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Forex: Where Do Central Banks Stand?

Last updated 1/18/2010 4:34 PM ET (GMT -5) 4 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• FOREX: WHERE DO CENTRAL BANKS STAND?
• EUR: NO DATA, BUT COMMENTS FROM ECB
• EUR/GBP HITS 4 MONTH LOW
• CAD: BANK OF CANADA MEETING ON TAP
• AUD: INFLATIONA INCREASES
• NZD: HOUSING DATA DISAPPOINTS
• JPY: BOJ TO KEEP MONETARY POLICY EASY

EXPECTATIONS FOR UPCOMING FED MEETINGS

FOREX: WHERE DO CENTRAL BANKS STAND?

It has been an extremely quiet day in the foreign exchange markets and in the words of my colleague Boris Schlossberg, it feels like a Sunday.  Even though U.S. markets were the only ones closed for trading today, the absence of U.S. traders and U.S. equities as a guide for the dollar was certainly felt across the globe. The lack of economic data from Europe also contributed to the lack of volatility in the forex market. The U.S. dollar weakened modestly against all of the major currencies but the trading range in the EUR/USD was limited to 70 pips and the range in USD/JPY was limited to approximately 50 pips.  With the dollar ending the NY trading session near its low, there is a good chance that the sell-off in the greenback could gain traction on Tuesday. The only pieces of U.S. economic data due for release tomorrow are the Treasury International Capital flow report and NAHB housing market index. As usual, it would be interesting to see if dollar weakness prompted foreign investors to reduce their exposure to dollar denominated assets. The greenback hit a year to date low in November and did not strengthen until the last month of the year. 

On quiet trading days such as today, we love to explore topics beyond the day to day fluctuations in the forex market. A topic that is extremely relevant to the outlook for the major currencies is how central banks compare in their degree of dovishness and hawkishness.  Of the 8 major central banks, the most hawkish is undoubtedly the Reserve of Australia who raised interest rates 3 times in a row last year and is slated to raise them again in February. In fact, we could see another 75bp of tightening from the RBA when all is said and done. The Reserve Bank of New Zealand is next in line to raise interest rates. They have been riding on the coat tails of the Australian economy and have been open raising rates in the first half of the year. Next in line are the Bank of Canada and the ECB. The BoC previously indicated that they plan on raising rates this year, but most likely not until June at the earliest. The ECB has recently toned down their degree of hawkishness amidst problems in their member nations but they are still more likely to raise rates before the Fed. The market is divided on how much tightening the U.S. central bank will deliver before the end of the year. Based upon Fed Fund Futures, there is only a 43.8 percent probability that U.S. rates will be at or above 0.75 percent by November. Depending upon how the U.K. economy performs this year, there is scope for a small degree of tightening towards the end of 2010. The Swiss National Bank and the Bank of Japan on the other hand are expected to remain on hold throughout 2010.  Interest rates are the number one driver of currency fluctuations which means that the willingness of a central bank to raise rates compared to their peers will determine how their currency trades. 

EUR: NO DATA, BUT COMMENTS FROM ECB

Although the euro ended the day virtually unchanged against the U.S. dollar, having traded as low as 1.4333, today’s price action reflects strength and not weakness. There was no major Eurozone economic data released today but positive comments from European Central Bank member Nowotny helped to keep the EUR/USD supported. According to Nowotny, there is no chance of a double dip recession in Europe, the ECB still has a lot instruments to provide cash if necessary, a stronger euro does not pose a threat to the recovery so there is no need for currency intervention. ECB member Bini Smaghi on the other hand was a bit more subdued. Although he acknowledged the improvements in the economy, he also said growth remains sluggish and the recovery relied largely on temporary factors. Looking ahead, domestic demand will be needed to help sustain the unfolding recovery but uncertain job prospects could damp consumption. The German ZEW survey is due for release tomorrow and given the improvement in trade and industrial production, investor sentiment may have increased. Meanwhile, EUR/CHF remains very weak despite more comments from Swiss National Bank President Hildebrand. In a newspaper interview this weekend, the SNB head said the central bank will prevent “excessive” franc strength but at this point foreign exchange traders are not swayed by words – they need to see action. 

EUR/GBP HITS 4 MONTH LOW

After a brief pause on Friday, the British pound extended its gains against the U.S. dollar.  Stronger housing market numbers helped to lift the GBP/USD on what was an otherwise quiet trading day. According to property site rightmove.co.uk, the average price of a home sold increased 0.4 percent in January. In London, prices increased 2.3 percent, which indicates that despite the troubles in the overall economy and the prospect of higher taxes, the housing market remains steady. U.K consumer prices are due for release tomorrow and given the sharp increase in producer prices as well as the BRC shop price index, prices on the consumer level are expected to have increased in the month of December. This is a big week for the U.K. with a number of market moving economic releases on the calendar. The recent price action of sterling suggests that traders are looking for a string of positive reports. The pound strengthened against the euro for the fifth consecutive trading day, taking EUR/GBP below 0.8840 to four month low. Given the technical formation and the break of a significant support level, EUR/GBP could be headed lower. 

