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THE STORIES IN THE CURRENCY MARKET

• FOREX: UNDERSTANDING IMPACT OF DUBAI
• EUR/USD: GERMAN RETAIL SALES AND EMPLOYMENT NUMBERS ON TAP
• GBP/USD: A DAY OF CONTRADICTION
• AUD/USD: WILL THE RBA RAISE RATES?
• USD/CAD: EXITS FROM RECESSION IN Q3
• NZD/USD: SHARP RISE IN BUILDING PERMITS
• USD/JPY: THE FUJII CONUNDRUM

EXPECTATIONS FOR UPCOMING FED MEETINGS

CURRENT US INTEREST RATE: 0.25%
	12/16 Meeting	01/27 Meeting
NO CHANGE	59.6%	58.4%
CUT TO 0BP	40.4%	37.8%
INCREASE TO 50BP	0.0%	3.8%
INCREASE TO 75BP	0.0%	0.0%

FOREX: UNDERSTANDING IMPACT OF DUBAI

Although Dubai’s troubles are making the headlines of many financial and non-financial media, the markets have already absorbed the news.  Asian stocks rebounded strongly last night while U.S. stocks ended the day virtually unchanged.  Even the dollar has given back its gains against nearly all of the major currencies.  Thanks to the UAE central bank’s support for commercial banks and new information on the world’s exposure to Dubai, traders are beginning to realize that this will not necessarily turn into a global contagion.  Yet it is important to realize that the situation is still unfolding and many investors are nervous.  Therefore even though the dollar’s downtrend could resume, until the Dubai story fades from everyone’s minds, there may not be any aggressive desire to sell dollars in the hopes that demand for risk will return.  

Who Has the Greatest Exposure to Dubai?

If the problems in Dubai escalate, money will most likely flow into the lowest yielding currencies which are currently the U.S. dollar and Japanese Yen.  However aside from flight to safety, there is another good reason why the dollar is a good place to hide if Dubai’s woes start impacting the world.  By now, we know that Dubai World’s liabilities are more than 50 percent of the government’s total liabilities.  Based upon the Bank of International Settlement’s cross border claims data, approximately 41 percent of that debt is owed to U.K. banks.  The next biggest creditors are France and Germany and then the U.S. who are owed approximately USD $10-11 billion each.  Canadian, Australian and New Zealand exposure have little to no exposure to Dubai World. This means that if Dubai World defaults on their debt, which we do not expect to happen, U.K. banks would be hit the hardest.  This explains why the British pound has struggled to rally on a day when all of the other high beta currencies have strengthened against the U.S. dollar.  The government has already signaled that they intend to restructure Dubai World which means that they will not guarantee or unconditionally support companies that have weak balance sheets and that the debt affected is approximately $26 billion.  Although this means that the banking sector remains vulnerable to further write downs and losses in the coming months, the risk for the time being appears to be contained.

Did Consumers Come Through on Black Friday?

As retailers turn their focus to Cyber Monday, the Black Friday results are in.  Based upon a report from the National Retail Federation, the number of shoppers increased by 13 percent this year but average spending declined by 7.9 percent.   The results have been far from impressive and if consumers do not come through on Cyber Monday when 87 percent of retailers are expected to have special promotions to attract the estimated 96.5 million Americans who plan to shop, it could be a particularly grim holiday shopping season.  Preliminary figures indicate that sales rose a modest 0.5 percent according to ShopperTrack who surveys the activity of 50,000 retail outlets.  In 2008, many consumers hunted for bargains and traded down and so far, this behavior is occurring again in 2009.  Meanwhile online sales have increased significantly in recent years which increase the significance of Cyber Monday sales.

Manufacturing Conditions Continue to Improve

Risk appetite in the forex market has also benefiting from positive U.S. economic data. Chicago PMI rose to 56.1 from 54.2, the highest level since August 2008. Earlier this month, there was a bit of confusion about how the U.S. manufacturing sector is performing. Conditions deteriorated in the NY region but improved in Philadelphia. We now know that the sector continues to expand in the Chicago and Milwaukee regions which suggest that the national ISM manufacturing index which is due for release tomorrow may have also risen in the month of November. All but one of the underlying components (production) increased, with the employment component of Chicago PMI rising from 38.3 to 41.9.  The weak dollar is contributing to the improvement in the manufacturing sector and another reason why we believe that like the Treasury Secretary, the Federal Reserve is only paying lip service to the U.S.’ strong dollar policy.  Aside from ISM manufacturing, pending home sales and construction spending are also due for release.

EUR/USD: GERMAN RETAIL SALES AND EMPLOYMENT NUMBERS ON TAP

The EUR/USD ended the U.S. trading session marginally above the 1.50 level.  Unlike Asian and U.S. equities, European traders sent stocks lower on the fear that their banking sector would be heavily affected by Dubai’s problems.  However the euro still remained afloat ahead of the European Central Bank’s monetary policy decision this week.  With inflationary pressures intensifying, as seen through the 0.6 percent increase in consumer prices this month, the ECB could start paving the way for an exit strategy.  At this meeting, the ECB is expected to decide what they want to do with the 12 month tender.  If they raise the rate of the tender, it would be perceived as a hawkish move.  Also, if the central bank upgrades its GDP outlook, it should be perceived as bullish for the currency.  However before the rate decision, EUR/USD traders will have to first contend with the German retail sales and unemployment numbers.  Based upon the rise in the retail PMI and the improvement in the employment component of the service and manufacturing PMI reports, we are looking for stronger numbers.  Sentiment in Germany has held up very well which will mean a lot if it translates into more aggressive spending.  

