Dollar Rally May Have Legs

Last updated 10/26/2009 5:01 PM ET (GMT -5) 0 Comments - Add your comment

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• DOLLAR RALLY MAY HAVE LEGS
• EUR/USD: LOSING SIGHT OF 1.50
• GBP/USD: MORE QE STILL POSSIBLE
• USD/CAD: CARNEY PUTS PRESSURE ON THE LOONIE
• AUD/USD: DISAPPOINTING PRICES MAY KEEP RBA AT BAY
• NZD/USD: NO OPTION TO DEVALUE KIWI IS AVAILABLE
• USD/JPY: PLANNING ECONOMIC TRANSFORMATION

EXPECTATIONS FOR UPCOMING FED MEETINGS

DOLLAR RALLY MAY HAVE LEGS

Volatility has ripped through the financial markets with currencies and equities staging sharp intraday reversals. All of the major currency pairs have seen an increase in one month volatilities on the fears that valuation and recovery expectations have become overextended. The U.S. dollar strengthened against all of the major currencies, driving the EUR/USD down more than 125 pips in the process. With such a strong reversal, the burning question on the minds of all currency traders is whether the latest move is merely profit taking on dollar short positions or the beginnings of a full fledged reversal.

Pause or Turn?

In order for a full fledged reversal to occur, there needs to be a worthwhile catalyst. Unfortunately that was not the case today. Today’s 1.0% fall in most major indices mirrors the agony that we saw on Friday with stocks first racing higher before reversing aggressively to end the U.S. trading session near its lows. However, being that there was no U.S. economic data to shake the markets, it is a little unclear what caused the panic. One potential explanation is uncertainty surrounding the continuation of the $8,000 tax credit given to first time borrowers. Current congressional discussions are pointing to a possible extension but with the plan to gradually fade out through the next few months. Since many were hoping for an outright extension, this was a bit of a disappointment. It is not hard to believe that the substantial jump in home sales, as exhibited by Friday’s report on existing home sales, would be unsustainable without government assistance making our economic recovery slightly more uncertain. To add on to stock market woes, it was reported that Bank of America’s repayment of government bailout funds is being delayed because regulators are requiring the company build-up more capital through a secondary offering before they would be allowed to loosen ties to the government. The company faces two difficult decisions - either dilute the value of their shares or submit to continued government intervention and unfortunately neither option looks particularly attractive.

Dollar Rally May Still Have Legs

Although the intraday reversal in stocks triggered a sharp selloff in currencies such as the euro, Australian, New Zealand, and Canadian dollars, the lack of a catalyst suggests that the latest move is more likely a relief rally in the U.S. dollar than a bottom. Nonetheless, this rally may still have legs given the strength of today’s move. Consumer confidence is due for release tomorrow and given the drop in the IBD Confidence report and the University of Michigan consumer sentiment survey, weakness is also expected in the Conference Board’s report. If currencies continue to take their cue from equities, then a larger than expected drop in confidence could drive equities lower and the dollar higher in the process as traders unwind some of their recovery trades. Another thing to keep in mind is that the Fed has committed to ending treasury purchases by October 31st. This could lift yields which would help the U.S. dollar. However in the grand scheme of things, a much deeper slide in the higher yielding currencies would be needed to negate the uptrend. In the case of the euro, we would have to see the 1.4600 level broken before the current trend would be invalidated. AUD/USD would have to fall below 0.9000 before we could start talking about a more significant correction. Even though the greenback may be set for an early week rally, it is still unlikely that the gains will be sustainable in the long-run as current economic dynamics have not changed enough to facilitate such a shift.

EUR/USD: LOSING SIGHT OF 1.50

The sharp slide in the EUR/USD today suggests that currency traders have rejected the 1.50 level. Despite claims that China is looking to accumulate more euros, the rally in the most actively traded currency pair has lost its steam. Not only did U.S. equities turn, but German consumer confidence also fell for the first time in fourteen months to 4.0 from 4.3 last month. Survey provider Gfk questioned whether personal consumption will be able to support the economy, like it has in the past few months. Interestingly enough, despite a drop in income, the economic expectations component of the report nearly doubled from last month. The question over the consumers’ ability to spend could be cleared by Thursday’s German employment report. If unemployment continues to rise, then consumer spending could really falter in coming months. So far, ECB officials appear to be comfortable with the rise in the euro which provides shelter from rising commodity prices. Unless the EUR/USD makes new highs, the risk of verbal intervention should remain contained. Tomorrow should be a quiet day overall with only Money Supply and French Consumer Confidence to fill the Eurozone schedule.

