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Will Dollar Extend Gains Post FOMC?

Last updated 1/27/2010 4:56 PM ET (GMT -5) 3 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• WILL DOLLAR EXTEND GAINS POST FOMC?
• EUR/USD COULD BREAK 1.40 AGAIN
• GBP/USD: LIFTED BY BOE COMMENTS
• NZD/USD: TIMETABLE INTACT FOR MID-YEAR HIKE
• AUD/USD: CONSUMER PRICES RISE MORE THAN EXPECTED
• USD/CAD: GOLD AND OIL PRICES FALL
• USD/JPY: EXPORTS ARE GROWING AGAIN

EXPECTATIONS FOR UPCOMING FED MEETINGS

WILL DOLLAR EXTEND GAINS POST FOMC?

The U.S. dollar climbed to a six month high against the euro following the Federal Reserve’s monetary policy announcement.  Dollar bulls have reacted very positively to the Federal Reserve’s optimistic tone. Going into the meeting, everyone had feared that the Fed would grow more pessimistic in reaction to the latest economic reports but instead of doing so or opting to leave the statement unchanged, they decided to let the market know that they believe “economic activity has continued to strengthen.” As a result, the dollar ended the day higher against nearly every major currency.  With the EUR/USD flirting with the 1.40 level, traders are now wondering whether the dollar will continue to rise.  In the short term, we think this is very possible considering that the dollar has either broken or is at the cusp of breaking important resistance levels.  Investors will also be inclined to “believe” the Fed but if economic data remains weak, the central bank’s credibility will come into question.

New Home Sales Disappoints

This morning, new home sales suffered the same fate as sales of previously owned homes.  The recovery in the housing market appears to be losing steam as the new home sales plunge 7.6 percent, far worse than the market’s expectations.  December’s decline in sales marks the weakest annual pace since last March. However, while conditions appear to be deteriorating, all hope is not lost and perhaps this is what the Federal Reserve is banking on. There were a few extraordinary items late last year that had significant impact on sales. The first has to do with the fact that consumers thought the $8,000 tax-credit offered to new buyers was set to end in late November. This resulted in a wave of buying before the deadline hit. However, by the time the program was extended, most serious buyers had already been flushed out of the market, bringing sales for December way below expectations. In addition, the final month of 2009 saw some of the coldest December temperatures on record, making it even more difficult for realtors to draw interest. However, combined with a record decline in Monday’s report on Existing Home Sales, this week’s economic data has added another degree of uncertainty to markets and cannot be ignored. Home sales may have taken a turn for the worse, but the numbers in coming months will offer a more accurate estimate of where the market is headed.   Durable goods and jobless claims are due for release tomorrow but over the next few hours, the State of the Union address will be the most anticipated event risk for the forex markets.  

Fed Grows More Upbeat, Ignores Recent Disappointments

Meanwhile the Fed managed to steal the limelight from Apple who was in the process of introducing its latest creation when the central bank released their monetary policy statement.  To the surprise of foreign exchange traders, the dollar skyrocketed as the Fed completely ignored the recent deterioration in the labor market and the decline in consumer spending.  Instead, the tone of FOMC statement was more upbeat than their tone back in December with the central bank saying that “economic activity has continued to strengthen.”  Adding to the bullishness of the statement was Fed President Hoenig’s dissenting vote.   The head of the Kansas City Federal Reserve believes that the improvement in the economy and the stabilization of financial conditions, no longer warrants “exceptionally low levels of the federal funds rate for an extended period.”  When you have one FOMC member voting in favor of more hawkish language in the monetary policy statement, additional members are likely to follow suit.  In fact, more members may even have sided with Hoenig if not for wanting to appear on the side Bernanke to smooth his nomination.  Not only did the Federal Reserve avoid acknowledging the recent deterioration in the labor market and retail sales reports, but they also completely took out their comment on the housing market.  As we have seen from this week’s data, the best days of the housing market could be over and instead of acknowledging or downplaying that information the central bank simply chose not to address it.  The Fed’s belief that the pace of recovery “is likely to moderate,” is an upgrade from their previous comment that it is “likely to remain weak.” Although the Fed is at risk of being blindly optimistic, the benefits far outweigh the costs particularly ahead of Bernanke’s nomination.

EUR/USD COULD BREAK 1.40 AGAIN

The euro broke the 1.40 level on an intraday basis and even though it ended the NY trading session above this psychological price point, its proximity to that level suggests that another break below 1.40 is possible.  Inflationary pressures in Germany remain muted with consumer prices falling 0.5 percent in the month of January.  Inflation is a big deal to the European Central Bank and until price pressures accelerate, they will probably be very relaxed. Conflicting comments from European officials have also kept the EUR/USD within a very tight range.  Axel Weber who is one of the more hawkish members of the central bank said they could take further steps to withdraw liquidity from the system in the first quarter and that the overnight rate should gradually climb towards the repo rate. He also believes that there are upside risks to the ECB’s forecasts which suggest that he favors an earlier removal of monetary stimulus.  Meanwhile Eurogroup Chairman Junker noted that the USD is undervalued and the EUR is overvalued which suggests that his constituents may be comfortable with a rise in the euro.  However we are not sure what the basis of his statement is because based upon purchasing power parity, the EUR/USD is still overvalued by close to 19 percent.  German employment numbers are due for release tomorrow along with Eurozone business and consumer confidence. Job losses in Germany are expected to accelerate despite the recent improvements in economic data.  

