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 future results.

THE STORIES IN THE CURRENCY MARKET

• FOREX: CREDIT DEFAULT SPREADS AND EUR/USD
• EUR/USD: G7 LEAVES MUCH TO BE DESIRED
• GBP/USD: LEADS G7 PUSH FOR BANKING FEE
• USD/CAD: NEW BUBBLE IN HOUSING?
• NZD/USD: BOLLARD FINDS THAT ECONOMY IS STILL FRAGILE
• AUD/USD: CUTTING BACK ON FISCAL STIMULUS
• USD/JPY: EXPORTS LOOK HEALTHY DESPITE TOYOTA’S WOES

EXPECTATIONS FOR UPCOMING FED MEETINGS

CURRENT US INTEREST RATE: 0.00%
	03/16 Meeting	04/28 Meeting
NO CHANGE	64.7%	62.0%
CUT TO 0BP	35.3%	32.0%
INCREASE TO 50BP	0.0%	6.0%
INCREASE TO 75BP	0.0%	0.0%

FOREX: CREDIT DEFAULT SPREADS AND EUR/USD

It is an extremely quiet day in the foreign exchange markets with most of major currencies ending the NY trading session unchanged against the U.S. dollar. With no U.S. economic data on the calendar and little surprises from the G7 this weekend, we want to take this opportunity to explain credit default swap spreads – a term that is used often in the financial media these days.

What are Credit Default Swaps ?

A credit swap is like an insurance contract. The buyer of a credit default swap receives a payment if the underlying (company or country) defaults which basically means that he or she is buying insurance for a default. In return, the seller will require regular payments from the buyer. The best way to describe a 5 -ear credit default swap is to compare it to a 5 year term life insurance contract. You make a payment at regular periods of time so that if the “credit event” or “death” occurs within 5 years, a lump sum is paid. If it does not happen, then the seller simply retains to payment and your “insurance” expires.

What are Credit Default Swap Spreads ?

Credit default swap spreads are the cost of the protection expressed as an annualized percent of the notional amount. So for example if the 5-year swap spread on Greek debt is 400 basis points it means that it costs 4 percent of the notional to protect against a default of Greek government debt within 5 years. On a $10 million bond, investors would require an annualized payment of $400,000 in this case to be willing to bear the risk of Greece defaulting on their bonds.

Why is this Important for Forex Traders ?

The spreads of credit default swaps are important because they measure how investors feel about the likelihood of a default and these days, the focus is on sovereign debt default. If the spread increases it means that investors believe the possibility of a default has risen as well. Since the value of a currency also reflects how investors feel about that country, it is natural for credit default spreads and currencies to move in the same direction especially when there is a serious risk of default. The following chart illustrates the relationship between the EUR/USD (white line) and the 5-year Credit Default Swap Spread for Greece (orange line). As you can see, they have a very strong correlation because the fear of a Greek default has encouraged investors to pull money out of the Eurozone. The chart also shows that the Orange Line (Greek CDS) has been leading the White Line (EUR/USD) over the past few months which means that for the EUR/USD to recover, Greek CDS spreads need to stop falling and start stabilizing.

How Does the Risk of Investing in Greece Compare to the Rest of the World ?

Greek 5 year CDS spreads are approximately 400bp. To compare that with the rest of the world, the 5-year spread for the U.S. and Germany are approximately 35bp. The spread for Canada is in the area of 15bp. For France it is 60bp and for Japan and the U.K., who have recently received warnings from ratings agencies about possible downgrade have, their CDS spreads are approximately 90bp. These are substantially less than Greece’s credit default spreads but of course that reflects the risk of investing in a nation that could be at the brink of bankruptcy.

There are no market moving U.S. economic data on the calendar tomorrow which means that sovereign debt risk and CDS spreads will continue to be one of the primary drivers of currencies. We hope that you now have a bit more understanding of CDS spreads which are mentioned on a daily basis these days. Feel free to post questions if you need further clarification.

EUR/USD: G7 LEAVES MUCH TO BE DESIRED

Traders continued on course in the euro after a crippling week that saw the pair decline to eight month lows. The euro’s earlier gains were quickly undone as equity markets sank by late trading. Clearly debt concerns continue to drive markets. Credit default swaps for Greece, Spain, and Portugal remained volatile as this past weekend’s G7 meeting left little in terms of confidence to boost morale. While CDS spreads in Greece and Spain narrowed, Portugal’s widened. The anticipation for the G7 meeting to produce a fix to these problems went unanswered as European officials tried to buy time and avoid any mention of the word ‘bail-out’. The French Finance Minister Lagarde noted that European members will ensure that the situation is “managed.” However, in a slightly less comforting note, German Finance Minister Schaeuble referred to Greece’s situation as “paying a price” for running up huge fiscal deficits. Today’s economic data was limited to the Sentix index of investor confidence which plummeted to a four month low, clearly showing the effects that debt traumas are having on sentiment. It remains to be seen whether current concerns start to seep their way into more of the region’s economic data. Tomorrow is a relatively busy day and includes such items as German Consumer Prices and their Trade Balance.

