U.S. Dollar: Bernanke Derails Pro-Dollar Trade

Last updated 12/7/2009 4:28 PM ET (GMT -5) 5 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• U.S. DOLLAR: BERNANKE DERAILS PRO-DOLLAR TRADE
• EUR/USD: CONVICTION IS BUILDING IN EURO DECLINE
• GBP/USD: UK WEIGHS TAX HIKES VS SPENDING CUTS
• USD/CAD: GOOD DATA SHOULD BOOST BoC OPTIMISM
• AUD/USD: JOB ADVERTISEMENTS CONFIRM STRONG JOB MARKET
• NZD/USD: WEAKENS FOR FOURTH DAY
• USD/JPY: NEW INCENTIVES MAY REVITALIZE THE YEN

EXPECTATIONS FOR UPCOMING FED MEETINGS

U.S. DOLLAR: BERNANKE DERAILS PRO-DOLLAR TRADE

Bernanke largely unraveled the force behind dollar strength, leaving currencies mixed in today’s volatile session. By pointing out the unconvincing strength in the employment market, Bernanke spelled an end to what was shaping up to be another day of strength in the greenback. Among the gainers against the dollar was the yen, rebounding by 1.13%, and the pound and loonie. Even after today’s comments, dollar strength was potent enough to depress the euro, aussie, and kiwi. In other markets, stocks remain uncertain over how to interpret the events of the last few days, closing only one point higher. Commodities have taken a more definitive direction, with oil falling for the fourth straight day and gold seeing the biggest two-day decline in a couple of months.

Bernanke is not convinced

In a speech today, the Fed’s Bernanke candidly spelled out his observations and expectations of the U.S. economy. The bottom line is that Bernanke remains unimpressed by now what seems like a statistical anomaly in last Friday’s Non-Farm Payrolls report. The Chairman of the Fed actually referred to the job market as ‘weak,’ dispelling much of the euphoria that had surrounded the tremendous build-up in NFP. Bernanke reminds us that more evidence is needed before we declare victory in fighting off economic hardship, saying that “we still have some way to go before we can be assured the recovery will be self-sustaining.” This realization will prompt heightened interest on the outcome of Friday’s Retail Sales report. If the latest NFP report is truly indicative of our path to economic recovery, then spending should recover as well. If it does not, clearly there are more substantial complications in the employment market than the NFP was able to quantify. Aside from the jobs front, Bernanke explains that our most likely path will be one of a ‘moderate’ recovery, held back by subdued inflation and tight credit. Nevertheless, we have “moved back from the brink” as “signs of economic recovery have become more widespread.” On monetary policy, Bernanke gave no inclination that he was considering a sharp reversal in his course. He maintains his inclination that rates will remain low for an “extended time”, drawing his lessons from the 1930’s in which policies were tightened too quickly. Still, Bernanke assured that he was giving careful consideration to an exit strategy. All in all, today’s commentary was very telling of where the Fed is headed. Clearly, the course of monetary policy will be kept accommodative because the economy has yet to show maintained evidence of a convincing recovery.

The NFP Changed Things

A closer observation of the effects of last Friday’s Non-Farm Payrolls report is warranted considering that many patterns have completely broken down as a result. With regards to the dollar, we have consistently noticed the fact that, up until last week, good U.S. data meant a rally in risk, not in the dollar. Prior months have shown that signs of improvement on the U.S. front had more implications for the demand for high beta currencies that they did for the greenback. However, this was not the case on Friday. The blow away numbers changed the relationship to mean that strong American data translated into a dollar demand. In addition, there was no V-shaped, knee-jerk reaction this time around, a pattern that we have noticed invariably in price action following the NFP. On 8:30 am EST, on the dot, EUR/USD spiraled into oblivion, as the employment report left no confusion in the mind of traders. We can also observe effects in non-currency markets. For one, equities have held up despite the sharp advance in the dollar. This is counterintuitive since the last six months have been riding on a near inverse relationship between equity rallies and dollar declines. Nevertheless, while stocks did not decline, they did not gain either, remaining very flat over the past couple of days. On the other hand, the decline in gold was fully expected, as investors found a rare opportunity to start unwinding dollar hedges.

