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U.S. Dollar: Curb Your Optimism

Last updated 1/15/2010 5:05 PM ET (GMT -5) 2 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• U.S. DOLLAR: CURB YOUR OPTIMISM
• EUR: SUCCUMBS TO POLITICAL UNCERTAINTY
• GBP: BIG WEEK AHEAD
• CAD: VERBAL INTERVENTION HEATS UP
• AUD: GOLD PRICES DOWN
• NZD: OIL PRICES DOWN
• JPY: BOJ EXPECTS GROWTH TO SLOW

EXPECTATIONS FOR UPCOMING FED MEETINGS

U.S. DOLLAR: CURB YOUR OPTIMISM

It has been quite a while since we have seen a sea of red in the forex markets, with nearly all of the major currency pairs ending the day in negative territory. The dollar strengthened against everything except for the Japanese Yen which only confirms that risk aversion is driving the flows in the forex market today. Unfortunately this means that the rally in the buck is a reflection of weakness and not strength. After a week of mostly negative U.S. economic reports, traders have found themselves overly bullish and are now compensating by taking profits on some of their positions. Even strong earnings from Intel last night or JPMorgan this morning failed to sustain risk appetite. Whether this sell-off in equities and rally in the dollar can be sustained remains to be seen but traders won’t find many answers in next week’s economic reports. The U.S. calendar is light with only the Treasury International Capital flow report, Producer Prices, Housing Starts, Philadelphia Fed and Leading Indicator reports due for release.

Curb Your Optimism

Up until last week when we saw the horrid December labor market numbers, most market participants were banking on a stronger U.S. recovery. However now traders have been forced to curb their optimism as the recent trend of economic data could prompt the Federal Reserve to grow more dovish and not hawkish. The U.S. central bank's monetary policy meeting is in 2 weeks. Between now and then the focus of the foreign exchange will be on the possible tone that the Fed adopts on January 27th.  The University of Michigan sentiment survey rose from 72.5 to 72.8 in the month of January which suggests that even though consumer confidence increased, the improvement was modest. This is a bit of concern considering that spending was weak last month. If consumers only grew only a tad more optimistic, then their spending habits may not have changed. Meanwhile industrial production grew by 0.6 percent in Dec, which was the same pace as the previous month after the downward revision to the November report. However capacity utilization increased which means that manufacturers have become more productive. The one piece of overwhelmingly positive data was the Empire State manufacturing survey which jumped from 4.50 to 15.92. Consumer prices also grew at a slower pace and the details of the report confirm that discounts led to weak consumer spending last month. Prices for personal computers for example fell 0.2 percent, leaving CPI growth at 0.1 percent for December. On an annualized basis, consumer prices rose from 1.8 to 2.7 percent but the bulk of that increase was due to energy prices.

Forex Traders Increase Short Dollar Positions

According to the latest commitment of traders report from the CFTC, forex traders have increased their short dollar positions in the futures markets. This report reflects position adjustments following last week’s disappointing non-farm payrolls report. The weak number prompted speculators to cut back on their long dollar positions as they grow more worried about the U.S. recovery. A closer look at the data reveals that long AUD/USD and short USD/CAD positions reached the highest level since June 2008.  This suggests that at least in the near term, the upside potential in AUD and CAD could be limited barring any extremely dollar bearish or AUD bullish news. Futures traders trimmed their net short EUR/USD and long USD/JPY positions but increased their short GBP/USD positions. Since there are still many traders net short the EUR/USD, the downside risk in the currency pair could also be limited. 

EUR: SUCCUMBS TO POLITICAL UNCERTAINTY

There are three reasons why the EUR/USD weakened dramatically today, breaking its recent uptrend. The euro primarily sold off on fears that German Chancellor Angela Merkel plans to resign amidst low approval ratings. Although she dismissed the idea as “absurd,” the damage on the euro was already done. We have learned a long time ago that political uncertainty is never good for a currency especially if it involves the head of state. At the same time, concerns about Greece’s fiscal problems have escalated after the cost of insuring against a Greek default hit a record high. This basically means that investors are demanding a greater premium to hold Greek debt. In response, European Union head Junker echoed ECB President Trichet’s comments by saying that Greece will not default on their debt or abandon the euro. Finally, weaker economic data also weighed on the euro. Even though Eurozone consumer prices increased modestly, the region’s trade surplus fell from EUR 6.6 billion to EUR 4.8 billion. Although the strength of the euro did not hurt trade in Germany, it negatively affected exports in Ireland, Greece and Spain. In the week ahead, there are a number of potentially market moving Eurozone economic releases including the German ZEW survey, the advance PMI releases and German producer prices.

