U.S. Dollar: Race to Parity

Last updated 10/14/2009 5:01 PM ET (GMT -5) 2 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• U.S. DOLLAR: RACE TO PARITY
• EUR/USD: ON ITS WAY TO 1.50
• GBP/USD: UNEMPLOYMENT RATE HITS 11 YEAR HIGH
• USD/CAD: NEW 14-MONTH LOW
• AUD/USD: CHINESE DEMAND PROVES CRITICAL
• NZD/USD: RBNZ TO FOLLOW IN RBA’s FOOTSTEPS?
• USD/JPY: READY TO START AN EXIT?

EXPECTATIONS FOR UPCOMING FED MEETINGS

U.S. DOLLAR: RACE TO PARITY

With the Dow breaking 10,000 and the dollar falling to fresh 14 month lows against 4 out of the 7 major currencies, it is time for traders to just accept the dollar’s weakness. The dollar has not been able to benefit from good news or bad news. The better than expected U.S. retail sales report lifted equities and risk appetite at the expense of the U.S. dollar. The selling exacerbated after the FOMC minutes revealed that committee members were open to the idea of expanding purchases of mortgage backed securities. In contrast to last week’s comments from Fed Chairman Ben Bernanke, this sentiment puts the central bank further and not closer to implementing an exit strategy. As a result, unless there is an exogenous event such as verbal intervention by the European Central Bank to stop the euro from rising, the dollar could continue to fall, pushing the EUR/USD to 1.50 and the Canadian dollar and Swiss Franc towards parity with the greenback.

Race to Parity

As recently as one month ago, not many people could have imagined that one Canadian dollar and Swiss Franc would be worth one U.S. dollar. However, with both currencies trading within striking distance of parity (1 to 1) against the greenback, this possibility could soon become a reality. The last time that USD/CAD and USD/CHF traded at 1.0 or lower was more than 17 months ago and they both spent a very limited amount of time below parity. This is because the risk of intervention goes through the roof whenever these currencies become more valuable than the dollar. Parity is also on the radar for the Australian dollar, but we do not believe the currency will reach that level anytime soon because before that occurs, the EUR/USD would most likely have to break 1.55 and USD/CAD and USD/CHF would have to break parity. There is a good chance that when those levels are hit central banks will be forced to verbally or physically intervene in their currencies, which could trigger a wave of dollar strength. However in the meantime, Newton’s Law still holds – the dollar will keep falling until an external force stops the freefall. The “external force” that we are looking for would be open discomfort about the weakness of the U.S. dollar from global central bankers.

FOMC Kills the Dollar

With each passing day, there are fewer and fewer reasons to be bullish dollars. The tone of the latest FOMC minutes confirms our belief that the Federal Reserve will be one of the last central banks to tighten monetary policy. On the most fundamental level, currencies move on interest rate expectations and unfortunately, the Fed has given us more rather than less reasons to believe that U.S. interest rates will remain low for an extended period of time. Last week, Federal Reserve Chairman Ben Bernanke gave the markets false hope. According to the tone of the minutes from the September monetary policy meeting, his inherent optimism failed to accurately reflect the central bank’s stance on monetary policy. As we suspected, they are in fact much more dovish than many would have expected. This leaves us with no choice but to assume that his comments were purely attempts to indirectly talk up the dollar. For the time being, plans for increasing stimulus have taken the place of any serious discussions about exit strategies. It was reported that several board members actually wanted to extend Mortgage Backed security purchases beyond the currently staggering $1.25T allotment. Their primary concern is the labor market and how the economy would react without additional government aid. Although members of the FOMC believe that a recovery is underway, it is “quite restrained” as consumers are expected to remain cautious. Improvements in the labor market are not expected to be dramatic. By the end of 2010, the unemployment rate is expected to fall to 9.25 percent and only by the end of 2011 is it expected to hit 8 percent. The minutes also highlighted a growing division within the Fed, which is reminiscent of Bank of England’s disagreement over how much quantitative easing should be expanded. A few members wanted to slow asset purchases over a longer period of time while others wanted to taper asset purchases quickly. The lack of agreement within the FOMC suggests that not only will they will lag their peers in exiting from their ultra easy monetary policies but more easing is not off the table.

Another Busy Day Ahead

Aside from the FOMC minutes, retail sales were also stronger than expected. Our full synopsis on the consumer spending report can be found on FX360.com . Looking ahead, it will be another busy day with the dollar remaining in focus. Consumer prices, jobless claims, Empire State and the Philadelphia Fed manufacturing surveys are due for release on Thursday. With oil prices rising, we anticipate an increase in inflationary pressures. The manufacturing sector should also benefit from the weaker dollar but jobless claims could increase which may offset any positive sentiment.

