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THE STORIES IN THE CURRENCY MARKET

• HOW DOES DOLLAR STACK UP HISTORICALLY?
• EUR/USD: ECB TALKS EXIT STRATEGIES
• GBP/USD: QUARTERLY INFLATION REPORT SENDS POUND PLUMMETING
• NZD/USD: HIT BY WEAKER RETAIL SALES AND BUSINESS PMI
• AUD/USD: CONSUMER CONFIDENCE DECLINES
• USD/CAD: HOUSING DATA ON TAP
• USD/JPY: JAPAN REAPS REWARDS FROM CHINA’S IMPROVEMENT

EXPECTATIONS FOR UPCOMING FED MEETINGS

CURRENT US INTEREST RATE: 0.25%
	12/16 Meeting	01/27 Meeting
NO CHANGE	55.9%	54.4%
CUT TO 0BP	44.1%	38.8%
INCREASE TO 50BP	0.0%	6.8%
INCREASE TO 75BP	0.0%	0.0%

HOW DOES DOLLAR STACK UP HISTORICALLY?

Even though it has been another quiet day in the foreign exchange market, the sharp intraday reversal of the U.S. dollar has caught the eye of many currency traders.  After falling within a whisker of its 15 month low against the euro, the dollar changed course and rose aggressively against most of the major currencies, turning profits into losses.  The currency that dropped the most against the dollar was the British pound and the only currency that managed to hold onto its gains was the Canadian dollar.  No major U.S. economic data was released and equity markets closed in positive territory.  The latest pieces of economic data from China were strong with industrial production rising more than expected.  This means that there is no “fundamental” reason for why the dollar has recovered. Instead the most practical reason is simply profit taking around key levels.  The 1.50 mark has been a tough barrier for the EUR/USD to break and so far, it has not been able to close above that level in more than 2 weeks.  

How Does the Dollar Stack Up Historically?

With no major dollar related news, we take this opportunity to compare how the dollar stacks up historically.  Recently there have been a number of economists talking about the “historical average” of various currencies.  For example, Barclay’s Chief Japanese FX Strategist recently said that the reason why the Japanese government has not intervened in the Yen is because the Yen’s value is “close to its long term basis.”  We are not sure where this observation comes from since the currently level of USD/JPY (89.84) is far from its historical 30+ year average of 175.  The Yen is also overvalued compared to its historical average against the British pound and Australian dollar.  EUR/JPY is the only currency pair that is trading close to its historical average of 131. The data also diverges significantly from purchasing power parity which is also another long term way of looking at currency valuation.  For example, according to PPP, the least overvalued G10 currency is the Japanese Yen but the Yen has the largest gap between its current price and its historical average.  In our opinion, “historical averages” are not very applicable to forecasting exchange rates, but they nonetheless provide context and we leave it up to our readers to decide whether or not the data can be a helpful guide of future price action.   We believe that the Dollar could fall another 5 to 7 percent .  Read our special report to find out why.  

Geithner Delivers, Yellen Warns of L Shaped Recovery

Treasury Secretary Timothy Geithner has finally delivered.  This morning in Tokyo, Geithner told reporters that a strong dollar is very important to the economic health of the United States.  However dovish comments from Fed Presidents indicate that Fed officials remain very cautious.  Last night, Fed President Janet Yellen warned of an L shaped recovery which means little to no growth.  On currencies, Fed President Fisher said the "dollar depreciation is not disorderly" which indicates that the Fed is not very concerned about the weak dollar.  The big economic releases this week are due for release on Friday but in the meantime we have weekly jobless claims and mortgage claims tomorrow.

EUR/USD: ECB TALKS EXIT STRATEGIES

The Euro shed its earlier gains against the U.S. dollar amidst the lack of Eurozone economic data.  Comments from ECB member Wellink were relatively optimistic and in line with the hawkish tilt of the ECB.  He said that there are signs of stabilization in the Dutch economy and a pickup in a number of sectors.  As a result, excess liquidity will need to be curbed at some point.  ECB member Weber was a bit more direct. He said the economic freefall has stopped and the outlook has improved.  Even though now is not the right time remove monetary or fiscal stimulus, Weber also said the ECB must not miss the right time for exit either.  This suggests that the central bank is very keen on making sure that they are not withdrawing stimulus too late.  Going into the release of the ECB’s monthly bulletin tomorrow, we expect the report to echo the slightly more hawkish tone.  However it will be interesting to see if fundamentals will be enough to help the EUR/USD close above 1.50.  In addition to the monthly bulletin, Eurozone industrial production will also be due for release.  Manufacturing activity accelerated in Germany, but weakness in France and Italy may offset that growth.  If the EUR/USD rallies above 1.5060, the year to date high, there is no major resistance until 1.55. 

