Forex Market Hit By Crisis Of Confidence

Last updated 2/4/2010 5:21 PM ET (GMT -5) 16 Comments

Kathy Lien

Director of Currency Research, GFT

Note: Forex Trading involves high risks, with the potential for substantial losses and is not suitable for all persons. Past performance is not necessarily indicative of futures results.

THE STORIES IN THE CURRENCY MARKET

• FOREX MARKET HIT BY CRISIS OF CONFIDENCE
• EUR/USD: HITS 8 MONTH LOWS
• GBP/USD: RISK IS TO THE UPSIDE FOR BOE
• USD/CAD: EMPLOYMENT NUMBERS COULD DISAPPOINT
• AUD/USD: CONSUMERS CUT BACK HOLIDAY SHOPPING
• NZD/USD: SHARP DECLINE IN OIL AND GOLD
• USD/JPY: YEN SURGES AGAINST ALL CURRENCIES

EXPECTATIONS FOR UPCOMING FED MEETINGS

FOREX MARKET HIT BY CRISIS OF CONFIDENCE

A full-fledged meltdown in the forex markets is the best way to describe today’s price action as investors sought safety in the low yielding U.S. dollar. The greenback rose against every major currency except for the Japanese Yen which further indicates that risk aversion is behind today’s strong demand for dollars. Do not be mistaken - traders are not loading up on the buck because they believe that tomorrow’s non-farm payrolls report will be strong, but because they are unwinding high risk positions and reducing exposure ahead of NFPs. With credit default spreads for Greece, Portugal and Spain rising significantly, traders are nervous about how the situation in Europe will pan out. So far, the European Union has failed to calm investors by bailing out Greece or any other nations but they could easily end the euro’s crisis of confidence if did what the UAE did for Dubai. Although investors are not as worried about the U.S. deficit as they are about European deficits at this time, the S&P 500 still fell by the largest amount since October 30th which indicates that Greece’s problems have influenced the world, whether the Europeans like it or not. It also didn’t help that the ratings agency division of Standard & Poor’s downgraded Berkshire Hathaway and that Bank of America agreed to shell out $150 million to strengthen its corporate governance and disclosure practices as part of their settlement with the SEC. This is a story of deleveraging in an environment that is not as severe as the credit crisis, but just as nerve racking in its own way. A strong non-farm payrolls report could turn risk appetite around, but skittish investors will need a lot of convincing to get them to stop selling and to start buying.

Non-Farm Payrolls Should Improve but Positive Job Growth is Uncertain

Based upon the leading indicators for non-farm payrolls, the labor market should have improved in the month of January but economists are not only looking for an improvement but positive job growth. If they are right, this would be the second month out of the three that more jobs were added than lost after the recession ended as revisions last month revealed that 4k jobs were created in November. A small uptick in jobs would indicate that the labor market is slowly improving much like a semi making a wide turn on a highway. It will eventually round the corner, but it will be a gradual and messy process. Also, this morning’s jobless claims report dashed hope for a healthy improvement in payrolls. First time jobless claims rose from 472k to 480k, matching the highest level since mid-December. All signs point to an improvement in the labor market but after shedding 85k jobs last month, smaller jobs losses would still represent an improvement. The more important question is whether job growth in January was the strongest in more than 2 years. The consensus forecast is currently favoring a 15k rise in non-farm payrolls but with estimates ranging from up 100k to down 100k, no one really knows. For forex traders, this means that there could be an unusual amount of volatility in the dollar following the payrolls report on Friday. For our full non-farm payrolls preview, read our special report on the risks for January payrolls including the potential for big birth/death mode revisions.

The Good News: Reports from Retailer

On a day in which we had a blood bath in the financial markets, we believe that it is also important to talk about the good news. Based upon the latest reports from individual retailers, January was a strong month. Companies like Macy’s and Aeropostale reported an increase in earnings and raised their outlooks based upon the results. After the non-farm payrolls report, the market will turn its focus to retail sales which is due for release next week. Stronger consumer spending numbers could help to relieve some of the fear induced selling in the financial markets.

