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THE STORIES IN THE CURRENCY MARKET

• U.S. DOLLAR: IS THE RISK RALLY SUSTAINABLE?
• EUR/USD: GERMAN ZEW SURVEY BEATS EXPECTATIONS
• GBP/USD: BREAKS TO UPSIDE
• AUD/USD: FUELED BY HAWKISH RBA MINUTES
• NZD/USD: PRODUCER PRICES RISE IN Q4
• USD/CAD: MANUFACTURING SALES SLOW
• USD/JPY: JAPAN BECOMES LARGEST HOLDER OF US TREASURIES

EXPECTATIONS FOR UPCOMING FED MEETINGS

CURRENT US INTEREST RATE: 0.25%
	3/16 Meeting	4/28 Meeting
NO CHANGE	60.7%	59.1%
Cut to 0.00%	39.3%	36.4%
Increase to 0.50%	0.0%	4.5%
Increase to 0.75%	0.0%	0.0%

U.S. DOLLAR: IS THE RISK RALLY SUSTAINABLE?

Stronger economic data triggered a sharp rally in the foreign exchange market that has many traders wondering if the dramatic shift in risk appetite is here to stay.  With the Dow Jones Industrial Average up more than 165 points, investors pulled their money out of the safety of U.S. dollars and put them back into higher yielding and riskier currencies such as the Australian and New Zealand dollars and for the first time in 5 trading days, in euros as well.  Investors barely blinked after the stronger retail sales report on Friday but this morning’s upside surprises may have finally convinced them that there are broad and not isolated improvements in the U.S. economy.  The answer to the question of whether the risk rally is here to stay larger depends upon whether the FOMC minutes tomorrow will reinforce the hawkish comments made by Fed Chairman Ben Bernanke earlier this month.  

 

FOMC Minutes and Fed Comments

The tone of the most recent FOMC statement was almost blindly optimistic.  Despite the deterioration in the labor market and consumer spending prior to the FOMC meeting, the Fed upgraded their assessment of the economy by saying that that “economic activity has continued to strengthen.”  At that time, everyone was skeptical but based upon the economic data released since the last meeting, their optimism is vindicated.  Adding to the bullishness of the FOMC announcement was Fed President Hoenig’s dissenting vote.   The head of the Kansas City Federal Reserve believed 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 and traders will be looking to see if this sentiment is reflected in the minutes.  If the minutes reveal optimism, it could fuel further gains in currency pairs such as USD/JPY, AUD/USD and EUR/USD.  However given this morning’s comments from Fed officials, the sentiment at the Federal Reserve is still very cautious as they worry about unsustainable fiscal deficits in the U.S., an elevated unemployment rate and low inflation.  Yet if crude prices, which are up 4 percent today continue to rise, inflationary pressures could return.  

 

Japan Overtakes China as World’s Largest Holder of U.S. Treasuries

One of the more interesting outcomes of today’s economic reports was news that Japan is once again the world’s largest holder of U.S. Treasuries.  According to the Treasury International Capital flow report in December, China sold $34 billion in long and short term Treasuries while Japan bought $11.50 billion.  Since September 2008, China has been the world’s largest holder of U.S. Treasuries.  However China and Japan’s holdings are relatively close in dollar terms which mean that it won’t take much for China to reclaim its title.  Nonetheless, China’s disposal of U.S. dollars may reflect their concerns about being overly exposed to the U.S.’ rising budget deficits.  China also recently become agitated at the U.S. for a number of political reasons involving Taiwan and the Tibetan spiritual leader.  China buys and sells U.S. dollars for both economic and political reasons.  It will be interesting to see if China continued to sell dollars as the greenback strengthened throughout January and into February because there is a good chance that they may have sold the low.   In general, demand for dollar denominated assets remains healthy with foreigners investing $60.9B into the U.S. at the end of the year.  Although the demand was primarily for short term U.S. Treasuries and stocks, net purchases doubled from November.  The Empire State manufacturing survey also rose to the highest level since October and the NAHB housing market index moved up 2 points, which reflects an improvement in builder confidence.  Aside from the FOMC minutes, housing starts, building permits and industrial production are due for release tomorrow.   

EUR/USD: GERMAN ZEW SURVEY BEATS EXPECTATIONS

For the first time in 5 days, the euro ended the NY trading session higher against the U.S. dollar.  Better than expected economic data and an overall improvement in risk appetite has helped the EUR/USD recover.  The German ZEW survey which measures analyst and investor sentiment in Germany fell from 47.2 to 45.1.  Investors were more optimistic about current conditions but felt that the outlook for Germany could deteriorate.  However the ZEW survey for the Eurozone tumbled from 46.4 to 40.2, the lowest level since May 2009.  This deterioration is directly tied to the PIGS in Europe whose fiscal irresponsibility have rocked the Eurozone to its core.  Speaking of which, no news is good news for Greece.  Members of the European Union are still calling for Greece to meet their deficit goals and they have pledged support if necessary.  However, George Papaconstantinou, the Finance Minister of the European Union said that a bailout may not be needed and Greece has not asked for a handout.  Perhaps the lack of details in the support that EU nations are willing to give to Greece is a reflection of their lack of desire to receive support. Why give someone something that they don’t want? It remains to be seen whether Greece is able to solve their problems on their own and judging from the market’s prior reaction to the Greek saga, nothing has changed to suggest that Greece will be more capable of reining in their deficits now compared to a week or even a month ago.  The Eurozone trade balance is due for release tomorrow and the market expects a small increase in the region’s trade surplus.  