EUR/USD: ON ITS WAY TO 1.50

The euro strengthened against the U.S. dollar every single day this week, taking out year to date highs in the process. The next barrier for the currency pair to break is 1.50 and it may just be a matter of time before that happens. Eurozone economic data was disappointing with industrial production growing less than the market expected. Of course the EUR/USD is not trading on day to day fundamentals but rather relative hawkishness of the European Central Bank compared to the Federal Reserve. As an inflation targeting central bank, the latest rise in price pressures is irritating. Thankfully the strong euro is helping to curb inflation, but that leaves Trichet with the tough about decision of what to do with the rapidly appreciating currency. We don’t think it will be long before officials from the European Union start to complain about the euro’s strength, but concern from Trichet is what really matters. Until we hear that from the ECB President, the 1.50 level is very tempting. Eurozone consumer prices are due for release tomorrow and for the time being, inflationary pressures should remain muted following the drop in consumer prices in Germany and France. If that is the case, then the strong euro is doing its job. Aside from CPI, the ECB will also be publishing its monthly report which could shed some light on where the central bank stands on monetary policy, the currency and their outlook for the region’s economy.

GBP/USD: UNEMPLOYMENT RATE HITS 11 YEAR HIGH

The British pound extended its gains against the dollar on the heels of stronger than expected employment numbers. A total of 20.8k people lost their jobs in the U.K. last month compared to 23k in August. The market had expected job losses to accelerate to 24.5k and for the unemployment rate to hit 5.1 percent. Instead, job losses were less and the unemployment rate only rose to 5.0 percent. This is still the highest unemployment rate in the U.K. in more than a decade but the number of people filing for unemployment benefits rose by the smallest amount in since May 2008. The labor market is improving, albeit at a snail’s pace. However unlike many of the other major currencies, the pound has not strengthened dramatically which may actually help to buffer the U.K. economy. Inflation on the other hand could actually be exacerbated by the relative weakness of the British pound. Either way, like the Federal Reserve, the Bank of England is in no rush to raise interest rates and could actually loosen monetary policy further before tightening.

USD/CAD: NEW 14-MONTH LOW

The Canadian and Australian dollars extended their gains as dollar weakness, risk appetite and higher commodity prices fuels demand for commodity currencies. In the case of the AUD/USD, the pair hit yet 14 month high while USD/CAD fell to a 14 month low. Interestingly enough, the New Zealand dollar largely missed out on today’s action and was subjected to continued range trading. One of the primary factors giving the aussie an added jolt were reports of strong import demand from China. Although this is good news for all commodity countries, it is particularly positive for Australia because the report showed a substantial rise in iron ore imports which just happens to be one of Australia’s primary exports. Growth driven by Chinese demand should continue to uphold the optimistic global outlook for the country. Westpac Consumer Confidence added to such optimism and reached the highest level in about 24 months. The Reserve Bank of New Zealand took an important step today that may indicate that the bank is following in the RBA’s footsteps. The RBNZ decided to eliminate certain lending facilities, like the Term Auction facility and bill auctions, in an effort to jumpstart the unwinding process. In Canada, New Motor Vehicle Sales plunged and showed little benefit from the boost in spending that may have followed last week’s employment report. Tomorrow is a busy day as well with New Zealand Consumer Prices, Australian Inflation Expectations, and Canadian Manufacturing Shipments. RBA Governor Stevens and Treasury Secretary Henry are also scheduled to speak this evening.

USD/JPY: READY TO START AN EXIT?

At the onset of trading, it looked like it was going to be another day of sharp USD/JPY declines but the pair regained some composure by mid-day, coming away with small losses. Aside from leaving rates unchanged, we got more from the Bank of Japan than we expected. The bank lifted its economic assessment for a second straight month as they indicated they are starting to see things “pick-up.” Later on, BoJ head Shirakawa discussed his belief that the need for support in the corporate bond market was beginning to wane as companies were becoming more able to find financing from private sources. This indicates that the bank is on the cusp of ending corporate debt purchases which could be the official start to some sort of an exit strategy, one which many hoped the bank would be more specific about. The only impediment that still remains is that small businesses are struggling to get the financing that they need. The improvement in the bank’s outlook is largely the reason why yen crosses did not benefit as much as expected from a surge in risk tolerance. However, Shirakawa indicates that the unwinding of purchase programs does not mean the bank is getting ready to hike rates. Oddly enough, Finance Minister Fujii stepped in to contradict what the BoJ was saying and explained that their estimates were too optimistic. Economic data was promising as well with Consumer Confidence surging to a nearly two year high. Producer Prices are still under pressure but managed to lift off of record lows. We have Industrial Production to look forward to tomorrow.

EUR/USD: Currency in Play for Next 24 Hours

EUR/USD will be the currency pair in play for the next 24 hours. First off, we have the ECB’s Monthly Bulletin at 4:00 am ET or 8:00 GMT followed by Euro-zone Consumer Prices at 5:00 am ET or 9:00 GMT. In the US, we expect Consumer Prices and the Empire State Survey to be released at 8:30 am ET or 12:30 GMT followed by the Philly Fed Survey at 10:00 am ET or 14:00 GMT.

EUR/USD

Comments (2)

spunky

October 15, 2009 at 01:13 AM ET

So Kathy: would you care to toss out some levels, at which you think, some central banks might intervene ???

Regards
Brad

klien

October 15, 2009 at 10:15 AM ET

Probably looking at 1.50 in EUR/USD. Parity in USD/CAD and USD/CHF and 87 in USD/JPY

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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.