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THE STORIES IN THE CURRENCY MARKET

• U.S. DOLLAR: FUNDAMENTALS VS. RISK
• EUR/USD: EURO SHEDS EARLY LOSSES ON PMI
• GBP/USD: NO SURPRISES EXPECTED FROM BOE
• USD/CAD: CLOSING IN ON 18 MONTH HIGH
• AUD/USD: BUILDING PERMITS OVERSHADOW SLUMPING SERVICES
• NZD/USD: TRADE DEFICIT SHRINKS
• USD/JPY: FUJII OUT, KAN IN

EXPECTATIONS FOR UPCOMING FED MEETINGS

CURRENT US INTEREST RATE: 0.25%
	01/27 Meeting	03/16 Meeting
NO CHANGE	58.0%	62.6%
CUT TO 0BP	42.0%	37.4%
INCREASE TO 50BP	0.0%	0.0%
INCREASE TO 75BP	0.0%	0.0%

U.S. DOLLAR: FUNDAMENTALS VS. RISK

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On a day when bond yields increased, U.S. stocks ended mildly positive and the dollar strengthened against the Japanese Yen, the greenback’s weakness against other major currencies reflects the positive risk appetite in the financial markets.  For example, the Australian dollar’s ability to climb to the highest level against the buck in more than a month indicates that demand for high yielding currencies remain strong.  Considering the possibility of job growth returning, the optimism in the markets may not be misplaced.  Based upon the leading indicators for non-farm payrolls released this morning, all signs point to an improvement in the labor market.  After 23 consecutive months of job losses, positive job growth would be breath of fresh air for all.  However for currency traders, Friday’s non-farm payrolls report will be the test of whether the dollar will be driven by fundamentals or risk appetite.  Given the reaction to the previous NFP release, we believe that it will be the former rather than the latter.  

Fed Divided on Withdrawing Stimulus

In the meantime, the minutes from the December FOMC meeting reveals division and disagreements within the Fed about when to remove stimulus.  One member of the FOMC expects the Fed’s asset purchase program to be completed by the end of the first quarter but some of the other officials argued about the benefits of expanding the scale and extending the length of the purchases.  Their big concern is the economy’s ability to grow without government support.  Policy makers predicted moderate growth in 2010 along with a slow rise in output and employment. Although the asset purchase program remained unchanged, the cautiously optimistic tone of the minutes suggests that the Federal Reserve is in no rush to raise interest rates.  In fact, PIMCO bond fund manager Bill Gross predicts that the Fed will not raise interest rates this year.   Today’s price action in the currency and bond markets indicates that this sentiment is not shared by traders and investors who are still holding out the hope that continued improvements in the labor market will push the Fed to act sooner.  

Counting Down to Non-Farm Payrolls

As far as the leading indicators for NFP goes, according to the Challenger Report, there was a marginal decrease in layoffs in December, a smaller decline in private sector payrolls and an increase in the employment component of service sector ISM. Although the ADP release has been a poor predictor of non-farm payrolls on an absolute basis, it is fairly accurate directionally. The employment component of service sector ISM rose from 41.6 to 44.0 indicating that job losses are moderating. Although the index is still in contractionary territory, since the start of the ISM report, there have been 4 months where NFPs printed positive even though the employment component of service sector ISM was below 50.The ISM non-manufacturing index rose from 48.7 to 50.1, putting service sector activity back into expansionary territory. The increase was less than the market had anticipated, but the negative impact on the dollar was limited as traders were relieved by the expansion in the service sector and the increase in the employment component of the ISM report. However looking beyond payrolls, it is important to realize that the details of the ISM reveal pockets of weakness. For example, the new orders and export orders components decreased along with inventory sentiment which suggests that the pace of improvement in the U.S. economy could be slowing. Meanwhile Jobless claims are the only U.S. economic reports due for release tomorrow.

EUR/USD: EURO SHEDS EARLY LOSSES ON PMI

The euro is higher on the day but still struggling to gain ground. The day started off on a rocky footing when ECB member Stark said the markets “are deluding themselves” if they think that European nations will come together to bail-out Greece. The situation in Greece is not essential to viability of the EU system. If Greece should default, many expect that a domino effect could cause the union to implode but the comments from Stark indicate that ECB officials are not worried.  Signs that Greece will receive no assistance to in alleviating their debt load hurt the euro even after the country countered by saying that they had no intentions on asking for a bail-out in the first place.  However the euro managed to recover thanks to stronger economic data.  Eurozone service sector PMI was revised up from 53.7 to 54.2, the highest level in 2 years. Germany reported that their Services sector strengthened as well with the index rising from 51.4 to 52.7. Yet there was bad news as well.  Service sector activity was revised down in France, Producer Prices declined for the eleventh straight month on an annualized basis while Industrial New Orders posted their biggest fall in twelve months.  The drop in orders would be more significant if not for the fact that the data is from October.  Tomorrow, the European economic calendar is particularly heavy, helping to balance out the lack of U.S. economic reports.  German retail sales, Eurozone retail sales, confidence and German factory orders are due for release.  Given the rise in the German retail PMI index, we expect stronger consumer spending in November.  