EUR/USD: HITS 8 MONTH LOWS

The euro hit an 8 month low against the U.S. dollar as the European Commission and the European Central Bank fail to calm the fears of a default by Greece, Portugal or Spain. Credit default swaps, which measure the cost of insuring against a default of debt continued to rise with Portuguese CDS spreads hitting an all time high. The reason why the market obsesses over CDS spreads is because the higher the spreads rise, the more investors require to bear the risk of owning Greek, Portuguese or Spanish debt. Over the past 24 hours, the European Commission added more pressure on Greece to rein in their deficit. Portugal reported weak demand for their bonds at a recent auction while Spain raised its budget deficit forecasts. Unfortunately the problems in Europe aren’t getting any better and the European Commission’s cautious endorsement of Greece’s budget plan or ECB President Trichet’s attempt to downplay the situation by saying that Greece is on the right track has failed to pacify investors. In fact, Trichet even admitted that EU deficits could “burden” or influence monetary policy. If that is true, then until the PIIGS resolve their deficit problems, the ECB may put off plans to raise interest rates. This morning, they left rates at 1.00 percent, which was right in line with expectations. According to the German Finance Minister, the government is assuming that the ECB will keep interest rates at 1 percent until 2013 – and this ominous forecast may be part of the reason why the EUR/USD fell sharply today. German industrial production is only major Eurozone economic release on the calendar tomorrow. The sharp drop in factory orders suggests that production declined last month but the rise in manufacturing PMI makes the data difficult to call.

GBP/USD: RISK IS TO THE UPSIDE FOR BOE

Of all the major currencies, the one that fell the least against the U.S. dollar was the British pound. As everyone expected, the BoE left interest rates unchanged at 0.5 percent and its asset purchase program at GBP200 billion. The recent improvements in economic data eliminated the need for additional quantitative easing at this time which traders reacted positively to. However it is important to note that the BoE left the door open to further easing. They believe that the signs of recovery and the rise in inflation are temporary and therefore further purchases could be “made should the outlook warrant them.” Given the government’s need to reduce spending and raise taxes to rein in the deficit, growth could be negatively affected and the Bank of England is most likely giving themselves some flexibility before committing to a new course of action. We expect this sentiment to be echoed in their Quarterly Inflation Report which is due for release next week. In the meantime, producer prices are on tap and a rise in the price components of the PMI reports suggests that inflationary pressures increased last month. Given the BoE’s comment on inflation rising and the recent decline in sterling which is inflationary, we believe the odds are skewed towards stronger PPI numbers.

USD/CAD: EMPLOYMENT NUMBERS COULD DISAPPOINT

Weaker economic data, the decline in commodity prices and risk aversion has driven the Canadian, Australian and New Zealand dollars sharply lower against the U.S. dollar and Japanese Yen. On a percentage basis, we have not seen such a deep slide in CAD/JPY, AUD/JPY and NZD/JPY since October. As a result of today’s sell-off the Canadian dollar hit a 3 month low against the greenback, the Australian dollar hit a 4 month low and the New Zealand dollar reached a 5 month low. Like the U.S, Canada has an employment report due for release on Friday. Although the IVEY PMI edged higher, it fell short expectations and the employment component dipped. This suggests that the Canadian employment report may not live up to the market’s expectations. Another month of job losses would weigh heavily on the loonie. According to Bank of Canada Governor Carney, Canada’s labor market has stopped worsening and job growth will be very slow. Meanwhile the Australians disappointed once again with retail sales falling 0.7 percent in December. Although consumer spending picked up on a quarterly basis, the Reserve Bank’s 3 rate hikes successfully sapped demand during the holidays. Yet the housing market is still humming along with building approvals rising 2.2 percent in December. Construction sector PMI is due for release this evening and given the strong housing market reports, we expect activity to expand. This will be followed by the RBA’s Quarterly Monetary Policy Statement.

USD/JPY: YEN SURGES AGAINST ALL CURRENCIES

Japanese Yen crosses took a beating today with AUD/JPY and NZD/JPY plunging more than 4 percent. The exaggerated sell-off in these currency pairs stem primarily from the sharp slide in USD/JPY. Carry trades are generally very sensitive to volatility and the fact that the VIX which measures volatility in the equity markets rose close to 20 percent is very bearish for the yen crosses. On a pip basis, the biggest moves were in EUR/JPY which fell to an 11 month low and GBP/JPY which is at the cusp of breaking the psychologically important 140 level. Despite the fact that investors are also flocking into the safety of the Japanese Yen, Bank of Japan board member Nekamura said the Japanese are also concerned about their credit rating being downgraded and therefore urged the government to take steps to reduce their deficit. Nekamura denied the claims that pumping more money into the system will alleviate deflationary pressures. At the same time, Toyota’s problems seem never ending. Although the company is expected to report a profit of 80 billion yen for the fiscal year ending March 31, there are a new host of problems with its popular Prius models. Leading indicators are due for release tomorrow and a mild improvement is expected.