GBP/USD: A DAY OF CONTRADICTION

The pound is weaker across the board as conflicting economic data led to a revived sense of disappointment with the U.K. economy.  The British pound gave back earlier gains against the dollar while EUR/GBP rose to its highest levels in more than four weeks. The one piece of good news released today was relating to housing. The Hometrack Index showed that house prices rose for the fourth consecutive month, while Mortgage Approvals reached their highest level in about eighteen months. Both are continued to indicate that Britain’s beleaguered housing market is starting to come around. However, the rest of the data released today gave an entirely different impression and expectation that rejuvenation in housing will not be able to keep pace. GFK Consumer Confidence was the biggest disappointment, declining for the first time in 10-months. In addition, even more importantly for the housing situation, an underlying component which tracks consumers’ willingness to make major purchases also fell by seven points. Combined with the fact that Net Consumer Credit dropped by the most on record, it appears that individuals are planning to keep debt and spending at a minimum. Such a combination could be problematic for housing, which is obviously driven by spending and borrowing. Another report showed today that even though the Bank of England tops the list of most likely to ease, money supply actually contracted in the month of October. The main event risk for tomorrow will be the Manufacturing Purchasing Manager Index.

AUD/USD: WILL THE RBA RAISE RATES?

This evening, the Reserve Bank of Australia will be faced with a very difficult decision. So far, they have raised interest rates two months in a row and at this point, there is a fifty-fifty chance that the central bank will raise interest rates to 3.75 percent. Although the tone of the minutes from their November meeting suggests that they could take a break from hiking rates, the latest comments from RBA deputy governor Battelino suggests otherwise. The futures market is currently in pricing an 80 percent chance of a rate hike in December. If the Reserve Bank follows through with additional tightening, it should help to resurrect the rally in the Australian dollar because it reflects their conviction towards normalizing monetary policy. A pause on the other hand could trigger a temporary correction in the AUD/USD& nbsp; and the degree of correction will be contingent upon what the RBA says because if they still plan on hiking rates in the first quarter, the dip may be nominal. As long as the economy remains resilient in the face of additional rate hikes and barring fresh concern about Dubai, the Australian dollar should continue to outperform. It is important for traders to look at the big picture and think about the long term trajectory of interest rates because the RBA may simply pause to avoid being labeled the Grinch who stole Christmas. For more on what we think the RBA will do, read our RBA Preview: Will they Risk Spoiling Christmas .  Meanwhile Canada reported GDP and inflation numbers this morning.  According to the reports, the Canadian economy grew 0.4 percent in the third quarter with a similar degree of growth in September. The Q2 data was also revised higher from an annualized rate of -3.4 to -3.2 percent. In other words, Canada, like many other countries around the world came out of recession in the third quarter. The latest industrial product and raw material price figures were mixed with the former falling 0.3 percent and the latter rising 2.5 percent. Relatively low inflation levels and positive growth reflects the improvements in the Canadian economy. However the Canadian dollar has struggled to rise since growth in Q3 fell short of the market's 1.0 percent forecast. There are no additional reports from Canada until Friday, when employment numbers and IVEY PMI are due for release.

USD/JPY: THE FUJII CONUNDRUM

For the fifth trading day in a row, USD/JPY ended the U.S. session in negative territory. However this was not before the currency pair attempted to test the 87 level.  Partly responsible for the yen’s volatility are conflicting comments coming from the newly elected government. The Fujii saga has definitely returned with force after a quiet stint while the yen remained range-bound. A Japanese paper reported overnight that the finance minister had said that he does not plan to intervene in the currency markets. However, Fujii quickly retracted the statements, saying that he was misunderstood and does not rule out the possibility of weakening the yen. The government’s handling of financial matters may start to lose credibility if a firm currency stance is not clearly established. Shirakawa also held a speech today in which he said that the bank is always ready to “act promptly and decisively”. After re-acknowledging the fact that deflation is a reality, the BoJ Governor said that he will do his “utmost to overcome deflation in terms of monetary easing.” Clearly, the timeline for an exit has been pushed back indefinitely thanks to the increasing severity of several complications, namely deflation and the yen. Industrial Production increased for the eight consecutive month by 0.5%, but was way below forecasts for a 2.5% rise. Housing Starts came in better than expected at -27.10%.

EUR/USD: Currency in Play for Next 24 Hours

EUR/USD will be the currency pair in play for the next 24 hours. The first wave of data is set to come in the form of German Retail Sales at 2:00 am ET or 7:00 GMT, German Unemployment at 3:55 am ET or 8:55 GMT, followed by Euro-zone Manufacturing PMI at 4:00 am ET or 9:00 GMT and the Unemployment Rate at 5:00 am ET or 10:00 GMT. The U.S. is set to release the ISM Manufacturing PMI and Pending Home Sales reports at 10:00 am ET or 15:00 GMT.

EUR/USD lost track of earlier gains but still manages to stay above 1.50, barely pushing the pair into the Bollinger band buy zone. In case today’s small gain signals that there is more to come, resistance is very strong at the 1.5143 level, which was the high reached on November 25th. However, on the way down, the strongest level of support is the 20-day moving average at 1.4933, followed by the heavily psychological 1.4800 level. Today’s selloff off of earlier highs, does not give the impression that momentum is mounting for a significant break. However, tomorrow may provide the catalyst needed to propel the pair to new highs.

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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.