CAD: BANK OF CANADA MEETING ON TAP

The weakness of the U.S. dollar pushed the Canadian, Australian and New Zealand dollars higher despite mixed economic data. Foreign demand for Canadian dollar denominated securities surged in the month of November but house prices and sales in New Zealand decreased last month. In Australia, inflationary pressures escalated, paving the way for another interest rate hike from the Reserve Bank next month. Speaking of rate hikes, the Bank of Canada has a monetary policy announcement tomorrow. No surprises are expected in terms of interest rates since the central bank pledged last month to leave rates unchanged at 0.25 percent through June. However the BoC could grow more cautious which could halt the rally in the Canadian dollar. Since the last monetary policy meeting, economic data has taken a turn for the worse. Employment unexpectedly fell by 2,600 in December, retail sales grew at a slower pace, the country's trade surplus turned into a deficit according to the latest figures, new motor vehicle sales plunged and manufacturing activity contracted for the first time since April. Yet most importantly, the Canadian government is growing concerned about the weakness of the U.S. dollar and the strength of the loonie. The BoC previously indicated that the main risks for the Canadian economy is "persistent strength in the Canadian dollar that could act as a significant further drag on growth and put additional downward pressure on inflation." Unfortunately USD/CAD has fallen 400 pips since the last monetary policy meeting and we are already seeing the negative impact that the strengthening currency is having on the economy. Deteriorating economic data and a stronger CAD could make the BoC less hawkish. The continuation in the downtrend of USD/CAD rests in the hands of the BoC.

JPY: BOJ TO KEEP MONETARY POLICY EASY

The Japanese Yen ended the day unchanged against the U.S. dollar but sold off against all of the other major currencies. Weaker economic data and dovish comments from the Bank of Japan are to blame with BoJ Governor Shirakawa pledging to maintain easy monetary conditions to help pull Japan out of deflation and return to sustainable growth with price stability. Although the Japanese economy is improving, domestic demand remains weak and therefore the pace of recovery is expected to be modest. Japan has been grappling with deflationary conditions for some time and until companies start to pass their profits to their employees and consumers start to spend, it may be difficult to reverse this vicious cycle. Finance Minister Kan agreed with Shirakawa that beating deflation and ensuring an economic recovery is the government’s top priority. Meanwhile industrial production in November was revised down from 2.6 to 2.2 percent. This means that on an annualized basis, IP fell by 4.2 percent compared to 3.9 percent. The only piece of Japanese economic data due for release this evening is Tokyo Condominium Sales. 

USD/CAD: Currency in Play for Next 24 Hours

USD/CAD will be the currency pair in play tomorrow.  Canadian leading indicators are due for release at 8:30am ET or 13:30 GMT followed by the Bank of Canada interest rate decision at 9:00am ET or 14:00 GMT. The U.S. will also be releasing its Treasury International Capital flow report at 9:00am ET or 14:00 GMT.

USD/CAD is currently trading in the Sell Zone, which we determine using Bollinger Bands. Since the beginning of this month, the currency pair has been in a very strong downtrend and remains weak going into tomorrow’s Bank of Canada monetary policy meeting. On a technical basis, USD/CAD appears poised for a test of its 2009 low at 1.0205 followed by a move down to parity, but any cautionary comments from the BoC could erase the downtrend in USD/CAD. A move above 1.0315, which is not far from current levels would take the currency pair out of the Sell Zone and a move above 1.0450 would completely negate the downtrend in the currency pair. 

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Comments (4)

alexjbrandt

January 19, 2010 at 06:41 AM ET

Another reason to not have a US based FCM:

CFTC wants to limit leverage to 10:1 on OTC Forex Retail Trading:

http://www.cftc.gov/newsroom/generalpressreleases/2010/pr5772-10.html

BW

January 19, 2010 at 08:41 AM ET

On a scale of 1 to 10 how serious should we take these comments about leverage dropping to 10 to 1. And as far as risk disclosure. I have seen many disclosures for all retail brokers. Even every book on trading has some sort of risk disclosure. The funny thing is that I have been in forex for 9 months and have done well. I got into forex because my "real" business has slowed to a snail's crawl because of obvious reasons. 10 to 1 leverage would be just my luck. lol. Actually not that funny.
Happy trading people.

alexjbrandt

January 19, 2010 at 09:27 AM ET

I've only been trading for a year on the forex, and it initially appealed to me cause I could make more money with a small deposit (about $1k) in a shorter time frame compared to stocks. Where you need a good amount of capital to get any meaningful return. As for the proposed new regulation passing, not certain it would. It would depend on how much the US based FCM's object to it due to the increased probability of loss of business. US traders with $100k+ trading accounts wouldn't be as affected if the max leverage was lowered, but it'd be the people who have anything less in their account who would be affected. I myself do not trade through a US based FCM for multiple reasons, and this new possible regulation is just another reason. As for risk disclosure, they are everywhere nothing new.

FXDragon

January 19, 2010 at 09:50 AM ET

What are the reasons you dont trade through a us company? Tax purposes?

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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.