimism index fell from 52.5 to 48.7. A reading over 50 indicates a positive outlook while a reading below 50 signals a negative outlook. For the past 2 months, Americans have grown more optimistic, but in October, optimism turned into pessimism as consumers grew more concerned about the economic outlook, their personal financial situation and federal policies. The deterioration in sentiment is most likely tied to the rise in gasoline prices and the latest acceleration of job losses. If non-farm payrolls do not rebound this month, the U.S. economy could be in for some big trouble. Even though the IBD/TIPP index is not as closely followed as the University of Michigan or the Conference Board’s consumer confidence survey, it has a strong correlation with both releases.

Retail Sales vs. FOMC

Wednesday’s retail sales report will provide the clues to whether the deterioration in the labor market has hit spending. Economists expect overall consumer spending to drop by 2.1 percent after a 2.7 percent rise in August. Excluding automobile purchases, spending is expected to rise 0.2 percent. This divergence in expectations clearly reflects the end of the cash for clunkers program. However there is a good chance that back to school sales may have been stronger than the market expects. The ICSC retail index reported a rise in sales for the first time in more than a year while Retail Metrics announced that more than two-thirds of retailers are reporting better-than-expected September results. Among these outperformers includes companies like Kohl’s, who reported a rise in sales of 5.5%, compared with expectations for a modest decline. There was also American Eagle who reported that sales were unchanged, compared with expectations for a significant decline of 4.4%. Similar results were followed by major retail players like Macy’s, Limited Brands, and Aeropostale. Macy’s actually said that they believe they have “a better handle” on where the company is going. It took awhile, but companies have finally come to the realization that consumers have moved away from big-ticket items. This does not necessarily mean they are not spending as the switch has been rapid to a more thrifty and frugal customer base. However, before betting on a rejuvenated holiday shopping season it is important to recognize the contribution of back to school shopping and the fact that consumers are trading down. As for the FOMC minutes, the risk is for surprisingly hawkish comments but given the latest comments from Fed officials, we do not believe this is likely. Last week, Bernanke’s comment about the improving economic outlook helped to lift the dollar but FOMC member Kohn’s warning today that the recovery will subdued suggests that Fed officials really have no intention of unloosening monetary policy anytime soon.

EUR/USD: INVESTORS ARE COMING BACK TO REALITY

The euro raced to a fresh 13 month high of 1.4876 against the U.S. dollar at the open of the NY Trading session despite weaker economic data. Investors believe that the current state of the Germany has improved but they are growing less optimistic about the outlook. As a result, the German ZEW survey fell from 57.7 to 56.0. The recovery in Germany hit its peak in August and has been losing traction since then as the car scrappage and other stimulus programs start to wane. This does not mean that investors expect the Eurozone to fall back into recession, but instead they have become more realistic about the pace of the recovery. The recent strength of the euro has most likely contributed to the drop in optimism but at the same time, the stronger euro offsets some of the inflationary pressures created by higher commodity prices. This puts the European Central Bank in an interesting place and may help to explain why they are not actively talking down the euro. The latest comments from ECB officials including Noyer indicate that the central bank is comfortable with the current policy and will only exit when the time comes. They are optimistic about the recovery and credit the expansion in Asia for contributing to global growth. Noyer also talked about how replacing the dollar as a reserve currency is “not obvious” but the euro would be an “obvious candidate” for reserve currency along with the Chinese Renminbi if it became fully convertible. We believe that is may be a sentiment shared by many central bankers although few would openly admit it. Eurozone industrial production is the only euro centric report due for release tomorrow. Healthy numbers from France and Germany is expected to translate into a strong report for the Eurozone as a whole. Meanwhile the Swiss Franc traded higher against the dollar but lower against the euro despite an uptick in producer prices. Unlike the Eurozone which has a strong currency to mitigate inflationary pressures, fears of intervention have capped the gains in the Swissie which in turn limited its impact on inflation.

