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THE STORIES IN THE CURRENCY MARKET

• U.S. DOLLAR: KEY LEVELS
• EUR/USD: WHY ECB IS NOT WORRIED ABOUT EURO
• GBP/USD: BROWN PUSHED FOR FINANCIAL OVERHAUL
• AUD/USD: HOUSING MARKET PROVES TO BE IMPRESSIVE
• USD/CAD: OIL PRICES JUMP 2 PERCENT
• NZD/USD: BIGGEST MARKET MOVER
• USD/JPY: EASING FEARS SIGNAL YEN WEAKNESS

EXPECTATIONS FOR UPCOMING FED MEETINGS

CURRENT US INTEREST RATE: 0.25%					Data Distorted by Expectations for Continued Fed Stimulus
	12/16 Meeting	01/27 Meeting
NO CHANGE	14.8%	39.7%
CUT TO 0BP	85.2%	49.4%
INCREASE TO 50BP	0.0%	4.7%
INCREASE TO 75BP	0.0%	0.0%

U.S. DOLLAR: KEY LEVELS

The weakness of the U.S. dollar was one of the leading stories in the financial markets today as the trade weighted dollar index fell to a 15 month low.  Every single major currency except for the Japanese Yen strengthened against the greenback, recovering all of Friday’s losses.  Moves in the equity and commodity markets were also credited to the weak dollar and there are plenty of reasons why the dollar could continue to weaken.  In our special report on 5 Reasons Why the Dollar Could Continue to Fall , we have outlined a few of them but everyone seems to have their own explanation for why the dollar will remain the whipping boy of the financial markets.  With no major U.S. economic data on the calendar until Friday, the relative performance of the U.S. economy should be the primary driving force for the U.S. dollar.  Traders will be looking at incoming data from Europe and Asia and comparing that with U.S. data.  The only support for the dollar would have to come from the 7 Fed officials scheduled to speak this week or Treasury Secretary Geithner.  However judging from last week’s FOMC statement and the comments from Geithner after the G20 meeting, there is little chance that Fed officials will deliver the hawkishness that the market needs to turn the dollar around. 

IMF, G20 and the Fed

The G20 pledges to keep interest rates low and to provide continued stimulus to their respective economies.  More stimulus means more spending and with the dollar already crumbling under the weight of fiscal imbalances, foreign investors have even fewer reason to hold dollars.  This cohesive message also suggests that despite the recovery in equity markets, central bankers are not getting overly excited about the rise in share prices.  The IMF believes that the greenback is still overvalued and more investors will be using it as a funding currency.  On the flip side, the Fed sees improving credit conditions.  According to their latest report, fewer banks have reported tightening credit in the third quarter.  Nine out of ten banks that have undergone the stress tests now have sufficient capital.  This is good news but unfortunately not good enough to help the dollar.

Impact of Dollar Weakness

As a result of the dollar’s weakness, the Dow Jones Industrial average has soared 203 points to a new 13 month high.  Oil prices also rose 2.4 percent while the price of gold increased 0.7 percent.  As the dollar continues to fall, talk of inflation will return.  Demand is weak, but companies are already trying to sneak in surcharges where they can. For example, U.S. airlines have raised holiday peak travel fees from $10 to $20 each way.  If oil prices continue to rise, we may even see a return of fuel surcharges.  Rising commodity prices could cause a further strain on the pocketbooks of Americans if they boost food and energy prices.  Combined with continuing job losses, it should be a very weak holiday shopping season.  Electronic Arts and Sprint both announced additional job cuts today.  However countries outside of the U.S. are the ones that will really feel the consequences of dollar weakness.  The U.S. on the hand wants a weaker dollar.  

Key Levels in the Dollar

However the primary reason why the dollar is weakening remains intact.  Last week, the Fed reaffirmed their steady as she goes mentality by leaving the FOMC statement virtually unchanged. The Fed is very happy with the way things are right now and are not in a rush to unwind Quantitative Easing. In contrast, the central banks of Australia, the Eurozone and even Japan are much more likely to continue "deloosening" monetary policy. We still believe that the U.S. central bank will be amongst the last to raise interest rates and for that reason the dollar carry trade should remain intact. The key levels for the dollar will be 74.93 for the dollar index, 1.5060 for the EUR/USD and 87 for USD/JPY.  If those levels are broken, we could see an acceleration of dollar weakness.

EUR/USD: WHY ECB IS NOT WORRIED ABOUT EURO

The latest trade numbers from Germany helps to explain why the European Central Bank is not worried about the strength of the euro.  Typically the primary consequence of a rising currency is the toll that it takes on exports.  However in the case of Germany, the largest country within the Eurozone, exports surged 3.8 percent in September despite as much as a 6 cent rise in the EUR/USD.  Imports were also strong, reflecting improved domestic demand.  Exports of cars by Germany’s Diamler, the world’s second largest luxury car manufacturer to China rose 55 percent which suggests that the world has become less reliant on the U.S. and more reliant on China. Germany’s trade surplus rose from 8.1B to 10.6B in September while the current account surplus more than doubled from 4.4B to 9.4B.  As a result, currencies were not discussed at the G20 meeting according to ECB President Trichet.  Comments from monetary policy committee member Stark also helped the euro.  He believes that not all liquidity measures are needed as much and he is worried about the side effects of emergency measures.   In other words, members of the central bank are becoming concerned about the consequences of keeping monetary policy too easy for too long.  Meanwhile the German ZEW survey is due for release tomorrow.  Even though the trade numbers were strong and industrial production increased 2.7 percent in September, retail sales fell for the second month in a row and factory orders were weak.  Therefore investor sentiment could still deteriorate.  

