How Much Impact Can The Fed Have On The Dollar?

Last updated 11/17/2009 5:24 PM ET (GMT -5) 2 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• How Much Impact Can The Fed Have On The Dollar?
• EUR/USD: SHRUGS OFF STRONGER TRADE NUMBERS
• GBP/USD: WATCH OUT FOR BOE MINUTES
• AUD/USD: RBA HINTS AT DEC PAUSE
• USD/CAD: CPI NUMBERS ON TAP
• NZD/USD: GOLD AND OIL PRICES UNCHANGED
• USD/JPY: HITS ONE MONTH LOW INTRADAY

EXPECTATIONS FOR UPCOMING FED MEETINGS

How Much Impact Can The Fed Have On The Dollar?

Over the past 24 hours, the U.S. dollar gained strength against all of the major currencies. However the rally, particularly against the British pound and Canadian dollar has been far from impressive. The GBP/USD is virtually unchanged while other currencies such as the euro and Australian dollars are off their lows. There is no question that central bank officials are trying to talk up the dollar and to some degree it is working because investors are starting to think that the dollar is not a one way trade. Yet just because the central banks want to see a stronger dollar does not mean that they will do anything to engineer one, particularly the Fed. Incoming economic data indicates that the pace of recovery is slowing which validates Bernanke’s concern that future setbacks are possible. Unless the recovery gains traction, the Fed may not want to take steps to derail it.

How Much Impact Can the Fed Have on the Dollar?

This morning, ECB President Trichet joined the chorus of central bank officials talking up the dollar and unlike the Fed, a stronger greenback is really in the interest of the Eurozone. However with the current level of inflation, growth and export demand, the euro is not a major threat unless it rises towards 1.60. We believe that Bernanke’s comment about the dollar is important, particularly after Fed President Lacker repeated this morning that the central bank is paying close attention to the value of the dollar. This is not a coincidence and not an off the cuff comment because Fed officials rarely talk about the dollar. At the same time, every single Fed official has also expressed caution about the outlook for the U.S. economy which makes it difficult for the Fed to even consider tightening monetary policy. Even though we are long term dollar bears, we caution traders against underestimating the power of currency related comments from Bernanke. The last time the Fed Chairman surprised the market with a comment on currencies was back in June 2008 and as you can see in the following chart, the EUR/USD initially fell but then quickly resumed its uptrend and went onto break 1.60. (This is a correction from the previous chart used)

Source: DealBook

Will the Recovery in Housing Also Slow?

Tomorrow we will learn whether or not the pace of recovery in the housing market has also slowed. Housing starts and building permits are due for release Wednesday morning and unfortunately the disappointment in the NAHB housing market index points to weaker housing market activity. Along with the manufacturing sector, housing was one the first to recover. However the latest industrial production figures and yesterday’s Empire State manufacturing survey indicate that the growth is beginning to slow. Producer price pressure remains muted and because of that, consumer price growth could also be tepid. CPI numbers are due for release on Wednesday and any upside surprise should only come from gas prices which rose approximately 20 cents in the month of October.

EUR/USD: SHRUGS OFF STRONGER TRADE NUMBERS

The euro gave back yesterday’s gains to end the U.S. trading session lower against the U.S. dollar. ECB President threw a wrench into the EUR/USD rally when he joined the chorus of central bankers supporting a strong dollar. Unlike the U.S. who really needs a weaker dollar, the Eurozone will actually benefit from a stronger one. So far, ECB President Trichet has been comfortable with the strong euro because it has not affected trade materially and instead helps to reduce inflationary pressures. This morning's trade numbers from the Eurozone indicated that the deficit turned into a surplus thanks to the strongest rise in exports in 20 months. If the strong currency was really having a detrimental effect on the export sector, we would not have seen a 5.5 percent increase in foreign demand. Imports also rose by 1.1 percent which suggests that domestic demand is steady as well. Although Trichet has a vested interest in seeing the dollar rise, he is not immediately concerned about the decline. This morning, the ECB head said he "notes with interest" Bernanke's comments on the dollar and believe it is a "very important statement" because "a strong dollar is in the world's interest." According to Trichet, the "euro was not created to become a reserve currency" and to replace the dollar. On monetary policy, interest rates are still appropriate, but Trichet said unconventional steps will be phased out "progressively." The central bank is gearing up for an exit and the closer they get, the more demand there will be for euros instead of dollars. Eurozone current account figures are due for release tomorrow and we expect the same strength as the trade numbers. For the time being, the 1.47 level should hold as near term support for the EUR/USD.