GBP/USD: RALLIES ON POSITIVE COMMENTS FROM BOE

The British pound staged a strong recovery against the U.S. dollar and Euro on the heels of optimistic comments from Bank of England Deputy Governor Bean. According to Bean, there is evidence that Quantitative Easing is finally having satisfactory effects on the U.K. economy. There has been significant asset price increases and improvement in consumer confidence since QE began and because of that activity in the U.K. has probably bottomed. These are the most optimistic comments that we have heard from BoE officials in a long time and explain why the pound has responded so positively. However, this does not mean that further Quantitative Easing is out of the question. Bean also noted that the ultimate goal of QE is to get nominal spending to 5 percent. We are nowhere near those levels right now and therefore QE may still need to be increased in order to achieve that goal. Meanwhile consumer price growth was flat last month, driving annualized CPI growth from 1.6 to 1.1 percent, the lowest level in 5 years. For an inflation targeting central bank, this is actually quite a big deal because it gives them more rather than less reasons to increase stimulus. Looking ahead, employment numbers are due for release tomorrow. Deterioration in the employment component of service and construction sector PMI suggests that job losses may have accelerated last month. The labor market situation in the U.K. is much closer to that of the U.S. than Australia or Canada, and therefore we expect the nation’s unemployment rate to rise.

USD/CAD: HITS 13 MONTH LOW

One of the biggest stories in the currency market today is the sharp appreciation of the Canadian and Australian dollars. Both currencies reached a new 13 month high against the U.S. dollar before giving back its gains. The Canadian dollar is inching towards parity with the U.S. dollar and we would not be surprised if that level is reached before the end of the year. Oil prices continue to rise and it has helped the loonie shrug off weaker housing market data. House prices grew at a slower pace in August but after 9 months of negative growth, an increase is still better than a decrease. Meanwhile business confidence in Australia is receding. It will be interesting to see if this filters over to consumer confidence, which is due for release this evening. Of the 3 commodity producing countries, the New Zealand dollar staged the best performance following a sharp improvement in consumer spending. Retail sales doubled expectations by rising 1.1 percent in August while the less volatile core retail sales rose 1.2 percent. As a direct input into GDP, the latest report also means that the recovery gained traction in the third quarter. There is even a good chance that the RBNZ could drop their dovish bias on the heels of this report.

USD/JPY: BOJ UNLIKELY TO STIR MARKETS

The Japanese Yen weakened against every major currency except for the U.S. dollar. USD/JPY continues to have difficult time rallying as investors find it cheaper to fund in dollars than yen. Although the British pound staged the strongest performance against the Yen, it was NZD/JPY that hit a one year high. Bank lending and money supply data was mixed with lending growth falling but money supply increasing. The Bank of Japan’s monetary policy announcement is due for release this evening. The BoJ is not expected to raise interest rates or make any other changes but given the recent trend of economic data, we could hear some optimistic comments from the central bank. Forex traders may be looking for comments on the Yen, but since decision of intervention rests with the Ministry of Finance and not the BoJ, we believe that their comments on the Yen will be limited.

USD/JPY: Currency in Play for Next 24 Hours

USD/JPY will be the currency in play for the next 24 hours. Japan expects the release of Consumer Confidence at 5:00GMT or 1:00AM ET and the Bank of Japan interest rate decision which usually comes at that time as well. U.S. Advance Retail Sales are due out at 12:30GMT or 8:30AM ET, followed by FOMC Meeting Minutes at 18:00GMT or 2:00pm ET. Over the past two months, USD/JPY remained in a downtrend. However the pair finally managed to break into Range Trading Zone which we determine using the Bollinger Bands earlier this week. Despite a minor rebound, the pair remains in a downward channel. However, if the upper bound of the channel is broken expect USD/JPY to rise to next level of resistance represented by upper 1st Standard Deviation at 91.00. Being on the crossroads of a distinct trend, the pair may continue to fall and in that case, USD/JPY may retreat to support represented by lower 1st Standard Deviation at 89.00.

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.