EUR/USD: CONVICTION IS BUILDING IN EURO DECLINE

Declines in the euro are intensifying after last week’s spectacular fall. Price action has faced a volatile trading day, seeing earlier losses turn into gains and back into losses. European data was very mixed and offered little indication of where the economy might be heading. Sentix reported that investor confidence rose for the fifth straight month to an eighteen month high. Nevertheless, the index is still negative, posting -5.5 in today’s releases, as Sentix cautions that “there is no reason for euphoria.” The second release from earlier this morning showed that German Factory Orders faced pressure, stemming primarily from a glut in exports. Orders fell to -2.10% from the 0.9% reported last month, while international orders contracted sharply by 3.5%. It is very likely that the effects of a strong currency are to blame. It is has been a long time since we have discussed the risk of credit rating cuts for Euro-zone nations. Unfortunately, the issue has erupted once again in Greece, thanks to their quickly deteriorating fiscal health. S&P noted that the country’s current A- rating has been put on “credit watch with negative implications.” Greece currently has the largest fiscal deficit out of all European Union nations, and if the rating was cut, the ECB might be put under additional pressure to keep extraordinary support available. The main release for tomorrow will be German Industrial Production.

GBP/USD: UK WEIGHS TAX HIKES VS SPENDING CUTS

The pound is experiencing a slight recovery on hopes that the British government, during Wednesday’s Pre-Budget report, will announce significant and viable plans to reduce the country’s record budget deficits. Chiefly among their plans has been a tax on bankers bonuses or, perhaps more controversially, a tax on all banking institutions. However, the government must weigh the public uproar for vengeance against the financial sector versus the possible harm that such taxes might inflict. A tax on banks might hurt a sector that the government has spent feverishly to protect. Furthermore, a tax on bonuses may result in highly paid bankers seeking work elsewhere, causing a significant drain on the competitiveness of Britain’s banks. However, despite the focus on these issues, it has been pledged that only a quarter of the plan will be rooted in new taxes. Instead, the government is planning spending cuts as well as announcing plans for governmental savings. However, the budget will have to tread lightly when it comes to spending cuts because, with a highly contested election coming up, the political fallout could be immense. This leaves the £12 billion in efficiency savings that President Brown said he would be able to extract from the government. It will be interesting to see if budget talks will continue to be pound positive by Wednesday’s conference. No data has been released today, but we are expecting the NIESR GDP Estimate, RICS House Price Balance, and Industrial and Manufacturing Production for tomorrow.

USD/CAD: GOOD DATA SHOULD BOOST BoC OPTIMISM

Lingering effects of dollar strength have kept the aussie and kiwi depressed, despite earlier gains. The loonie, on the other hand, managed to end multi-day declines as the force behind the dollar’s surge has eased. In Canada, Building Permits showed a huge increase, rising to 18.0% versus expectations for only a 1.0% increase. This report strengthens the foundation behind arguments that the Canadian economy is rebounding with grace, especially after last week’s very promising employment report. Permits were driven to the highest in about fourteen months primarily on single-family housing and non-residential building. However, some worry that with Bank of Canada’s Governor Mark Carney assuring that interest rates will not budge until mid-2010, a new housing bubble may start to build momentum. This brings us to the BoC interest rate decision for tomorrow. Mark Carney has unambiguously laid out plans to keep rates low until June 2010. However, judging by the improvement in economic data, Carney may have to adopt a more hawkish stance and lead considerations about exiting from extraordinary monetary measures. Canada will also be releasing Housing Starts for tomorrow. In Australia, ANZ Job Advertisements rose by the most since mid-2007. However, the AIG Construction index fell back into the contractionary range at 47.6. The country will be releasing the Current Account and NAB Business Conditions for tomorrow. New Zealand is set to produce Manufacturing Activity for tonight.

USD/JPY: NEW INCENTIVES MAY REVITALIZE THE YEN

USD/JPY suffers from a strong pullback as traders started to doubt the resiliency of dollar strength. Last week had seen the biggest weekly plunge in the yen in a decade. Therefore, a pullback today does not necessarily indicate the yen is back on track. However, other factors may be falling into place that could stand to keep the yen in its unusually strong territory. It was reported today that the Japanese Tax Commission has chosen to abolish taxes on interest earned on corporate bonds that are purchased by international investors. Such a decision could result in heightened demand for Japanese Corporate bonds. If the estimated effects turn out to be correct, the flow of money into the Japanese economy will be a boosting factor for the yen. No data for the economy has been released today, but more in on the way for tomorrow. We can expect the Current Account, Trade Balance, and Eco Watchers Survey to warrant trader’s attention. The Trade Balance is always an interesting report as it clearly displays the effects the yen is having on trade. Even though the yen has rapidly sold off in the last week, concerns about the currency hurting the economy is still fresh in everyone’s mind.