GBP/USD: BROWN PUSHED FOR FINANCIAL OVERHAUL

The GBP/USD was sent to a new three-month high, as the results of this weekend’s G-20 meeting sent the greenback tumbling. Even though the meeting largely fueled today’s resurgence in risk appetite and a continued winning streak in equities, UK Prime Minister Gordon Brown is spearheading new financial regulatory proposals that may place a significant strain on the country’s most important industry. Brown announced to G-20 finance ministers that he favors the implementation of a new Tobin tax that would place a fee on financial transactions. Furthermore, he suggests the consideration of ideas like forcing banks to pay an insurance premium related to the amount of risk they take and developing a fund that could be tapped to pay for any future bail-outs. Although the suggestions were met with some opposition at the gathering from people like U.S. Treasury Secretary Geithner, similar programs could slow the financial sector recovery and reduce its dominance on the global stage. Data for the start of the week has been at a minimum. However, tomorrow should be a bit more significant as far as data goes. We will receive a couple of indicators on the housing market, including RICS and DCLG House Prices, as well as the Trade Balance. The UK has been posting consistently strong housing numbers, so tomorrow’s figures could reiterate the same story.

AUD/USD: HOUSING MARKET PROVES TO BE IMPRESSIVE

All commodity currencies are benefitting from the latest dollar selling frenzy, and have posted significant rallies. The aussie, in particular, proved to be an outperformer with four straight daily gains bringing the pair extremely close to a new 15-month high. Of course, the latest string of data seems to support growing Aussie optimism. Home Loans in Australia have skyrocketed from prior months, accelerating the most in 6 months to 5.1%. The number indicates the success of Australian programs to provide first-time home buyers with an ample rebate check, one that is far greater than what is being offered in the United States. In addition to boosting sales, the program has also been a factor in pushing up home prices by more than 8.0% over the last half-year. However, the country did offer disappointing results when it came to the ANZ Job Advertisements index, which fell drastically to -1.7%. With Australia’s employment report being readied for Wednesday night’s trading, such an indication may foreshadow some weakness in the critical sector. In recognition of the country’s recent strength, the RBA’s Assistant Governor Lowe said that the country maintains foreign exchange flexibility, a quality that signals the country will not be adversely affected by a continued rally in the aussie. For tomorrow, we can expect the NAB report on Business Conditions and Confidence. At last weekend’s Group of 20 meetings, BoC Governor Mark Carney noted that even though the recent string of weak data indicates a “somewhat softer fourth quarter”, his expectations for a strengthening recovery remain in place. Canadian data has gotten off to a good start this week after Friday’s miserable employment report, with Housing starts rising to the highest since the beginning of the year.  New Zealand is expected to release Credit Card Spending for overnight trading.

USD/JPY: EASING FEARS SIGNAL YEN WEAKNESS

USD/JPY is lingering at around 90.00 as traders grapple with the fact that both countries are expected to keep rates extremely low for an extended period of time. Considering the low levels of the pair and the similar monetary policy outlook, USD/JPY may be doomed to fluctuate within a tight trading range. However, other yen crosses show a different story entirely. The yen is experiencing broad based weakness, especially against the commodity currencies. Judging by the six day dip in the Volatility index, the dissipation of trading fears has significantly boosted risk tolerance, thereby eliminating the demand for Japan’s safe haven assets. An interesting report recently surfaced that indicates that Japan has outpaced China as the largest purchaser of U.S. treasuries, as Japanese economists expect the U.S. to dip into a deflationary spiral. Although there were no releases on the schedule for today, we are expecting a pretty significant release for tonight. Japan is set to produce Trade Balance figures which will paint a telling picture of how currency woes are actually affecting export competitiveness. As of late, the barrage of currency-related comments has significantly abated, indicating that officials have found that the threats have eased. However, with USD/JPY hesitancy to move off of 90.00, the country may have to respond, especially if exports take a dip in tonight’s report.

EUR/GBP: Currency in Play for Next 24 Hours

EUR/GBP will be the currency pair in play for tomorrow. The Euro-zone will produce a shopping list of indicators which include German Consumer Prices at 2:00 am ET or 7:00 GMT, French Manufacturing and Industrial Production at 2:45 am ET or 7:45 GMT, and the ZEW Economic Survey for Germany and the Euro-zone at 5:00 am ET or 10:00 GMT. In the UK, expect the release of the Trade Balance and DCLG House Prices at 4:30 am ET or 9:30 GMT.

Today’s small gains are unable to take the currency pair out of the Bollinger band sell zone. Nevertheless, a continued downward drift in EUR/GBP remains contained by a critical support level at 0.8900. There are confluences of indicators that make this level significant, not the least of which is the fact that it is the 50% retracement from June lows to October highs. In addition to its psychological influence, today’s earlier selloff was reversed once the level was hit. A rally in the pair could be capped at the 38.2% retracement of 0.9025. Even though support is strong for the pair, recent price action has given no indication that momentum is building to the upside.

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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.