GBP/USD: BREAKS TO UPSIDE

After consolidating against the U.S. dollar for the past week, the British pound has finally broken out of its trading range.  As we suggested in yesterday’s daily report, the recent trend of stronger economic data put the odds in favor of an upside breakout.  In fact, the GBP/USD managed to hit a high a few pips shy of 1.58 despite a larger than expected decline in consumer prices in the month of January.  Although CPI fell 0.2 percent last month, on an annualized basis, it rose from 2.9 to 3.5 percent, the fastest pace in 14 months.  The drop in January was also the smallest on record as the recent increase in the Value Added Tax boosted prices charged by retailers.  With the annualized CPI rate above the Bank of England’s 2 percent target, central bank Governor King warned that the rise in inflationary pressures is temporary because they expect it to ebb as “short-run factors wane and the influence of spare capacity builds.”  The minutes from the most recent Bank of England meeting are due for release tomorrow along with the labor market report.  With manufacturing PMI showing the sector adding jobs once again and the service and construction pmi reports showing slower attrition, the odds favor an improvement in the labor market which could fuel further gains in the British pound.  However traders need to be careful with the minutes because the monetary policy committee was not as hawkish as the market anticipated when they met earlier this month.   They left the door open to further easing which suggests that they may have a more tepid outlook for the U.K. economy.  

AUD/USD: FUELED BY HAWKISH RBA MINUTES

The Australian and New Zealand dollars rose strongly against the U.S. dollar on the heels of hawkish RBA minutes. Over the next 24 hours, the minutes from the Fed and BoE meetings will be released and the market’s reaction to the RBA minutes is an example of how the USD and GBP could react to tomorrow’s reports.  As our colleague Boris Schlossberg pointed out this morning, the central bank is still open to raising interest rates this year, albeit at a slower pace than the end of last year.  The Board noted that, “If economic conditions continued to improve as expected, further increases in the cash rate were likely to be necessary. But they did not regard that outlook as requiring an increase at every meeting.”  Although the RBA is clearly slowing down, they are still the only major central bank raising rates at this time.  Their hawkish stance and an improvement in business confidence have fueled sharp gains in the Aussie.  The kiwi also rallied as deflationary pressures eased in New Zealand.  Prices paid by producers rose 0.3 percent in the fourth quarter but prices charged by producers fell by 0.4 percent which means that they are having a tough time passing higher costs off to consumers.  There are no economic reports from New Zealand this evening but Australia will release their consumer confidence figures. Meanwhile the Canadian dollar also rallied but given the smaller rise in manufacturing sales, the rally was less than 50 percent of the AUD and NZD.  

USD/JPY: JAPAN BECOMES LARGEST HOLDER OF US TREASURIES

Despite the improvement in risk appetite, the gains in USD/JPY were modest as the currency pair struggles to hold above the psychologically important 90 level.  With little Japanese economic data being released in the next couple of days, traders will pay close attention to the upcoming BoJ meeting. The central bank will likely maintain interest rates at current levels while keeping the lending program intact. Despite receding fear of a double dip recession, deflationary pressures remain a concern. The rising debt burden of the Japanese government may put additional pressures on the central bank to keep monetary policy loose in order to spur economic recovery. In the meantime, Japan reclaimed the title of being the largest holder of U.S. Treasuries. Currently, the Japanese are holding approximately $768.8 billion of U.S. debt. Previously the top holder of U.S. Treasuries, China, reduced their holdings by $34 billion, reinforcing a predisposition of diversification from American debt. The tertiary Index which measures the output in service industry is expected to be released this evening. With a drop in unemployment rate, rising consumer confidence, and stellar economic growth in the previous quarter, the figures may surprise to the upside.

GBP/USD: Currency in Play for Next 24 Hours

The currency in play for the upcoming 24 hours will be GBP/USD. Initiating an eventful day in terms of economic releases are Unemployment figures and the Bank of England minutes from U.K. at 9:30GMT or 4:30AM EST. Shortly after, Housing Starts and Import Prices from the U.S. will be announced at 13:30GMT or 8:30AM EST. Lastly, Federal Open Market Committee Meeting Minutes will be released at 19:15GMT or 2:15Pm EST. After a break of an asymmetrical triangle, the GBP/USD entered the Range Trading Zone established through the Bollinger Bands. With a temporary bounce due from the pair, the resistance level to watch is 20-day SMA at 1.5920. However, the downtrend will continue if the pair drops into the Sell Zone by breaking below 1st Standard Deviation at 1.5680.

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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.