GBP/USD: LEADS G7 PUSH FOR BANKING FEE

The pound loses track of earlier rallies and falls for the fourth straight day. EUR/GBP, on the other hand, remains unchanged despite a volatile day that took the pair to both extremes. The U.K.’s presence at the G7 meeting became one focused mostly on new financial regulations and restraints. A UK official proposed a plan that would create some sort of a tax, the proceeds of which would be put in a pool to be tapped in case of economic shocks. The plan reflects growing pressure on policy makers to act quickly to implement such policies, but represents a new level of uncertainty for markets in an already fearful environment. After Saturday’s conference, Alistair Darling summed things up by saying that the “position of most countries is to support the economies now and get the budget deficit down as the economy recovers.” However, as concerns mount over the U.K.’s fiscal standing, it is unclear how far Darling will be able to take new spending propositions. The start of the week has seen no data, keeping markets fixated on European debt problems. However, tomorrow presents more in the form of concrete data with the RICS House Price Balance along with the Trade Balance.

USD/CAD: NEW BUBBLE IN HOUSING?

Commodity currencies headed lower on the day as continued fears over European debts overshadowed the lifting effects of short covering after a significant drop. The Canadian dollar weakens despite yet another piece of evidence that shows the economy is exceeding expectations. Housing Starts for January increased to a 15 month high as low borrowing costs have rejuvenated the housing sector. However, with the swift recovery in housing have come new fears that suggest the sector has entered into a bubble. After all, house prices have rebounded to at least their prerecession highs. The big question is whether housing will pose a shift to the Bank of Canada’s inflation outlook, one that may see rates go higher before previously estimated. However, Canadian Finance Minister Jim Flaherty finds that “no compelling evidence” of a bubble can be found. Housing starts may be rebounding rapidly but they are still almost 30% below highs reached two years ago. Nevertheless, Flaherty still notes that he will be “watching and monitoring” the situation. The kiwi is the biggest loser on the day after Reserve Bank of New Zealand chief Alan Bollard cautioned that because of rising unemployment, the economy is still “fragile”. Australia has taken its first steps in unwinding certain fiscal programs that helped banks access credit during the crisis, which included measures that provided insurance on large deposits. Nevertheless, the aussie ended the day lower.

USD/JPY: EXPORTS LOOK HEALTHY DESPITE TOYOTA’S WOES

USD/JPY posts very subdued rallies as today’s trading has become a wait and see game for more developments on global concerns. Japan’s Current Account was released and showed that their surplus expanded for the fifth month thanks to a significant rise in exports. Export growth reached 11.7%, posting its first gain in more than a year. Clearly, Chinese demand is still keeping the countries ports busy. Exports to the country rose more than 40%, a development that may have somewhat offset the fallout surrounding Toyota’s latest woes that were expected to find their way into trade. However, imports still slumped by 6%, underscoring the fact that domestic demand still remains very weak. A separate report showed that Bank Lending plunged by the most in four years as borrowing needs have slackened due to companies’ hesitancy to spend and invest. This still means that job conditions could continue to worsen as employers opt for productivity gains rather than increased hiring. The influx of economic data also showed a sharper fall in the amount of bankruptcies and large gain in the Eco Watchers Outlook survey to 41.9. Tomorrow’s schedule includes only Machine Tool Orders.

EUR/GBP: Currency in Play for Next 24 Hours

EUR/GBP will be the currency pair in play for tomorrow. First up for tomorrow will be German Consumer Prices and Trade Balance at 2:00 am ET or 7:00 GMT. This will be followed by the U.K.’s Trade Balance at 4:30 am ET or 9:30 GMT.

EUR/GBP continues to trade within the Bollinger band range trading zone after closing mostly unchanged on the day. The pairs hesitancy to move higher may be related too two key hurdles that lie ahead. The first is the 23.6% retracement from October highs to January lows at 0.8793. In addition, lying only slightly above is the 200-day moving average at 0.8829. This level is also very close to lows placed in mid-November. Loses may be contained in the short-term at Friday’s low of 0.8685. The lower one standard deviation bollinger band should also provide some support. In any event, tomorrow’s data may provide the opportunity for EUR/GBP to establish a more definitive path.

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.