EUR/USD: Currency in Play for Next 24 Hours

The EUR/USD will be the currency in play for the next 24 hours. German Industrial Production figures are due for release at 11:00GMT or 6:00AM EST followed by the U.S. Non-Farm payrolls report at 13:30GMT or 8:30AM EST. The sharp sell-off in the EUR/USD today has pushed the currency pair deeper into the Sell Zone which we determine using Bollinger Bands. The lowest point of the day perfectly coincides with 50% retracement of 2008 low and 2009 high at 1.3725. If the following level is breached expect the pair to continue dropping to next level of support at 1.3600. If the pair reverses, the 1st Standard Deviation Bollinger Band at 1.3940 should act as resistance.

Comments (16)

FXDragon

February 04, 2010 at 06:43 PM ET

Mathematically we believe solid job growth is distant before initial claims print below 450k.

hsbc

February 05, 2010 at 10:19 AM ET

damn i really could use u as a mirror

hsbc

February 04, 2010 at 07:05 PM ET

mathematically u keep getting it wrong, dragon

hsbc

February 04, 2010 at 07:07 PM ET

if the world is having another credit crunch, how can china hike that aggressively?

FXDragon

February 05, 2010 at 03:08 AM ET

Inflation. Microeconomics 101. Did you take it? If you did, your teacher sucks.

hsbc

February 05, 2010 at 04:59 AM ET

wait. how did inflation get into credit crunch?

world believe that china willl hike to cool its economy.

however if u have a credit crunch will inflation be that large?

perhaps they teach econ 101 differently from where u come from ...

hsbc

February 05, 2010 at 05:01 AM ET

think about it. if china hikes, what will happen next? ur cause and effect is v poor

alexjbrandt

February 05, 2010 at 05:21 AM ET

Well, China's forecast for inflation this year is 5% or so I believe. Thats kind of high, so China would be forced to raise rates even if there was a 'credit crunch'. However, Chinese banks loaned out 1.5T Yuan just last month, that doesn't sound like a credit crunch to me.

hsbc

February 05, 2010 at 07:27 AM ET

wat do u think is in the inflation in china? i live in china and i tell u food is the only component in it. when chinese regulators tell u that its inflation they are concern abt they mean asset bubble. given that its property speculation, int rate hike will not bring it down

hsbc

February 05, 2010 at 07:27 AM ET

wat do u think is in the inflation in china? i live in china and i tell u food is the only component in it. when chinese regulators tell u that its inflation they are concern abt they mean asset bubble. given that its property speculation, int rate hike will not bring it down

Oyster

February 04, 2010 at 11:05 PM ET

Thank you, Kathy.
On GER industrial production (dec),
GER PMI manufacturing (dec): act 52.7, cons 53.1, prev 52.4.
GER factory orders (dec): act -2.3%, cons 0.2%, prev 2.8%.

Omalaq

February 05, 2010 at 08:18 AM ET

can you please post again the website where i can learn more about the basic stuff in forex trading.

Doobp

February 05, 2010 at 10:31 AM ET

go to www.babypips.com? i learnt mine from there.

moneyworld

February 05, 2010 at 11:00 AM ET

is there anybody out there that knows anything about the iraqi dinar. i cannot find any news about it

Silenus

February 05, 2010 at 11:31 AM ET

I know some one who went long Iraq. So far he's stuck 705 000 000 000 USD
But hey... you always win with a wide enough stop. Right?

fxmama

February 05, 2010 at 04:34 PM ET

What kind of news are you seeking moneyworld? The Central Bank of Iraqs homepage: http://www.cbi.iq/

... and there are a lot of sites that offer to sell the dinar. These are (I detect) people who either live arond the Gulf or in Iraq. (Been there and yes, did buy some).

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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.