U.S. Dollar: Have We Hit A Capitulation Point?

Last updated 2/5/2010 5:28 PM ET (GMT -5) 6 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• U.S. DOLLAR: HAVE WE HIT A CAPITULATION POINT?
• EUR/USD: STRONGER ECONOMIC DATA BRINGS REPRIEVE
• GBP/USD: WILL HOTTER INFALTION BE SUSTAINABLE?
• USD/CAD: SURPRISING INCREASE IN EMPLOYMENT
• AUD/USD: OIL PRICES DOWN, GOLD UP
• NZD/USD: DECLINES FOR THIRD DAY
• USD/JPY: DEFICITS EXPECTED TO SHRINK

EXPECTATIONS FOR UPCOMING FED MEETINGS

U.S. DOLLAR: HAVE WE HIT A CAPITULATION POINT?

It has been an extremely volatile day in the financial markets with the Dow Jones Industrial average falling close 160 points only to recover aggressively in the last hour of trading to end the day in positive territory. The turn in risk appetite has caused a similar reaction in currencies with the dollar also ending the North American session higher against the Japanese Yen. We can tell this is not a dollar move because the greenback gave back part of its gains against high yielders like the euro and Australian dollars. With no trigger for the abrupt turn, many traders are wondering whether we have finally hit a capitulation point in the financial markets. Although the recovery in stocks was impressive, the reversal in bond yields and currencies were not nearly as strong. Nonetheless barring any major surprises from the G7 this weekend, if we have really hit a capitulation point in the financial markets, risk appetite should continue to recover in the beginning of the week, which will stem the bleeding in forex.

Currencies on the Discussion Table at G7?

Finance ministers and central bankers of the G7/G8 nations have gathered in Canada to talk about global monetary and fiscal policies. Financial regulation, Greece, toxic banks and Haiti’s debts are the key topics on the discussion table but according to Canadian Finance Minister Flaherty, he’s “sure” that currencies will be discussed at the meeting since “some Asian economies have rigid exchange rates.” France’s Finance Minister seems to agree that Yuan talks are still on the table. However given that the finance chiefs agreed back in October that big decisions will be made at G20 and not the G7/G8 meetings, it will be interesting to see if they diverge from that plan because traders have been conditioned to hang onto the words of the G7. Unlike past meetings, no official statement is expected to be released and the Canadians want to keep the event as informal as possible, but there will be joint press conference on Saturday where questions will be taken. It appears that the Japanese are leading the push because according to Flaherty, "The new Japanese finance minister has been clear in his wish that ... we have this item on the agenda. So we will have it on the agenda, and we will discuss it together," "It is a concern when people ask about the weakness in the American dollar one has to look at the fact that some of the Asian currencies, including the Chinese currency, are artificially constrained." It is obvious that Japan wants to single out China but in the current environment, it may be hard to avoid talking about the greenback.

Non-Farm Payrolls: Bad But Not Horrific

The latest non-farm payrolls report indicates that the U.S. labor market remains weak but like a semi truck turning on a highway, it is slowly moving in the right direction. Although the unemployment rate dropped from 10 to 9.7 percent, payrolls, fell by 20k and job losses in November was revised down from -85k to -150k. The jobs data was bad but not horrible because at minimum the pace of job losses is slowing and more importantly the manufacturing sector reported the first month of positive job growth after 25 months of consecutive job losses. Based upon the recent trend of economic data, the manufacturing sector is the leading the service sector recovery. The discrepancy between the payrolls survey and the unemployment report lies in the fact that one calculates their data from payrolls provided by over 390k establishments employing over 45 million people and the other surveys approximately 50k families. As you can imagine, the payrolls survey is usually more accurate than the household survey which releases the unemployment rate. Nonetheless, it is important to acknowledge that the unemployment rate has not only fallen below 10 percent but is at the lowest level in 5 months. Jobs were found in the government, at retailers, companies offering professional and business services, health and education. As we suggested in our non-farm payrolls preview, the market’s forecast was overly optimistic. Most of the labor market numbers released before the payrolls report pointed to an improvement but did not necessarily imply positive job growth. Revisions due to the birth death model also reduced payrolls by 930k jobs between the months of April 2008 and March 2009. Since the recession began 8.42 million Americans have lost their jobs. However based upon today’s number, it is becoming increasingly clear that the U.S. labor market has turned a corner and positive job growth will probably return in February but unemployment remains high which means that recovery will still be slow and messy. The most important U.S. economic releases on the calendar next week is the trade balance, the retail sales report and consumer confidence.

