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U.S. Dollar: Will The Trend Last?

Last updated 10/15/2009 5:08 PM ET (GMT -5) 4 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• U.S. DOLLAR: WILL THE TREND LAST?
• EUR/USD: EXIT STRATEGY IN DEC?
• GBP/USD: MASSIVE SHORT SQUEEZE
• AUD/USD: RBA STILL PLANS TO RAISE INTEREST RATES
• USD/CAD: OIL PRICES AT $77, CPI ON TAP
• NZD/USD: BUSINESS PMI AND INFLATION RISE
• USD/JPY: BREAKOUT MOVES IN THE YEN CROSSES

EXPECTATIONS FOR UPCOMING FED MEETINGS

U.S. DOLLAR: WILL THE TREND LAST?

It has been an exceptionally active day in the currency market particularly for the GBP/USD and USD/JPY which have recently been lagging their peers in terms of volatility.  The biggest mover of the day on a percentage basis is the British pound which rose 1.66 percent against the dollar, 1.64 percent against the euro and a whopping 3.1 percent against the Japanese Yen.   Prior to today’s moves, the GBP/USD and USD/JPY remained under pressure while other currency pairs such as the EUR/USD, AUD/USD and NZD/USD climbed to new highs.  On Tuesday, we had warned that the lack of volatility and quiet trading represented the calm before the storm and now that breakout moves have occurred, the big question is whether the trends will last.  

Will the Trends in the Forex Market Last?

Although the dollar traded lower against nearly all of the major currencies, the velocity of the move is different depending upon the pair in question.  For example, the dollar ended the U.S. trading session virtually unchanged against the euro, stronger against the Japanese Yen, Swiss Franc, Canadian and New Zealand dollars but weaker against the British pound and Australian dollar.  This type of divergence suggests that at least for some currencies, the upside momentum may be waning, particularly for those that are trading well off their highs.  This does not mean that dollar weakness is over.  The problems plaguing the dollar have not gone away and so far, we have yet to hear any convincing verbal or physically intervention from foreign central banks.  Although the risk intervention escalates with every 1 percent fall in the dollar, unless the intervention actually occurs, the trends in the forex market could continue.  However, we believe that we will start to see much bigger moves in the GBP/USD and USD/JPY compared to other major currencies.

The Data to Watch – Treasury International Capital flow report

One of the pieces of economic data on the calendar tomorrow could threaten the downtrend in the dollar.  The Treasury International Capital flow report which measures foreign demand for dollar denominated assets is due for release at 9am NY Time.  One of the primary arguments for long term dollar weakness is the need for reserve diversification and tomorrow’s report will shed light on whether central banks have been all talk and no action.  If demand for dollars remains strong, it could lend support to the currency but if foreigners become net sellers of dollars, we could see an acceleration of dollar weakness.  The TIC report will be a number that we will be keeping a very close eye on for the next few months.  The dollar began its latest wave of weakness in August, but it did not really go into freefall mode until September.  Holding dollars for yield right now is a losing proposition and at some point, central banks could balk at the idea of holding dollars and that is when the dollar greenback could really be in trouble. Aside from the TIC report, industrial production and the preliminary release of the University of Michigan consumer confidence survey for October are also due for release on Friday.  

Positive Economic Data Sustains Risk Appetite

The first batch of U.S. numbers this morning was unambiguously positive, but the disappointment in the Philadelphia Fed survey at 10am took some steam out of the markets. Deflationary pressures are easing with consumer prices rising 0.2 percent in September. The annualized pace of CPI growth is still negative at -1.3 percent but core price growth accelerated by 1.5 percent. Manufacturing conditions in the NY region also improved dramatically with the Empire State survey rising from 18.88 to 34.57, the highest level since May 2004.  However the conditions in the Philadelphia region did not fare as well with the index falling from 14.1 to 11.5. The weaker dollar is helping to extend the recovery in manufacturing which is part of the reason why the Fed has not done anything to stop the freefall. Jobless claims also fell from 524k to 514k while continuing claims broke below the 6 million mark for the first time since March.  Although part of the drop in continuing claims is due to the expiration of jobless benefits for some Americans, it is also possible that the labor market is improving.  Meanwhile the Treasury released their semiannual report on currency manipulation.  No country was identified as a currency manipulator but the Treasury did criticize China for a lack of flexibility in the Yuan and pointed out that it is undervalued.  This is the same sentiment that Timothy Geithner shared days after President Obama took office so there was nothing new in this report.