GBP/USD: WATCH OUT FOR BOE MINUTES

The resilience of the British pound is surprising many traders. Of all the major currencies, the pound dropped the least against the dollar. In fact, it ended the U.S. trading session virtually unchanged. The currency’s strength can also be seen in EUR/GBP, which fell to a 2 month low. The strength of the sterling is due in part to the stronger than expected inflation numbers. Consumer prices rose 0.2 percent in October, driving the annualized pace of CPI growth up to 1.5 percent from 1.1 percent; core CPI rose from 1.7 to 1.8 percent. Inflation is a big focus of the central bank and the evidence of stronger inflationary pressures on both a core and headline basis could reduce the odds of further Quantitative Easing by the Bank of England. QE will be the main focus tomorrow with the minutes from this month’s monetary policy meeting due for release. Earlier this month, the BoE increased their QE program by GBP 25 billion, which was 50 percent less than the market had anticipated. Traders will be looking at the minutes for clues on why the BoE made the smaller move and how many members voted in favor of a 25B vs. 50B increase in the QE program. Yesterday, BoE member Sentance gave us a taste of how the central bank may feel. Based upon his comment that the next major QE decision will be in February, we believe that the central bank hasn’t made up their mind yet. Incoming economic data including this morning’s inflation numbers argue against additional easing and if the minutes reveal similar hesitancy by the BoE, the pound could extend its gains. The price action in the GBP/USD certainly suggests that traders are already positioning for a less dovish outcome.

AUD/USD: RBA HINTS AT DEC PAUSE

The Australian, New Zealand and Canadian dollars lost ground against the greenback. To the disappointment of Aussie bulls, the minutes from the most recent RBA meeting was not as hawkish as they have hoped. According to the minutes, the RBA still expects to gradually adjust the cash rate over time, “but the pace of that adjustment remained an open question.” They want to carefully balance the risks and make sure that their tightening does not derail the recovery. In other words the RBA is hinting that they plan on pausing in December. There can be a lot of stigma that comes with raising rates right before the holidays. The last time the RBA tightened monetary policy in December was 6 years ago and since 1990, the RBA has never raised interest rates three months in a row. Although the Australian economy is outperforming all of the other major economies, there are still pockets of weakness. The latest retail sales numbers revealed that consumers cut back in September despite the improvements in the labor market. Inflationary pressures are also under control. By raising rates in December, the RBA could dampen holiday spending because consumers, particularly those that recently bought new homes are extremely sensitive to rate hikes. The central bank could pause if they believe that it will benefit the economy in the long run and even though unprecedented times may call for unprecedented measures, the global recovery is still fragile. Australian leading indicators are due for release this evening along with Canadian consumer prices tomorrow. Raw material and industrial product prices have declined but the price component of IVEY PMI increased which makes the CPI numbers a tough call. The market is looking for stronger inflationary pressures.

USD/JPY: HITS ONE MONTH LOW INTRADAY

The rally in Japanese Yen stalled temporarily against the Dollar after reaching a one month low intraday. Meanwhile, the Yen continued to gain ground against the Euro, yet remained relatively unchanged against other currencies. Japanese demand for services unexpectedly fell in September amid improving economic conditions. The Tertiary Index slid half a percent as signs of domestic economic stimulus are beginning to fade. A drop in service sector activity confirms the disposition that recent gains in the economy were the result of increasing demand from abroad. Adding to the pessimism, the world’s second largest economy may not be able to grow at as strong of a pace as it did in the 3rd Quarter. The contribution from government stimulus may already hit a climax, while the labor situation continues to deteriorate. Moreover, strength in the Japanese Yen may additionally hurt exporters who are leading the current recovery. Meanwhile in China, president Obama urged Chinese officials to fulfill a promise to appreciate the value of Yuan. The Yuan, pegged to the struggling Dollar, decreased over the last few months. In reaction, economies with export based recovery which includes Japan are unable to fully reap the benefits of a rise in global demand. Later in the evening, Japan expects the release of Machine Tool Orders.

EUR/GBP : Currency in Play for Next 24 Hours

The currency in play for the next 24 hours is EUR/GBP. The Euro-zone expects the release of Current Account at 9:00GMT or 4:00AM EST followed by the UK BOE Minutes at 9:30GMT or 4:30AM EST and the CBI Industrial Trends at 11:00GMT or 6:00AM EST. After reaching a year to date high last month, EUR/GBP has formed an intermediate double top. The pair has dropped significantly from its high above 94 cents and is currently projecting further declines as it trades within the Sell Zone established through Bollinger Bands. The upcoming level of support is the 61.8% retracement of July’s low and this year’s high at 0.8785. The downtrend will be negated if EUR/GBP manages to rise above the 1st Standard Deviation Bollinger Band which also coincides with the 50 percent retracement of July’s low and this year’s high at 0.8900.

Comments (2)

GubyIQ

November 17, 2009 at 06:50 PM ET

hi Kathy
i must say i doubt that the decline in eur/usd at the beginning of June was because of Bernanke...if i remember correctly, there was a very good NFP on 5th June, that triggered a H&S formation,

FXDragon

November 18, 2009 at 01:54 AM ET

I remember nfp for may was bad but there was a major top and a retracement was due. That h&s was so good, many analysts thought that was a turning point(thank god thery were wrong). But when summer doldrums passed, an expected technical breakout materialized in Sept. Aug. nfp was good but that also triggered a pullback bec. of a good top. That was weird bec. stocks and eurusd moved in complete opposite direction that Friday.
Anyway i dont think Ben could beat technicals but a good friday seems to be approaching that deserves preparation!

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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.