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THE STORIES IN THE CURRENCY MARKET

• DOLLAR SOARS AS FED TALKS EXIT STRATEGIES
• EUR/USD: FEARS ABOUT ITALY
• GBP/USD: JOBLESS CLAIMS HIT 12 YEAR HIGH
• USD/CAD: EXTRAORDINARY MEASURES TO REMAIN IN ARSENAL
• AUD/USD: LEADING INDICATORS HIT 1 YEAR HIGH
• NZD/USD: GOLD PRICES FALL 1 PERCENT
• USD/JPY: BOJ FUTURE DEPENDS ON YEN

EXPECTATIONS FOR UPCOMING FED MEETINGS

CURRENT US INTEREST RATE: 0.25%
	03/16 Meeting	04/28 Meeting
NO CHANGE	55.9%	54.4%
CUT TO 0BP	44.1%	38.8%
INCREASE TO 50BP	0.0%	6.8%
INCREASE TO 75BP	0.0%	0.0%

DOLLAR SOARS AS FED TALKS EXIT STRATEGIES

Dollar bulls cheered as the minutes from the most recent FOMC meeting reveal that Fed officials have not only begun to discuss exit strategies, but are actually debating the specifics.  This discussion took place at the end of January, before the recent string of strong economic data which means the continued improvement in the U.S. economy will only strengthen the central bank’s desire to reduce their balance sheet.  In response to the hawkish minutes, the dollar soared against every major currency.  The biggest gains for the dollar were seen against the Japanese Yen and the euro, while the most resilient currencies were the Australian and Canadian dollars, which fell but not by much.  This type of power move in USD/JPY typically continues into the Asian trading session but fades by the end of following NY session which happened on August 7th and June 4th.  Although this price action could be repeated tomorrow, the prospect of stronger U.S. economic reports reduces that risk.

Fed Talks Exit Strategies

According to the minutes from last month’s monetary policy meeting the Federal Reserve discussed how and when to start unwinding their extraordinary stimulus.  The great depression caused the Fed’s balance sheet to balloon to $2.26 trillion, but with the economy stabilizing, some central bank officials are calling for asset sales in the “near future.” The Federal Reserve even upgraded their GDP forecast from 3.0 to 3.2 percent for 2010.  Despite their more optimistic growth outlook, unemployment is expected to remain high with the central bank increasing their jobless rate forecast from 9.5 to 9.6 percent.  However this has not stopped the members of the monetary policy committee from unanimously agreeing that the balance sheet would need to be reduced “substantially over time.” They even talked about specific changes to the language of the statement, replacing the word “purchases” of mortgage backed securities with “holdings.”  According to the report, “Most judged that a future program of gradual asset sales could be helpful” to shrink the balance sheet, while some officials were concerned about disrupting financial markets and the economy, the minutes said. “Several thought it important to begin a program of asset sales in the near future,” including spreading sales “over a number of years.”  The tone of the FOMC minutes is similar to that of Federal Reserve Chairman Ben Bernanke who surprised the markets by talking about exit strategies last week.  The minutes also provided more details on why Fed President Hoenig wanted to adjust the language about keeping interest rates low for an “extended period.” He wanted the Fed to say that rates would remain low for some time and be open to setting expectations for higher rates in the near future.  Monetary policy members also agreed that they should think about lifting the discount rate soon which would also be a precursor to a hike of the overnight lending rate.  Overall, the minutes reveal that the Federal Reserve is growing more hawkish at a time when central banks in the Eurozone and the U.K. have to remain dovish because of inflation or fiscal concerns, which is why the dollar has performed so well today.  

Economic Data Preview and Review

Producer prices, the Philadelphia Fed index and leading indicators are due for release tomorrow.  Stronger reports are expected all around following this morning’s hotter import prices and Monday’s stronger Empire State survey.  Import prices rose 1.4 percent compared to the market's 1.0 percent forecast. According to the report, higher petroleum and industrial supply prices boosted inflationary pressures last month and we expect tomorrow's producer price report to be affected by the same price pressures. Housing starts rose 2.8 percent to 591k, a 6 month high while building permits fell 4.9 percent. Building permits are usually a leading indicator for the housing market which suggests that even though the housing market is doing well now, it could deteriorate in the future. Industrial production also rose 0.9 percent last month, the strongest since August - manufacturing activity was especially robust in the automotive industry. Capacity utilization rose to the highest level in over a year and the decrease in excess slack supports the tightening telegraphed by Fed.