EUR/USD: EXIT STRATEGY IN DEC?

With each passing day, the EUR/USD is inching closer to the 1.50 level. This morning in the wee hours of the European trading session, the currency pair raced to a high of 1.4970 and came close to revisiting those levels after the Philly Fed number.  This morning, ECB President Trichet reiterated that it is very important for the U.S. to pursue strong dollar policies and he pointed out that the euro was not created to be a global reserve currency. These are comments that we have heard from the ECB President before but this is the first time in a while that we have also heard him say that "excess forex volatility is an enemy of stability."  However Trichet stopped short of calling the move brutal which may be part of the reason why the losses in the EUR/USD were limited.  Also, the central bank President himself may not be entirely convinced that the strong euro is hurting the economy. In the same speech, he also reminded the market that the ECB's primary mandate is price stability and that is most likely the "one needle" in their "compass." If inflation is his primary focus, then Trichet's comments on exchange rates may only be politically motivated because a strong euro helps prevent inflationary pressures from getting out of hand. Furthermore, ECB member Mersch said in an interview with Market News International that there are signs inflation expectations are inching higher and if there are upside inflation risks, the ECB may need to act.  More importantly however he said the central bank could present an exit strategy in December with new staff forecasts which could be very meaningful for the euro. The Eurozone trade balance is due for release tomorrow.  USD/CHF has fallen to levels where intervention risk is particularly high but the Swiss National Bank appears to be watching EUR/CHF much more closely than USD/CHF.   

GBP/USD: MASSIVE SHORT SQUEEZE

The British pound staged a very strong rally today indicative of a major short squeeze.  There was no economic data released from the U.K. today and no groundbreaking comments from government officials.  Yet the currency managed to stage its strongest rally against the dollar in more than 2 months.  Part of the currency’s strength was attributed to rumors that a Swedish energy company may be interested in buying British nuclear power plants but it is more likely that traders are still responding to Bank of England executive director Paul Fisher’s comment that quantitative easing is working.  However from a flow perspective, the price action in the pound today is definitely in line with a short squeeze.  Last week’s CFTC IMM report on positioning in the futures market revealed that net short positions in the GBP/USD reached record highs.  In an environment where the dollar is falling against nearly all of the major currencies, it was bound to eventually underperform the pound as well.  A look at the intraday charts also reveals that the rally in the GBP/USD only gained momentum when the currency pair broke above 1.6130 which is coincidently only a few pips above this month’s high.  There could have been a number of stops lined up at that level and when they were hit, the buying just exacerbated.  Looking ahead, there is no U.K. economic data on the calendar for the remainder for the week.

AUD/USD: RBA STILL PLANS TO RAISE INTEREST RATES

The Australian, New Zealand and Canadian dollars raced to new highs on the heels of stronger commodity prices, dollar weakness and hawkish comments from Reserve Bank of Australia Governor Stevens.  Earlier this month, the RBA shocked the markets with a quarter point rate hike, sending the Australian dollar to 14 month highs.  Almost immediately after the rate hike, traders started talking about another round of tightening before the end of the year.  Last night, central bank governor Stevens warned that “If we were prepared to cut rates rapidly, to a very low level, in response to a threat but then were too timid to lessen that stimulus in a timely way when the threat had passed, we would have a bias in our monetary policy framework. Experience here and elsewhere counsels against that approach.”  In other words, they fully intend to normalize interest rates as quickly as the economy can handle.  As long as they stick to this message, we expect further strength in the Australian dollar.  The New Zealand dollar ended the U.S. trading session weaker than the greenback despite better than expected economic data.  Business PMI rose back into expansionary territory last month while consumer prices grew by 1.3 percent in the third quarter.  The Canadian dollar also gave back all of its gains after much weaker than expected manufacturing shipments.  Consumer prices are due for release tomorrow and despite a strong currency, there is a good chance that inflationary pressures increased which could resurrect the rally in the loonie.  