GBP: BIG WEEK AHEAD

After strengthening against the U.S. dollar for six trading days in a row, the rally in the British pound has finally been halted. Yet the pound extended its gains against the euro for the fourth consecutive trading day. Unlike the U.S. economy and the U.S. dollar which fell victim to over-optimism, the British pound benefitted from too much pessimism.  Although not much economic data was released this week, the few reports that came out beat expectations. More specifically, the trade deficit shrank in the month of November, the BRC retail sales monitor increased significantly and industrial production accelerated. These reports suggests that the U.K. economy may not be doing as poorly as everyone had previously thought and may even be out of recession as of January. Next week, the most market moving economic releases are due from the U.K. This includes consumer prices, their labor market report, the minutes from the most recent monetary policy meeting, retail sales and public finances. There is a good chance that most of the reports will the positive for the GBP, helping to extend the recent gains in the currency pair. 

CAD: VERBAL INTERVENTION HEATS UP

All commodity currencies have fallen off in today’s session, with the loonie losing track of its 3-month high against the dollar. The combination of renewed risk aversion, driven by uncertainties in Europe, and declines in gold and oil has given the currencies little hope of continuing their winning streak. Even though these factors already provided a weakening force for the Canadian dollar, it was really comments from Finance Minister Jim Flaherty that offered the final blow. Flaherty subtly hinted at his disdain over dollar weakness, mentioning that “its plain to everyone that there’s downward pressure on the US currency.” He notes that his concerns run high anytime fluctuations in the greenback are abnormally volatile. It has been a while since we have heard comments like these coming from Canada, but with the currency approaching new lows, it was only a matter of time. Canada’s economic data was mixed with New Motor Vehicle Sales plunging 6.0% and Existing Home Sales rising to record highs. Next week’s schedule will be highlighted by Tuesday’s Bank of Canada rate decision. We can be sure that everyone is looking for more comments trying to talk down the loonie. In addition, we will see Consumer Prices on Wednesday and Retail Sales on Friday. Data from New Zealand and Australia have been light on the day. However, more is in store for next week with Tuesday’s New Zealand Consumer Price Index and Australia’s Westpac Consumer Confidence Index, followed by New Zealand Retail Sales on Wednesday.

JPY: BOJ EXPECTS GROWTH TO SLOW

The Yen was the only major currency that did not decline against the greenback, on a day of otherwise accelerated dollar strength. Today’s glut in economic data was offset by a new wave of central bank commentary. The Bank of Japan’s Kazuo Momma mentioned that the “pace of economic growth may slow temporarily because of decreasing public works spending.” These are grim comments from the central bank and indicate that they see the potential for the dreaded double-dip recession. Finance Minister Kan toned down his stance on the yen once again, saying that only under the exception where currencies are “extremely volatile” should the markets not govern exchange rates. This is Kan’s second revision to statements made upon his appointment in which he explained his preference for the yen to be a bit weaker. He also expressed his opinion that there are more measures that can be taken to fight deflation, signaling the governments hope that the BoJ takes easy money policies another step further. Next week’s data will come in the form of Industrial Production on Monday, Consumer Confidence, the Tertiary Industry Index on Tuesday, and the All Industry Index on Friday.

CAD/JPY: Currency in Play for Next 24 Hours

CAD/JPY will be the currency pair in play for Monday. Japan is set to release Industrial Production and Capacity Utilization at 11:30 pm ET Sunday night or 4:30 GMT Monday morning. On tap for Canada will be International Securities Transactions at 8:30 am ET or 13:30 GMT.

CAD/JPY remains hesitant to break back into the Bollinger band buy zone, as prices pullback after a two-day rally. In case losses extend further, support is in place at the January 12 ^th low of 87.26. However, if prices reverse, the January 7 ^th high of 90.61 remains the strongest level of resistance. Nevertheless, CAD/JPY& #8217;s inability to pull forward raises questions as to whether a deeper retracement will be required before a new leg higher can be maintained. This condition will be confirmed if the 87.26 support is broken.

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Comments (2)

bertobull

January 16, 2010 at 12:59 PM ET

Hi Kathy, great analysis as usual. I agree that when the Yen can hold its ground against a rising dollar, then risk aversion is at play. One thing I would like you to clarify for me is this: As China revalues their Yuan up, I've read elsewhere that the Yen will be likely to appreciate with it. I'm not clear on why this would happen. Can you explain? Thanks.

Pink Elephant

January 16, 2010 at 04:11 PM ET

I think dollar will go towards 1.42 due to some problems in the countries of Eurozone, especially Greece.

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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.