U.S. Dollar: What The Fed Expects

Last updated 11/24/2009 5:15 PM ET (GMT -5) 1 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• U.S. DOLLAR: WHAT THE FED EXPECTS
• EUR/USD: LIFTED BY BUSINESS CONFIDENCE
• GBP/USD: BOE KING OPEN TO FURTHER EASING
• NZD/USD: POLITICAL UNCERTAINTY HURTS CURRENCY
• USD/CAD: GOLD HITS RECORD HIGHS, OIL FALLS
• AUD/USD: LEADING INDICATORS RISE FOR FOURTH STRAIGHT MONTH
• USD/JPY: HITS 1 MONTH LOW

EXPECTATIONS FOR UPCOMING FED MEETINGS

U.S. DOLLAR: WHAT THE FED EXPECTS

The price action in the currency market over the past 24 hours suggests that foreign exchange traders may have already gone into holiday mode.  Intraday trading ranges are beginning to shrink and the performance of the dollar was mixed against the key currencies.  For example, the dollar traded higher against the British pound and commodity currencies (AUD, NZD, CAD) but fell against the euro, Japanese Yen and Swiss Franc.  Although U.S. equities ended the NY trading session in negative territory, it was off its lows.  With the holiday looming in the U.S., forex traders are hesitant about taking the dollar to a fresh year to date low against the euro and Japanese Yen.  However the fact that the EUR/USD remains above 1.49 and USD/JPY is trading at a one month low suggests that we could see further losses in the U.S. dollar.  

Federal Reserve Expects a Jobless Recovery

According to the minutes of the November 4th monetary policy meeting, Fed officials have grown increasingly aware of the risks associated with low interest rates and a weak dollar.  Some of the FOMC members noted the possibility of negative side effects that might result from very low interest rates such as excessive risk taking in financial markets or an unanchoring of inflation expectations.  Although the likelihood of this happening is “relatively low,” they are telling the markets that they will keep an eye on these risks.  As for the dollar, so far the Fed believes that the decline is orderly but they are growing wary of the falling dollar’s impact on inflation.   In other words, low rates and a weak dollar are not immediate threats, but the Fed is closely watching the effects of these two dynamics on the economy.  The risks to growth are roughly balanced with financial market trends supporting the recovery but capital spending is likely to be subdued. Commercial real estate poses a downside risk to their forecast of a stronger economy over the next 2 years.  The central bank also released their latest economic forecasts.  As indicated by the table below, the Fed revised their growth and inflation forecast upwards and revised their unemployment forecast downward.  Unfortunately, the central bank expects unemployment to remain “quiet elevated” throughout the recovery which means that they do not expect to return to the 4 to 5 percent unemployment rates that we enjoyed between 2007 and 2008 within the next 2 years.  In other words, the Fed expects a jobless recovery. 

U.S. Economic Data Indicative of Uneven Recovery

The latest economic reports confirm the uneven recovery in the U.S. economy.   Third quarter GDP was revised from 3.5 to 2.8 percent in the third quarter. Personal consumption took the biggest hit with growth revised to 2.9 percent from 3.4 percent.  According to S&P/Case-Shiller, house prices rose for the fifth consecutive month. The house price index stabilized which can still be considered positive. However the Richmond Fed index took a big tumble which suggests that the recovery in the manufacturing sector may be slowing. Consumer confidence edged higher but the Conference Board’s report is at odds with prior sentiment surveys.  With the U.S. markets closed on Thursday, Wednesday will be a particularly data heavy day.  Personal income, spending, durable goods, PCE, jobless claims, new home sales and the final University of Michigan Consumer Sentiment survey are due for release.  Overall, we believe that the odds are skewed towards stronger reports given the rise in retail sales in October and the improvement in the manufacturing ISM survey earlier this month.    

EUR/USD: LIFTED BY BUSINESS CONFIDENCE

The resilience of the EUR/USD is a testament to the market’s desire to test the 1.50 level. This morning, on the heels of the much better than expected German IFO report, the EUR/USD came within 10 pips of the key resistance level.  Business confidence in Germany hit a 13 month high in November thanks to increased optimism for current and future conditions.  Despite a strong currency, German businesses are optimistic about export opportunities.  The latest trade numbers from Germany were very strong and indicated that exports remain robust due to demand from Asia.  Meanwhile the third quarter GDP numbers for Germany was unrevised at 0.7 percent.  Rumor has it that the ECB is debating the possibility of putting an adjustable interest rate on December’s 12 month loans.  If the ECB was to offer an adjustable rate, it would most likely be higher than 1 percent (the expected fixed rate) and could signal to the market that they plan on unwinding their ultra easy monetary policies early next year.   All indications from the central bank suggest that they will most likely implement an exit strategy before the Federal Reserve.   German consumer confidence is the only piece of Eurozone economic data on the calendar for tomorrow.  The recent strength of the Swiss Franc reflects the improvement in Switzerland’s economy.  According to the UBS consumption survey, demand picked up in October.  Employment levels also edged higher in the third quarter with payrolls rising 0.2 percent.  If the Swiss economy continues to stabilize, it will reduce the need for the SNB to intervene in the currency.  