GBP/USD: LIFTED BY BOE COMMENTS

The British pound was the only major currency that managed to end the day higher against the U.S. dollar. The currency extended its gains against the euro and the greenback following hawkish comments from Bank of England member Sentance who basically said that the country cannot rely on lower prices on goods to hold back overall inflation, especially as the weak pound pushes other prices higher. This suggests that he supports raising interest rates even if CPI numbers are weak.  Sentence was also optimistic about the outlook for the U.K. economy and said the housing market could see a stronger recovery if bank pressures ease.  The key is the labor market which will be very important in assessing the pace of recovery and according to Sentence, the slack in the labor market may be less than the 80s and 90s.  These comments curtailed the British pound’s reaction to the extremely weak CBI Retail Sales number.  The index fell by the largest amount since August 2009 which suggests that U.K. consumers cut back spending after the holiday shopping season.   There is a very good chance that this weakness will feed into the retail sales report and therefore we remain skeptical of the rally in the GBP/USD and believe that the odds are skewed towards a move down to 1.60.

NZD/USD: TIMETABLE INTACT FOR MID-YEAR HIKE

Commodity currencies are getting no relief as of late, with the loonie, aussie, and kiwi each falling for six out of the last seven trading days. Declining commodity prices have made matters worse, with crude sinking more than 1.4 percent and gold losing 0.9 percent. There were no surprises at the Reserve Bank of New Zealand’s decision as rates remain firmly at 2.5 percent. RBNZ Governor Bollard noted that the economy is in-line with his previous expectations, meaning that the timetable is still set for mid-2010 for the removal of some policy stimulus. Bollard optimistically said that the economy was improving thanks to strong export earnings, stronger consumer spending and higher commodity prices but sustained growth with trade partners are not assured and business spending remains weak. The market’s reaction to RBNZ meetings should be relatively subdued until mid-year when speculation is sure to magnify for a potential hike. The country will be releasing M3 Money Supply tomorrow. In Australia, Consumer Prices came in slightly hotter than expectations, with annualized inflation reaching 2.1 percent. However, even though probabilities for an RBA hike surged as a result, the decision is far from a sure thing. There are still issues such as banks raising rates quicker than the RBA and uncertainties surrounding China that may curtail further tightening efforts. Westpac Leading Indicators showed a strong performance, rising at the fastest rate in about two years. The CB Leading Index should confirm today’s news when it is released tomorrow.

USD/JPY: EXPORTS ARE GROWING AGAIN

USD/JPY managed to reverse course to stage a small rally after reaching a new monthly low in early trading. The big news for Japan was that trade improved at a faster rate than predicted in the month of December. The overall Trade Balance came in at ¥545.3 from last month’s ¥371.3. More importantly, Japan’s exports showed their first annual rise in about 15 months. This development serves to dispel some of the concerns that a stubbornly high yen would significantly eat away export strength. However, in some ways it has. Shipments to the United States continued to fall by 7.6 percent. However, exports to Asia jumped by the fastest pace in a decade, helped by a 42.8 percent rise in trade with China. As expected, the continued strength in the Chinese economy has translated into new business for Japan. Aside from exports, imports dropped at the slowest rate in more than a year. Even though domestic demand is far from healthy, this could indicate the very beginnings of a revival in consumer spending. Tomorrow’s data will come in the form of Retail Trade and Large Retailers’ sales.  

EUR/USD: Currency in Play for Next 24 Hours

EUR/USD will be the currency pair in play for tomorrow. We expect the Unemployment Rate from Germany at 3:55 am ET or 8:55 GMT, followed by Euro-zone Consumer and Economic Confidence at 5:00 am ET or 10:00 GMT. The U.S. will release Jobless Claims and Durable Goods Orders at 8:30 am ET or 13:30 GMT.

EUR/USD

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Comments (3)

Darell

January 28, 2010 at 02:26 AM ET

I just not sure why did the Fed would leave rates unchange. Knowing that if they move it to 25 to 50bp they would see a lot more trades.

alexjbrandt

January 28, 2010 at 02:40 AM ET

I'm pretty sure that if the Fed was to raise rates now, they would hinder any 'recovery' that they have been trying to achieve. I personally don't see them raising rates till late 2010 at the earliest. Everyone got excited about last Novembers employment numbers, but clearly this is going to be more of a L shaped recovery then a V or a U shaped recovery, in my opinion.

Yaakub

January 28, 2010 at 08:50 AM ET

Is it true that the Goverment will help to solve the Greece issues? Will this will support Euro? What will be the damage?

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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.