GBP/USD: QUARTERLY INFLATION REPORT SENDS POUND PLUMMETING

The latest Bank of England inflation report was just released and showed a marked improvement in the bank’s inflation and growth forecasts from six months earlier. The bank sharply altered its growth estimates to 3.75 percent, compared to the 2.5 percent recorded in May, while inflation is expected to swell to 1.6 percent. However the British pound weakened significantly today after central bank governor King said he is keeping an “open mind” when it comes to expanding asset purchases and points to the weakness in the pound as one of the main drivers of the recovery. Rationally speaking, the BoE may want to provide further easing if only to take another bite out of the sterling. However, the way we see it, chances for another QE expansion stand at about 50/50. The fact of the matter is that data has been just too good to overlook lately, making further easing even more counterintuitive. Most recently, we saw that the increase in jobless claims was recorded at the slowest rate since early 2008. Furthermore, with both manufacturing and housing data coming around recently, it seems that the foundations of a recovery are starting to be put into place. In addition, with Fitch recently warning that the UK’s credit is at risk for a downgrade, the BoE may want to keep status quo in attempts to avoid the onslaught of credit warnings from other agencies. Therefore, it seems most likely that the course of quantitative easing will be altered only if there is a significant degradation in the improved data that we have seen over the last few months. Keep in mind that if we see any adjustment, it will probably not be until the release of the next quarterly inflation report. Nothing more is expected in terms of data from the UK for the rest of the week.

NZD/USD: HIT BY WEAKER RETAIL SALES AND BUSINESS PMI

The Australian and New Zealand dollars showed mild declines even as gold takes out a new high, while the loonie manages to post its third straight advance.  New Zealand economic data has taken a turn for the worse with business PMI slipping from 51.5 to 50.7. Retail sales rose by only 0.2 percent compared to a forecast of 0.4 percent.  Excluding automobile purchases, spending in the month of September was virtually unchanged. Consumer demand in New Zealand has clearly taken a hit, providing the latest piece of evidence that New Zealand is not benefitting from Australia’s recovery. RBNZ Governor Alan Bollard also recently commented on the strength of the kiwi as being unsustainable and recognized the damage it could create for continued improvement. Even though the bank has expressed its concerns about the currency before, the latest comments are a bit more direct and could signal a delay in the shift in monetary policy to ensure the kiwi does not strengthen further. Food Prices in New Zealand fell by 1.5% compared to last month’s -0.7%. However even in Australia, we are beginning to see signs of strain.  Last night, Australia reported Westpac Consumer Confidence which fell for the first time since last May. Signs of diminished confidence could prove to be especially significant going into tomorrow’s critical employment report. Even though Australia’s place as one of the most secure G-20 nations should remain unchallenged for awhile, a weaker employment number could damage the rate outlook for the country and may serve as a shock to the recovery trade. Canadian data will pick up for tomorrow with the New Housing Price Index.

USD/JPY: JAPAN REAPS REWARDS FROM CHINA’S IMPROVEMENT

USD/JPY is little changed on the day and saw earlier losses reverse for modest gains. A similar story is expressed across the board as holiday trading took a bite out of the volatility in yen crosses. Nevertheless, the currency did release data today that proved to be very promising. Japan produced Machine Orders which rose a substantial 10.5% after an increase of only 0.5% last month. The report credits a pick-up in export demand and indicates a possible increase in capital spending going forward. Since this particular area has been depressed in recent months, improvement in spending can possibly point to more hiring. The latest comments from Finance Minister Fujii have indicated his dissatisfaction with the recent rise in long-term interest rates. He remains “highly concerned” because the use of the bond markets is expected to reach a new record through intense borrowing in the new administration. As a possible cause of renewed Machine Orders, it was shown that that the Chinese economy continues to outperform. Not only did they report a 16.1% climb in production, but they also showed that retail sales rose and their trade balance expanded sharply on revived exports. Nevertheless, markets were a little dismayed on signs that bank lending is actually slowing. We can expect the Domestic Corporate Goods Price Index for overnight trading.

AUD/USD: Currency in Play for Next 24 Hours

AUD/USD will be the currency pair in play for the next 24 hours. The Australian employment report is expected for 7:30 pm ET tonight or 00:30 GMT tomorrow morning. Furthermore, Melbourne Inflation Expectations are scheduled for 7:00 pm ET tonight or 00:00 GMT. For the US, we can expect Jobless Claims at 8:30 am ET or 13:30 GMT and the Monthly Budget Statement at 2:00 pm ET or 19:00 GMT.

AUD/USD seems to have temporarily stalled in the Bollinger Band buy zone as it stands at a critical high. Resistance for the pair stands at today’s high of 0.9343, which is not only the highest since August of 2008 but is a low stretching all the way back to mid-June 2008. The closest area of support stands at the 20-day moving average of 0.9178. However, the real test of support exists at the November 2nd low of 0.8904. Momentum has all but dried up around the critical resistance so without a boost from tomorrows report, it is unlikely the aussie will be able to power through.

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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.