GBP/USD: NO SURPRISES EXPECTED FROM BOE

The Bank of England will be the first G10 central bank to make a monetary policy announcement this year but unfortunately for those traders seeking some action, we do anticipate any material announcements on Thursday.  Last month, the Monetary Policy Committee left the size of their Quantitative Program unchanged, saying that not much has changed since the previous meeting.  Given the lack of economic data over the holiday, the central bank will most likely wait until next month before making any major announcements.  Not only have BoE officials hinted that February is the month to watch but the MPC has usually delivered its major decisions in the month that the Quarterly Inflation Report is released.  Based upon the latest PMI reports, the U.K. economy appears to be recovering which limits the chance of additional stimulus.  Service sector PMI rose from 56.6 to 56.8 in December, helping to lift the British pound against the U.S. dollar.  However despite the strength against the buck, sterling sold off against the euro following the bigger surprise in Eurozone data.  

USD/CAD: CLOSING IN ON 18 MONTH HIGH

All commodity currencies strengthened today, as the rallies in gold and oil add to the effects of a renewed wave of risk tolerance. The loonie is continuing its ascent, coming within striking distance of an 18-month high.  Although the Canadian dollar has strengthened for five trading days in a row, the longest stretch of gains were in the Australian dollar which has either remained flat or edged higher for the past 11 eleven trading days. This strength drove the aussie a new 2-year high against the euro. Much of today’s strength has stemmed from the release of Building Approvals which blew away all expectations. On a monthly basis, approvals grew by 5.9 percent versus the revised loss of 1.8 percent last month.  In coming months however, the housing market faces many obstacles.  First, there is a reduction in first-time home buyer grants given out by the government and second, higher interest rates will start to curb demand. Furthermore, keeping in mind that Australian lenders have raised their rates quicker than the RBA, it may be even harder for consumers to justify home purchases. On a down note, the country released their Performance of Services index which showed that the growth in the industry has started to slow. The index is just barely hanging on to expansionary territory at 50.0 after suffering its second straight decline. The Trade Balance and Retail sales are due for release this evening along from Australia along with the Canadian IVEY PMI report tomorrow.  The New Zealand trade deficit shrank in November as exports increase and imports decreased.  

USD/JPY: FUJII OUT, KAN IN

The Japanese Yen weakened across the board, stemming a 2 day decline in USD/JPY.  The currency’s weakness was particularly significant against currencies like the aussie which is closing in on its highest levels since September 2008.   No economic data was reported today but after coping with various health related problems, Japanese Finance Minister Hirohia Fujii submitted his resignation. Fujii was a vital component in outlining the new administration’s financial goals, budgets, and especially their foreign exchange intervention policies. Furthermore, the resignation serves as a hit to the Democratic Party of Japan because Fujii was one of the most experienced members of their staff. Yukio Hatoyama, the Japanese Prime Minister, appointed Naoto Kan to fill the post. Mr. Kan may signal a shift in intervention policies, saying last month that “I am advocating a weak yen to a certain extent.” In addition, Kan has been a proponent of increased spending, which will undoubtedly be a hot topic going forward. The calendar has been mostly empty of economic data, with no relief coming until Friday.

EUR/GBP: Currency in Play for Next 24 Hours

EUR/GBP will be the currency pair in play for tomorrow. The Euro-Zone is set to release German Retail Sales at 2:00 AM ET or 7:00 GMT followed by Eurozone Economic and Consumer Confidence at 5:00 am ET or 10:00 GMT. The big event of the day will follow with the Bank of England’s Rate Decision at 7:00 am ET or 5:00 GMT.

EUR/GBP has rallied for the third straight day, but still manages to be contained within the Bollinger band range trading zone. Resistance is strongest at the December 30th high of 0.9054. This level was also influential in keeping prices depressed on November 3rd and 12th. However in order for the currency to press higher, it must first break the upper one standard-deviation band at 0.9020. Support is at 0.8850, where the 200-day moving average is as well as the low from December 31st.  EUR/GBP is still trading largely within a contractionary range, meaning it may need a surprise tomorrow to make a convincing break.

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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.