GBP/USD: MORE QE STILL POSSIBLE

The pound is regaining some composure today after Friday’s declines, thanks in part to weakness in the euro. Of all the major currencies, the British pound has the lowest level of volatility today against the dollar. All of the action was in EUR/GBP which fell close to 1 percent. According to Goldman Sachs, the British pound is the most undervalued since 1999 based on the purchasing power parity theory. However dovish comments from former and current Bank of England members are not helping. Bank of England’s Posen added to the quantitative easing speculation frenzy, by saying there is no evidence the program will result in uncontrollable inflation. Posen’s opinions seem to be stacked firmly on the side of expanding the program as he states that credit conditions are still tight for some businesses. He even made the somewhat radical suggestion that purchases be expanded beyond gilts. In addition, former BoE-member David Blanchflower’s comments from today gave little hope that the pound would see many more days of such gains. Mr. Blanchflower ominously noted that the “economy is on its back”, and continued his skepticism over the banks hesitancy to increase quantitative easing by another £50 billion. His comments mainly referred to the fact that he believes housing prices will start to decline again, noting that recent improvement was merely a bubble and not based on fundamental factors. Judging from the latest round of comments, it appears that the potential for an asset-purchase expansion may be the BoE’s next step. No economic data was released for today, but we are expecting the M4 Money Supply and Net Consumer Credit for tomorrow.

USD/CAD: CARNEY PUTS PRESSURE ON THE LOONIE

Both the Australian and Canadian dollars ended the U.S. trading session lower after failing to sustain earlier gains. However the action was in the Canadian dollar, which fell more than 1 percent against the greenback. The loonie plummeted in today’s trading as Bank of Canada Governor Mark Carney reiterated his concern for the excessive appreciation of the loonie. According to Carney, the Canadian Dollar is resulting in a “significant drag on growth” and will continue to keep prices depressed. Perhaps even more importantly, Carney said that the current level of the Canadian dollar more than fully offsets the favorable developments since July. As a result, the BoC will most likely keep interest rates unchanged throughout the first half of 2010. Of all the major central banks, the BoC has been the most vocal about the negative impact of a strong currency. These are the words of a dovish central bank who will most likely stall any plans to tighten monetary policy. If Carney’s main purpose was to talk down the currency, he may very well have been successful. The combinations of renewed talks on excessive CAD strength and keeping rates low should offer a one-two punch for the loonie. For the most part, Carney refrained from painting a “rosy picture”, but announced that they are “on track at the start of a very long road.” Canadian data will continue to be light for the next couple of days. Australian Producer Prices were a big disappointer for markets. Monthly producer prices rose from -0.80% to 0.1%, missing their target of 0.30%. To make things worse, yearly prices were at their lowest levels on record. The news suggests that there will be less urgency on the part of the RBA to cut off a sharp rise in prices and will have to slow their rate hike determination. Today’s report also signifies the possibility that the continued rise in the Australian dollar is starting to reap a deflationary effect. Meanwhile New Zealand’s Prime Minister John Key, who was once a foreign exchange trader at Merrill Lynch, acknowledged today that the country would be able to spur growth faster without the large rallies in the kiwi, but simply do not have the option to “engineer a lower exchange rate.” In other words, they do not have the bandwidth to physically weaken their currency.

USD/JPY: PLANNING ECONOMIC TRANSFORMATION

USD/JPY is managing to come away with small gains, marking its ascent to the highest levels since September 21st. The currency has risen nearly 5.0 percent since its lows hit in early October. One of the main drivers of a USD/JPY rally seems to be rooted in political uncertainty. Japan’s new Prime Minister, Yukio Hatoyama, gave an address to the country’s parliament today in which he reiterated one the main goals he attempts to fulfill in his administration – “building an economy for the people.” This vision involves making a switch in economic drivers, from exports to consumer spending. However, making such a radical change is not so simple, as many worry that governmental pledges of more spending to achieve such growth would expand the already crippling budget deficit. Furthermore, casting the export industry aside may result in unforeseen economic distress that will only create more problems than it resolves. Export dependence is one of Japan’s critical weaknesses, but it is very questionable how the newfound government will be able to move away from such a system. Data should be light until the end of the week when we receive the Bank of Japan’s semi-annual outlook on Friday.

EUR/USD: Currency in Play for Next 24 Hours

EUR/USD will be the currency pair in play for the next 24 hours. The Euro-zone will provide markets with M3 Money Supply at 5:00 am ET or 9:00 GMT. The U.S. will be releasing the S&P/Case Shiller Home Price Index at 9:00 am ET or 13:00 GMT along with Consumer Confidence for 10:00 am ET or 14:00 GMT.

EUR/USD

EUR/USD

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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.