USD/JPY: BREAKOUT MOVES IN THE YEN CROSSES

Breakout moves can be seen in all of the Japanese Yen crosses.  Industrial production fell short of expectations but the weaker numbers were certainly not the reason why the Yen sold off.  Instead, USD/JPY is finally playing catch up with the other major currencies.  For the past few days, dollar weakness has prevented USD/JPY from participating in the risk rally.  However now that the dollar is entering oversold territory, demand for USD/JPY has finally returned.  Of all the Yen crosses, the strongest gains were in GBP/JPY which rose by a staggering 450 pips.   The Australian and New Zealand dollars also hit one year highs against the Japanese Yen and as long as equities continue to rise, the Yen crosses should gain strength as well.   

USD/CAD: Currency in Play for Next 24 Hours

The currency in play for the next 24 hours will be USD/CAD. An eventful day will start with the release of Canadian CPI which is due out at 11:00GMT or 7:00AM EST. This will be followed by the U.S.’ Treasury International Capital flow report at 13:00GMT or 9:00AM EST and Industrial Production at 13:15GMT or 9:15AM ET.  Finally the U. of Michigan Confidence is due at 14:00GMT or 10:00AM EST. USD/CAD is currently trading well within the Sell Zone, which we determine using Bollinger Bands.  After falling for nearly 9 days straight, USD/CAD has finally staged a meaningful recovery.  However as long as the currency pair remains below the 1.0450 level the downtrend is intact and a move down to parity is still on the table.  If it breaks above 1.0450, then a larger rally towards 1.07 could ensue.

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Comments (4)

kbb

October 15, 2009 at 06:40 PM ET

Ohayougozaimasu,

First off I want to thank you for the NFP information. It was dead on, again, however I was unable to trade the data due to other issues.

What I would like to ask you is re: USDCAD. I was carrying a USDCAD short trade from the Tokyo to the London and into the US session. On the newswire there were some cautionary notes regading the commoditiy pairs being over stretched, and there were a few other comments but I didn't think they would carry any weight as the SSI and COT weren't giving any warning signals. (So my first question is who should I listen to, other than FX360, on the wire?) Last night I felt that I was blindsided by the sizeable retrace that blew out my stop. My thinking was that the US market was up, gold was up, oil was up and the CAD data released was not that important. So business as usual... should I have considered the double 00 trading strategy from your book as it was hovering at 1.0207 for three hours?

As for today/tonight. How would you trade the CPI data?

Thanks,

Richard Eley

October 15, 2009 at 07:32 PM ET

Hi Kathy,
Following th rally in GBP/JPY do you think that trend will continue? It looks like a reversal on the daily charts.

bojan

October 15, 2009 at 11:54 PM ET

Hi Kathy,

yesteday JPY showed general weakness against most of the currencies aud,nzd,cad,gbp,usd,eur.... Accept for the commodities currencies moves on the usd,gbp,and eur were not in tendem. Could you please gives us expended view on JPY pairs for oct. 15 and what can be expeted on euro and u.s. sessions.

Thank You

b.

jacobuzon

October 16, 2009 at 05:57 AM ET

I admit, I looked up "short squeeze" on investopedia.
Can anybody comment on how to anticipate a "short squeeze"? It apparently matched no chart patterns, and does not fit daily bollinger bands.

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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.