Forex: What Could Kill The Rally?

Last updated 11/13/2009 4:47 PM ET (GMT -5) 3 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• FOREX: WHAT COULD KILL THE RALLY?
• EUR/USD: GROWTH IS NOT EXCITING, BUT STILL PROMISING
• GBP/USD: LOOK FOR CLUES IN BOE MINUTES
• USD/CAD: CANADA PROVES STRENGTH IN TRADE
• AUD/USD: GOLD PRICES EXTEND GAINS, OIL LOWER
• NZD/USD: BIGGEST GAINER
• USD/JPY: CONSUMER CONFIDENCE IMPROVES

EXPECTATIONS FOR UPCOMING FED MEETINGS

FOREX: WHAT COULD KILL THE RALLY?

Based upon recent price action there are signs of exhaustion in the currency and equity markets as the 1.50 level in the EUR/USD and 1100 level in the S&P 500 appear to be insurmountable barriers. However with little U.S. economic data on the calendar this past week, traders had few reasons to press the dollar to new lows. Instead, most of the currency pairs consolidated with some profit taking seen on dollar short positions. Yet dollars bears have not given up as indicated by the lower close on Friday. All of that could change next week as the economic calendar heats up with a tremendous amount of data from across the globe and speeches by Fed officials. The major currency pairs are prime for a breakout and there is certainly sufficient catalyst to trigger one. The only question is, will these event risks kill the rally or pave the way for more gains.

What Could Kill the Rally in High Yielding Currencies?

Of all the big economic releases and speeches this week, the most important will be the U.S. retail sales report and speech by Fed Chairman Ben Bernanke on Monday. If October retail sales are very weak or Bernanke talks up the dollar, the rally in equities and high yielding currencies could come to a screeching halt. However we believe that the chances of this happening are slim. First, comments on the dollar are typically made by the Treasury Secretary and not the Federal Reserve Chairman and secondly, if anything Bernanke favors a weaker dollar in this low inflation environment. The focus then turns to what he says about the economy and monetary policy. According to the last FOMC statement, there have been no meaningful improvements in the outlook for the U.S. economy since the previous meeting. Asset prices have moved higher but that does not necessarily imply a stronger outlook for U.S. companies. Recent comments from other Fed officials remain relatively downbeat as growing unemployment caps optimism. Most likely Bernanke will remind us that the recovery is still vulnerable and therefore interest rates need to remain low for a very long and therefore implementing an exit strategy now is inappropriate. If Bernanke retains this tone, then the dollar carry trade should remain intact. As for retail sales, we have good reasons to believe that consumer spending could surprise to the upside. Both Redbook and the International Council of Shopping Centers (ICSC) reported a sharp rise in retail sales last month while similar results were reported by individual retailers. Good spending numbers would suggest that the economy is moving in the right direction even though the labor market is weak. Aside from these events, inflation, housing and manufacturing sector reports are also due for release from the U.S. along with the Treasury International Capital flow report. Eight Federal Reserve Presidents are scheduled to speak on a variety of topics while Treasury Secretary Geithner will be testifying to the Senate Foreign Relations Committee on Tuesday. Don’t forget that President Obama will be in Asia until next Thursday. Watch for any market moving comments, particularly during the Asia-Pacific Economic Cooperation forum (APEC), but most likely there will not be any dramatic breakthroughs on currency.

Forex Positioning and Economic Data

The latest data from the CFTC (COT report) confirms that profit taking is occurring in the U.S. dollar. In the week ending November 9, futures traders reduced their net long Aussie, Kiwi and Canadian dollar positions. They continued to cut their short pound positions and bought more euros, Swiss Franc and Japanese Yen. Meanwhile this morning’s economic reports were relatively disappointing with the trade deficit jumping by 18 percent to $36.5B in September, the widest gap since the beginning of the year. Consumer confidence also plunged as the University of Michigan Consumer Sentiment survey dropped to the lowest level since July. The sell-off in the U.S. dollar on Friday suggests that fundamentals are mattering once again and it is in this context that we head into the new trading week.

EUR/USD: GROWTH IS NOT EXCITING, BUT STILL PROMISING

The euro is experiencing a mild recovery off of yesterday’s selling frenzy, but the rally may have been stunted by the latest round of preliminary growth reports. Gross Domestic Product was released from around the Euro-zone, but the strength of the report really depends on the way you look at it. All reports were below expectations but were above second quarter growth. The latest figures were not the sign of blow-away expansion that the markets were hoping for. Euro-zone GDP expanded for the first time in five quarters by 0.4%, but missed expectations for 0.5% growth. The story is pretty much the same for both Germany and France. In Germany, the largest Euro-zone economy, growth was driven mainly by exports and capital investments, not domestic demand. The fact that personal expenditures continued to depress the figure is concerning because it is unlikely that trade will be able to continue to recovery indefinitely. This case is definitely true, and presents a major weakness in German economic structure, when considering that the euro continues to hold on to recent strength. Even though the pair has stabilized as of late, another strong rally spells trouble for German exports. On the back of the report, the country’s Council of Economic Advisers noted that they expect 1.6% growth in 2010 on a brittle export recovery. Now that the largest EMU nations have exited the recession, the focus once again shifts to what the ECB plans to do about rates. The problem becomes more perplexing considering that many smaller nations are still embattled in recession. Responding to such issues, Executive Board Member Paramo said that he cannot “rule-out” a rate hike even though other countries are still struggling. In any event, Paramo confirms that any action will be “gradual and opportune”. Next week’s big events include the Euro-zone Consumer Price Index, trade and current account numbers.