GBP/USD: BOE KING OPEN TO FURTHER EASING

The British pound weakened against all of the major currencies including the U.S. dollar and euro.  The only pieces of economic data from the U.K, were total business investment and loans for house purchases.  Both reports were better than the market had anticipated but neither yielded particularly market moving results.  Business investment fell at a slower pace while mortgage approvals rose to a 1.5 year high.  Bank of England Governor King testified on the Inflation Report this morning.   The central bank head warned of the difficulties that still lie ahead for the U.K. economy.  Credit to firms and households will remain impeded and there are powerful forces restraining spending.  He stressed the need for significant budget reduction and indicated that they will maintain stimulus if demand remains weak.  For the time being, the weakness in the pound is helping but at this stage, the central bank can’t rule out more asset purchases.   Previously, BoE officials suggested that the next important meeting for Quantitative Easing will be in February but according to King, they may take action earlier if necessary.  Overall, the tone of the speech was more dovish than hawkish and leaves the door open for further stimulus.  Regardless of whether they choose to do so or not, the BoE is still one of the most dovish central banks out there which could put a damper on the British pound.  All eyes will turn to the U.K. tomorrow with the second Q3 GDP report due for release.  The market is looking for a slight upward revision and we think this is likely given the upward revision in the trade numbers and the comments from BoE officials who were extremely surprised by the weak print.

NZD/USD: POLITICAL UNCERTAINTY HURTS CURRENCY

The Australian, New Zealand and Canadian dollars fell victim to the recovery in the U.S. dollar.  Of the three commodity producing countries, Australian was the only one that released economic data over the past 24 hours.  Leading indicators rose for the fourth consecutive month by 0.3 percent, but the September increase was the smallest during that period.  Gold prices continued to hit a record high but the recent outperformance of gold has not helped the Australian dollar.  There was no economic data from New Zealand but the currency remained under pressure as the Labour party turns its back on the monetary policy framework that it developed 20 years ago.  The weakness of the U.S. dollar has caused a tremendous amount of friction within the Labour Party and they blamed the weakness of the economy on the policy targets and tools used by the Reserve Bank.  Inflation has long been the RBNZ’s sole or over-riding policy objective but the Labour leader now says that he no longer supports the central bank’s focus on price stability. Unfortunately he has not provided an alternative but Phil Goff believes that the current policy framework is "not well designed to produce a stable and competitive exchange rate, nor to keep interest rates as low as possible."  Political uncertainty is negative for a currency and may the reason why the New Zealand dollar is underperforming.  No economic data is scheduled for release from New Zealand or Australia over the next 24 hours but Reserve Bank of Australia Deputy Ric Battelino will be speaking in Melbourne.    

USD/JPY: HITS 1 MONTH LOW

The Japanese Yen appreciated against all major counterparts on profit taking ahead of the holidays.  USD/JPY is approaching the October low of 88.00; if the risk aversion continues to weigh on the markets the level may easily be tested. Meanwhile, Finance Minister Hirohisa Fujji urged the central bank to take additional measure to ensure that falling prices would not hinder the economic recovery. The pressures from Japanese officials may spur the central bank to further expand the debt purchase programs which would bring down the borrowing cost. Nonetheless, Fujji agreed with remarks made by BOJ Governor Masaaki Shirakawa, that fiscal stimulus alone would not eliminate deflation. The Japanese government has a limited amount of ammunition to combat deflation. Increasing Public Debt and falling revenue along with potential downgrade in the credit rating reduces the options available to spur demand. Additionally, the head of the most powerful lobby, the Japan Business Federation, Fujio Mitara stated that the recovery is not self sufficient. Supermarket Sales dropped 5.2% in October as consumers tighten their wallets amid deteriorating labor conditions. Falling demand may push prices even lower, spurring a deflationary spiral. Merchandise Trade Balance will be released later tonight and the figures will be crucial in determining whether the strong yen has hampered the recovery.

GBP/USD: Currency in Play for Next 24 Hours

The currency in play for the next 24 hours is the GBP/USD. The UK’s Gross Domestic Product is due for release at 9:30GMT or 4:30AM EST. The U.S. will report Personal income, spending, durable goods and, Core PCE at 13:30GMT or 8:30AM EST, followed by the U. of Michigan Confidence and New Home Sales at 15:00GMT or 10:00AM EST. Although the GBP/USD is in an intermediate uptrend, the currency pair is currently trading within the Range Trading Zone which we established through the Bollinger Bands. The pair needs to breach above current resistance located on 1st Standard Deviation of 1.6730 to propel it into the Buy Zone, at which point we expect the highs of the year to be tested. However if the pair breaks below 1.65, 1.64 which is the 100-day SMA becomes support.    

Comments (1)

d@t

November 24, 2009 at 09:15 PM ET

New Zealand's Labour party is trailing by a huge margin in opinion polls and are almost certain to fair poorly in the next 2011 elections. Incumbent PM (and former currency trader) John Key is hugely popular and likely to win a second term. Phil Goff (or Goof as some call him) will likely be ditched as Labour leader at that point in time. Of course the subsequent Labour leadership might continue to criticise New Zealand's (some would say world leading?) monetary policy anyway.

So at this stage I think the market is probably giving too much weight to these remarks, if they are behind the NZD weakness over recent days. Realistically, the loose fiscal policies of the previous 9-year Labour government were no doubt a large contributor to the relative tightness of monetary policy in New Zealand and perhaps that's where Goff should be looking to place the blame for NZ's high interest and exchange rate.

Nonetheless I suspect the NZD has come a bit further than it has deserved to this year and will slip back a fair bit over the next few months anyway. If Goff's political grandstanding helps to catalyze this and I can find a nice short entry, then I can thank him for that much.

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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.