EUR/USD: FEARS ABOUT ITALY

The euro gave back all of its gains against the U.S. dollar, amidst fresh concerns about fiscal deficits and stronger U.S. data.  Interestingly enough it was not Greece that drove the euro lower but Italy.  Nobel Prize winner Robert Mundell, who is also considered the “father of the euro” said in an interview today that Italy and not Greece is the biggest threat to the euro.  With a 120 percent debt to GDP forecast by the IMF this year, compared to a 108 percent forecast for Greece, “Italy has to be worried” according to Mundell.  The Italians have gone out of their way to separate themselves from the PIGS and European officials have been careful not to lump them together because Italy is a much larger player within the Eurozone than Greece.  Italy’s owes 25 percent of the total debt outstanding for the Eurozone.  Therefore if Italy were to succumb to the same criticism as Greece, it could push the euro below 1.30.  However Italy has also not been lumped together with Greece, Portugal or Spain because their budget deficit is about half and there private savings rate is high.  Nonetheless it’s a country to watch because deteriorating finances will weigh on the euro.  Meanwhile the Eurozone trade balance rose from 4.0B to 4.4B in December.  On a seasonally adjusted basis, the improvement was even better with the trade surplus rising from 5.3B to 7.0B.  There are no Eurozone economic reports due for release tomorrow but Switzerland will be releasing their trade balance and ZEW survey.  

GBP/USD: JOBLESS CLAIMS HIT 12 YEAR HIGH

Considering the weakness of this morning’s U.K. employment report and the neutral to dovish tone of the minutes from this month’s Bank of England meeting, one would expect a more dramatic sell-off in the British pound or at least a sell-off that is comparable to the move in the EUR/USD.  Instead, the pound fell less than 1 percent against the U.S. dollar and actually strengthened against the euro despite the news that jobless claims rose 23,500 last month to a 12 year high.   There are now 1.64 million Britons who find themselves on the jobless roster. However, despite the gains in claims, the unemployment rate held steady at 5 percent while Average Earnings actually increased at a wider margin than expected. The other big deflator to the pound’s rally came from the Bank of England’s minutes. While the minutes did show that the decision to keep asset purchases unchanged was a unanimous one, BoE officials still held that further stimulus was not out of the question. Overall, like Mervyn King said last week, the bank seems to find that it is “far too soon” to pull out. The board kept the status quo because they did not find an “overwhelming risk of inflation being below the target over the forecast period.” However, the bank has made it clear that they are more worried about long-term prices and remain convinced that the recent spike in inflation is only temporary. Data for tomorrow comes in the form of Mortgage Approvals and Public Sector Net Borrowing.

USD/CAD: EXTRAORDINARY MEASURES TO REMAIN IN ARSENAL

All commodity currencies are pulling back today with the loonie declining for the first time in six trading days. The aussie pulled back only after reaching a new monthly high as gold makes a small move to the downside. In Canada, David Longworth, the BoC Deputy Governor, confirmed the bank’s intentions to keep rates at a record low through mid-year. This is despite his feeling that financial conditions had greatly improved. He notes that even though the bank is starting to pull back on extraordinary monetary measures, the techniques will remain in the banks “tool kit” when formulating future policy. Overall, today’s commentary was not exactly deserving of what many see as a healthy and outperforming economy. Meanwhile, the Canadian Wholesale Sales index rose for the fourth straight month but fell short of last month’s figure. Six out of seven of the indicator’s components reported improved performance. Tomorrow presents the much anticipated Consumer Price Index, which should hold substantial clout as to whether the BoC’s timeline for a hike gets expedited. Australia reported its Westpac Leading Index which rose to the highest in more than a year. Quarterly NAB Business Confidence is due for release tomorrow.

USD/JPY: BOJ FUTURE DEPENDS ON YEN

USD/JPY posted big gains today and came very close to reaching a new monthly high. In fact, it is the selling off in the yen that will give the Bank of Japan enough ammunition to keep all programs and lending facilities on hold for at least another month. However, the future of the bank’s policies will be even more linked to the currency’s fluctuations than ever. For one, a higher yen means that imported prices are less expensive, thereby intensifying the deflationary spiral. Secondly, even though government intervention into BoJ decisions has been subdued, it is likely that they will look toward the bank for more assistance if the yen makes new gains. Government pressure is already mounting with the Japanese Finance Minister Kan recently proposing that an inflation target of 1 percent be set for conducting future policies. This signals another attempt by the governement to gain influence over the bank’s decisions since it is traditionally the central bank that sets these bands. Today’s Tertiary Index made it even clearer that the drivers of the Japanese economy are not coming from within. The services index dropped at the quickest rate in nine months signaling that domestic demand is still contracting. Obviously, for Japan, it is an export driven recovery. We are awaiting the BoJ rate statement tonight followed by the Leading Index tomorrow.

USD/CAD: Currency in Play for Next 24 Hours

USD/CAD will be the currency pair in play for tomorrow. In Canada, we have Consumer Prices at 7:00 am ET or 12:00 GMT followed by International Securities Transactions at 8:30 am ET or 13:30 GMT. In the US, we are expecting Producer Prices at 8:30 am ET or 13:30 GMT and the Philly Fed Survey at 10:00 am ET or 15:00 GMT.

Despite today’s gains, USD/CAD is still well within the Bollinger band sell zone. Resistance looks really strong at the 50% retracement from mid-January lows to February highs at 1.0500. We can see both the lower one standard deviation band and the 50-day moving average all within a stone’s throw of that level. The pair could gain traction at the 61.8% retracement at 1.0435. In addition, the lower two standard deviation Bollinger band should provide further support since prices have bounced off the band for two days straight. Despite strong support and resistance, tomorrow’s data could provide the catalyst for a break.

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.