EUR/USD: STRONGER ECONOMIC DATA BRINGS REPRIEVE

The euro continued to slide against the U.S. dollar and even fell to a one year low against the Japanese Yen today. Weaker German industrial production numbers added pressure on the single currency which has been dropping like a rock since the middle of January. By now the problem is well known because it has been covered heavily by financial and non-financial media. Therefore in the coming week, the fate of the euro will depend upon whether sovereign debt problems will continue to overshadow economic data. Credit default swaps, which are the price of protection against a default on government debt by Greece, Portugal and Spain hit a record high. This suggests that traders are still nervous about being exposed to those nations. The European calendar is heavy with GDP numbers due for release from the Eurozone along with trade and industrial production numbers from Germany. If Asian and European equities recover like U.S. stocks did today, we could see a rebound in the euro. However the problems are very fundamental as investors around the world have become reluctant to put their money into the Eurozone. Unless European policymakers do for Greece, Portugal or Spain what the U.A.E did for Dubai, investors will be very weary of diving back into European assets. The G7 meeting that is already underway could provide some respite but based upon the European Commission and the European Central Bank’s attempts to calm the markets, anything short of a bailout may not help the euro. Nonetheless if investors have reasons to be less concerned about European fiscal deficits, the euro and stocks could recover, otherwise the path of least resistance is still downwards.

GBP/USD: WILL HOTTER INFALTION BE SUSTAINABLE?

The British pound hit an eight month low against the U.S. dollar despite stronger economic data. This has been the worst performing week for sterling against the dollar since last September. EUR/GBP, on the other hand, has held steady which signifies that it is more dollar strength than pound weakness that is ruling the day. Ironically, the declines in the pound have come on relatively optimistic economic data. Producer prices were reported hotter than expected, at 3.8 percent. This is the sharpest rise in annual producer inflation in about two years, confirming recent evidence that showed Consumer Prices surged the most on record in late-2009. Price pressures were broadly based as nine out of ten index components increased, led by scrap metal. Meanwhile, the monthly index climbed by a less than exciting 0.4 percent. Nevertheless, many still doubt that the rise in prices is a sustainable occurrence. The BoE has held consistently that while they do notice short-term pressures, the long-term picture looks fairly subdued. Data picks up next week with the release of the Trade Balance and RICS House Price Balance on Tuesday followed on Wednesday by the Bank of England’s Quarterly Inflation Report and Manufacturing and Industrial Production.

USD/CAD: SURPRISING INCREASE IN EMPLOYMENT

The aussie has fallen for the fourth straight day while the kiwi drops for the third as global concerns continue to dry up investor enthusiasm for tg risk. Nevertheless, even as crude dips to a seven-week low, the loonie defeats all odds and posts slight gains on the day. Of course, this rally was fueled by a huge surprise in the country’s employment report, which saw new hiring rise by 43k. Canada stole the show from the US’ NFP release as jobs nearly tripled estimates and unemployment dropped to the lowest in four months. Even more promising was the fact that the outperformance was driven mainly by hiring in the services sector, signaling renewed levels of consumer spending. However, one thing to be wary of was the surprise drop in wage growth which took the statistic to the lowest levels since 2003. Reduced pay may in fact be the reason behind the booming employment market. Coming up next week will be Canada’s reports on housing Starts on Monday and New Housing Prices on Thursday. In Australia, the RBA’s Quarterly Monetary Policy Report noted that “it is likely that borrowing costs will be increased further” to keep inflation in check. The RBA also noted that they do not expect higher rates to hamper the countries growth. Today’s report renders a slight up-tick in rate hike speculation after the surprise decision earlier this month to leave rates unchanged. Meanwhile, Australia’s AiG Construction Index showed the best performance in about two years with a sharp accumulation of jobs. The biggest events for next week will be Investment Lending on Wednesday and the employment report on Thursday. Meanwhile, New Zealand will be releasing Retail Sales on Thursday.