GBP/USD: LOOK FOR CLUES IN BOE MINUTES

The British pound continued to recover against the U.S. dollar and euro despite reports by the Financial Times that U.K. Chancellor Darling could present a more pessimistic forecast for the U.K. economy than the Bank of England when he delivers his Pre-Budget report next month. The FT even went onto say that Darling was very surprised last week when BoE Governor King projected growth of 4 percent in 2011. Not all BoE officials echo the same optimistic sentiment as King. BoE policy maker Posen said this morning that the global economy has improved but how the financial industry performs could determine if the world undergoes a double dip recession. Next week will also be a busy week for the British pound. Consumer prices and retail sales are due for release but the single most market moving event risk for the pound should be the minutes from the Bank of England’s monetary policy meeting. At that meeting, the BoE raised their Quantitative Easing program by GBP 25 billion, which was 50 percent less than the market anticipated. Traders will be looking for the minutes to explain why the BoE did not boost the program by GBP 50 billion and if they still intend do so.

USD/CAD: CANADA PROVES STRENGTH IN TRADE

All commodity dollars are higher today and marked gains for the second week in a row. AUD/USD is still edging closer to a new yearly high but has since been unable to accomplish this feat. The main report from today did a good job in spelling out to markets that Canada may be stronger than many expect. The country’s trade deficit declined to the smallest in about three months as exports shot up by 3.5%. Adding to the effects of a closing deficit gap was a small decline in imports. This time around, it was not U.S. demand that drove exports, but European purchases. This could suggest that Canada has found a trading partner that might be able to offset the slackened US demand. The strong trade numbers should also prove to be a slight boost to growth in upcoming figures. The nation also showed that New Motor Vehicle Sales rose 1.2%, which makes sense considering a revival in auto sales was a big reason for the trade improvement. In New Zealand, Finance Minister Bill English shared his thoughts on economic recovery, and noted that it would be “fairly bumpy.” He says that the economy’s return to growth was merely a technical formality and the country is still dealing with a critical lack in consumer spending. Consumers may be confident, English says, “but they are not backing confidence with more spending or more investment.” The Finance Minister did not have a lot to say when it came to the kiwi, but mentioned that he will be “thinking through the effects.” Next week’s focus will be on New Zealand’s Producer Prices on Sunday, followed by the RBA’s Minutes for Tuesday and Canadian Consumer Prices on Wednesday.

USD/JPY: CONSUMER CONFIDENCE IMPROVES

The Japanese Yen seems to be consolidating around 90.00 level against the US Dollar as market forces are unable to develop a consistent trend. The strength in the Yen has been both criticized and praised by the government officials. Lately the government officials started to advocate for a weaker Yen as the economy remains “very unstable,” according to Finance Minister Hirohisa Fujii. During the APEC meeting, Asia Pacific nations including Japan pressured China to revaluate the Yuan. China is the biggest trading partner of Japan, along with many other countries. Therefore any appreciation in the Yuan would provide additional revenue to Japan’s exporters in China who price their goods in Yuan, not to mention level the competitive advantage of China over Japan. Meanwhile on the economic front, Consumer Confidence inched slightly higher than expected reflecting a drop in unemployment. Industrial Output rose for seventh consecutive month on gradual improvement in foreign demand. The economic calendar heats up during the following week as Gross Domestic Product, Tertiary Index, and Bank of Japan Interest Rate Decision are on the schedule.

EUR/USD: Currency in Play for Next 24 Hours

The EUR/USD will be the currency in play on Monday. Euro-zone’s Consumer Price Index will be released at 10:00GMT or 5:00AM EST followed by the U.S. Retail Sales report and the Empire Manufacturing Survey at 13:30GMT or 8:30AM EST. Unable to breach the high of the year, EUR/USD retreated into the Range Trading Zone which we establish through Bollinger Bands. To resume the uptrend the pair must break into the Buy Zone of the Bollinger Bands after clearing the psychologically important 1.5000 barrier. Any upside momentum will be negated if the EUR/USD closes below support at the 50-day SMA of1.4765.

Comments (3)

Semaj

November 13, 2009 at 05:29 PM ET

K, whats up with the Nzd/Usd? The fundies this week don't explain the strength in the Nzd, right? It also broke thru the daily trendline with a 100% retracement of the prior swing. Any input? Thanks

FXDragon

November 13, 2009 at 07:06 PM ET

I understand Fed probably will look at employment and inflation to raise rates, not so much at gdp. The first two are more correlated anyway.

Meanwhile Kathy,
In a scenario where fed started raising rates, all other things being equal, would you expect a long term pullback in stocks?
or a temporary pullback first followed by more risk appetitte?

Sincerely,

Stephan Smith

November 15, 2009 at 12:21 PM ET

The USD/JPY seems to be at rock bottom prices. Consolidation could indicate a reversal. Plus, Officials are calling for a weaker yen, that is another sign of reversal. I see signs with my big ol' eyes.

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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.