USD/CAD: Currency in Play for Next 24 Hours

USD/CAD will be the currency pair in play for tomorrow’s trading. On tap is the Bank of Canada’s interest rate decision at 9:00 am ET or 14:00 GMT. Canada is also set to produce their Housing Starts at 8:15 am or 13:15 GMT. In the U.S., we will have the IBD/TIPP report on economic optimism at 10:00 am ET or 15:00 GMT.

The Canadian dollar gained some ground today but price fluctuations have been getting tighter and tighter, leaving the pair in the Bollinger band range trading zone. The psychological 1.0400 has provided the lower bound for the trading range, and should serve to be a strong level of support. Resistance could be established at today’s high at about 1.0650. It will take a big event to propel USD/CAD out of its range, one that may be provided by tomorrow’s interest rate decision.

Comments (5)

spunky

December 07, 2009 at 05:11 PM ET

Thanks Kathy

I made some nice pippage fading that move , but was it really all Helicopter Ben ???????

Vstocks

December 07, 2009 at 08:55 PM ET

Kathy,
Why would international investors be interested in Japanese corporate bond with such low yields?
Thanks.

FXDragon

December 08, 2009 at 02:53 AM ET

What is the yield on jap. corp. bonds on which corp.? Also comparing to uk and us corp. bonds how is it? Anyone knowledgeable about this issue? I think they give good yileds bec. they need money! You dont think they yiled 0.10 right:)
Because i know funds made great money in 2009 with those bonds, 2010 is in question however.

Know any good sites on the web i can find info about those bonds and their buying options?

Thanks,

yen-jan

December 07, 2009 at 10:40 PM ET

Bernanke's speech today was widely interpreted as dovish. However, I think the instant analysis might be off the mark. As I heard it, he left the door open for the FOMC to re-evaluate their economic forecasts at the next meeting, taking into account improvements in incoming data. He was also very clear about the direction of the next move in interest rates, leaving only the timing in doubt, and indicated that unwinding the Fed balance sheet was not necessarily a pre-requisite for raising rates. He also explicitly noted the effect of a weaker $ on commodity prices. His reference to the "extended period" could be interpreted more as a reference to the current policy stance, as articulated at prior FOMC meetings, rather than a commitment to leaving that language unchanged next week. There will no doubt be a lively discussion next week around the committee table, and I don't think he wanted to appear to prejudge the outcome, so he could not really have said much more than he did.

Darell

December 09, 2009 at 12:28 PM ET

I know that the Fed will still leave rates unchange tell the end of the year. The past two weeks have been extraordinary
ones for the markets and underlying
sentiment. It had seemed that the thin
liquidity through the US Thanksgiving holiday
combined with fear born from a potential
credit crisis emanating from the Middle East
would trigger the first serious correction in
risk appetite since the capital markets began
appreciating back in February. In the end, both
conditions would prove temporary; and
traders regained their footing. However, this
period of instability has exposed a deep-
seated incongruity that has developed just
under the surface of the seemingly
impervious bull market for some months: that
risk appetite has far outpaced reasonable
expectations for returns. Ever the balance of
risk and reward, the markets have backed up
to the brink of a true shift in underlying
sentiment; but there is still a critical final step
that must be taken to validate the turning of
the tides. And, this change can come through
fundamentals or through market flows
themselves. In the nine-month buildup in
capital markets to this point; the outlook has
improved modestly. In accounting for the
scenario for a potential financial collapse (a
genuine fear last year) to a return to a stable
foundation for pricing and capital flow; there
can certainly be a significant adjustment in
pricing. Yet, the bullish interest that has
developed since the beginning of the year
goes well beyond a ‘correction.’ It is not
difficult to interpret 60 percent-plus advance
in equities, record highs for gold and sixteen
month lows for the US dollar as being
excessive. Considering a buildup in risk
appetite (or positioning that has supported it)
was responsible for such extremes, it stands
to reason that the market itself will regulate
positioning.

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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.