USD/JPY: DEFICITS EXPECTED TO SHRINK

Despite its large trading range, USD/JPY finished the last day of the week largely unchanged. Japan’s cabinet office released a report today with estimates that showed that Japan’s deficit would shrink to 7.1 percent of Gross Domestic Product by 2011. The report may help fend off an S&P sovereign credit rating cut, after the ratings agency dropped the country’s outlook last month. However, the DPJ has yet to establish any fiscal goals that would signify an accelerated effort to bring down debt. The big problem for the new party is that their election was won based on promises of renewed spending, one that they may not be able to keep in a strained fiscal environment. Economic data was light today, but showed that the Leading index improved for the tenth straight month. This should serve as a positive forbearer for growth. The accompanying Coincident index also rose to 97.6 from 96. Next week’s schedule starts out with a bang. Monday will see the release of Japan’s Trade Balance, Current Account, Bank Lending, and the Eco Watchers Survey. Friday will see the release of Consumer Confidence.

CHF/JPY: Currency in Play for Next 24 Hours

CHF/JPY will be the currency play for Monday. Japanese Current Account and EcoWatchers Survey are due for release at 23:50GMT or 6:50PM EST on Sunday evening. The following morning, Swiss Unemployment Rate will be announced at 6:45GMT or 1:45AM EST, followed by Retail Sales at 8:15GMT or 3:15AM EST. After breaking a 10-month long trading range, CHF/JPY entered the Sell Zone which we determined using the Bollinger Bands. The downtrend may continue to the next level of support at 81.50 represented by a 50% retracement of 2008 low and 2009 high. Nonetheless, fake-out moves are frequent in trading ranges, thus, a break above 84.00 may propel the pair out back towards the first standard deviation Bollinger Band.

Comments (6)

Darell

February 05, 2010 at 07:12 PM ET

Well the G7 meeting is this weekend I would just like to know will someone try to bailout Greece so EUR CCY can stay alive. Or will it recover and rebound on it's own.

alexjbrandt

February 07, 2010 at 08:48 PM ET

Dollar longs have recently reached a high not seen since March, 2009 in which the dollar then had a 7 month down hill slide.

alexjbrandt

February 07, 2010 at 08:48 PM ET

Dollar longs have recently reached a high not seen since March, 2009 in which the dollar then had a 7 month down hill slide.

hsbc

February 07, 2010 at 09:39 PM ET

what i find surprising is that usd int rates esp irs is actually not falling at all. it seems that rates and fx mkt are trading seperately.

schultzz.at

February 08, 2010 at 03:53 AM ET

I think yields are currently held in check by counteracting forces. There is still hope of a strong rebound with robust spending and job growth. This seems to be reflected in the steep curve.
On the other hand, risk appetite seems to have hit a peak at the beginning of the year. Bond auction sizes are also no longer growing which could reduce fears that overwhelming supply will send yields up.

The spread between 10yr Treasuries and 10yr German Bunds is comparatively high, at +45 points. Treasuries are also yielding about 10 points more than French 10yr debt.
It seems that concerns about Southern Europe lead to a shift of funds within the Euro Area, but not (yet) a flight out of European debt in general.

The fx markets seem more accurate in reflecting the current score in this race to the bottom. The U.K. is leading among the G-7 countries while the euro is burdened by Southern Europe.
Tom Schultz.

hsbc

February 08, 2010 at 05:29 AM ET

It seems that concerns about Southern Europe lead to a shift of funds within the Euro Area, but not (yet) a flight out of European debt in general

EXACTLY

that is my suspicion too. that money is still in euroland as seen from the ust action

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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.