All Trade Ideas and trading scenarios found on FX360.com are hypothetical. FX360.com has not placed these Ideas in a live trading environment. Forex Trading involves high risks, with the potential for substantial losses that exceed your initial deposit and is not suitable for all persons. Past performance is not necessarily indicative of futures results.

Dollar: Why It Is Not Threatened By Euro Rally

Last updated 2/19/2010 4:51 PM ET (GMT -5) 11 Comments

• Share this:

Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• DOLLAR: WHY IT IS NOT THREATENED BY EURO RALLY
• EUR/USD: SHORT EURO POSITIONS EXPLODE
• GBP/USD: RETAIL SALES PLUMMET
• AUD/USD: RATES TO RISE TO NORMAL LEVELS
• USD/CAD: CONSUMERS INCREASE SPENDING
• NZD/USD: GOLD AND OIL PRICES UP
• USD/JPY: SHIRAKAWA FIGHTS BACK

EXPECTATIONS FOR UPCOMING FED MEETINGS

DOLLAR: WHY IT IS NOT THREATENED BY EURO RALLY

The sharp recovery in the EUR/USD has traders across the globe confused about why the dollar gave up its gains against the euro if normalization of U.S. monetary policy should be positive for the dollar.  Given that the euro was not the only currency to strengthen against the greenback, the price action in the forex markets is clearly indicative of a short squeeze, especially after the CFTC revealed that short euro positions hit the highest level ever on Tuesday.  The EUR/USD has been oversold for some time but the drop to a fresh yearly low proved to be a capitulation point that triggered end of the week profit taking. Some people have attributed the move to an improvement in risk appetite, but with U.S. equities posting marginal gains and USD/JPY ending the day unchanged, we question this possibility.  The larger portion of the rally in the EUR/USD did not really begin until 11:55am NY Time, 5 minutes before the 12:00 fix.  It is also option expiration Friday which tends to trigger unusual price action in the forex markets.

The Dollar is Not Threatened by Euro Rally

The recovery in the euro poses little threat to the dollar’s rally because fundamentally, the Eurozone is in worse shape than the U.S.  In terms of economic data, we have seen many upside surprises in U.S. reports over the past 2 weeks while Eurozone economic reports are still anemic.  Due to the Maastricht Treaty, Eurozone nations are under greater pressure to rein in their deficit than the U.S. who is not mandated to adhere by an official debt ceiling.  This suggests that Eurozone nations will probably have to be more aggressive about instituting hard measures to rein in their deficits than the U.S. which could lead to slower growth in the Eurozone.  Greece’s problems have fallen to sidelines but they have certainly not gone away.  The market is still waiting for Greece to provide details on their credit default swaps (at the time of publication, Greece has yet to send a report to the Eurostat).  As for monetary policy, the Fed has begun what will be a continuous process of unwinding extraordinary measures.  The ECB on the other hand has warned that the fiscal problems in member nations could affect monetary policy by slowing the implementation of exit strategies.  In other words, the central bank (Fed) that is normalizing monetary policy faster should see greater upside pressure on its currency. The outlook for interest rates is the number of driver of currency fluctuations.  Federal Reserve President Ben Bernanke is scheduled to deliver his semi-annual testimony on the monetary policy and the economy next week.  We expect Bernanke to talk more about exit strategies and express a cautiously upbeat outlook on growth which should also help the dollar.  Bernanke’s testimony will be the biggest event risks for the currency market next week but, the U.S. calendar also includes the release of confidence, housing, and durable goods data along with the second fourth quarter GDP report in which no major revision is expected.   The U.S. consumer price report was released this morning and CPI rose less than the market’s forecast but more than the previous month.  Price pressures came primarily from higher energy costs because excluding food and energy, CPI fell 0.1 percent.  The lack of inflation on the consumer level will not affect the central bank’s plan to continue normalizing monetary policy and if anything, the Fed may cite the rise in producer prices as a reason to tighten.  

Fed Puts Their Faith in Banks to Borrow and Lend

The question going forward is whether the higher penalty to borrow at the discount window will be enough to encourage banks to lend to each other. Last week, primary credit borrowing at the discount window was only $15 billion compared to a peak of $110 billion in October 2008. Yet if banks were reluctant to borrow from each other and from the Fed before the discount rate hike, it is questionable whether the hike will change things. Of course the Fed also raised the discount rate because they want to stop adding money to the financial system. By increasing the penalty for borrowing from the Fed, they have in essence encouraged banks to borrow from each other, recycling money that should already be in the financial system. Therefore the Fed's announcement raises just as many questions as it answers. Nonetheless it should be a major driver for the dollar until the next monetary policy meeting in March.

EUR/USD: SHORT EURO POSITIONS EXPLODE

After hitting a fresh yearly low of 1.3440 during the Asian trading session, the EUR/USD recovered all the losses that it incurred following the Fed announcement.  Eurozone economic data was mixed with service sector activity slowing and manufacturing sector activity expanding.  In Germany, manufacturing activity is still chugging along but the service sector, which has benefitted less from the stimulus is struggling to maintain its prior momentum.  Growth in services slowed for the second month in a row, falling to the weakest level since last September.  The current account balance on the other hand was relatively healthy which is not surprising considering that manufacturing is driving the region’s recovery.  Inflationary pressures are also on the rise with German producer prices increasing 0.8 percent last month. Although we are still waiting for Greece to provide details on their swaps, there are no scheduled meetings or policy developments on Greece next week.  Instead, we have a heavy economic calendar that includes the German IFO report, unemployment numbers, confidence and consumer prices.  Greece will still remain in the background unless breaking developments bring it forward. Even if they fade completely, it will be some time before investors will be willing to jump back into euros.  Meanwhile traders on the futures markets have increased their short euro exposure to the highest level ever on Tuesday.  Therefore today’s price action can mostly be attributed to end of the week profit taking. Finally Switzerland will be releasing their employment numbers and UBS Consumption Index next week.  EUR/CHF remains trapped in a tight trading range that will remain intact for the time being.  

GBP/USD: RETAIL SALES PLUMMET

Like the euro, the British pound fell to a fresh 9 month low against the U.S. dollar.  However unlike the euro, the pound failed to recover its losses because the outlook for the U.K. economy has deteriorated rapidly.  Apparently the U.K. economy is extremely sensitive to weather conditions.  We learned yesterday that heavy snowfalls at the beginning of the year prevented prospective homeowners from finalizing their mortgage approvals and today we saw that it also kept consumers out of the stores. U.K. retail sales fell 1.2 percent in the month of January, the sharpest decline in 11 months.  Spending in December was already very weak and the disappointing numbers in January spells more trouble for the U.K. economy especially after the horrid employment numbers that were released earlier this week - if you recall, jobless claims hit a 12 year high.  The recent disappointments should cause the British pound to underperform all of the other majors because the data validates the dovishness of the Bank of England who left the door open to further easing.  Next week, the U.K. economic calendar is relatively light with only the fourth quarter GDP report due for release.  However GDP numbers are always significant.  The market expects GDP growth to be revised be upwards but we doubt that it will provide any relief for the British pound.

AUD/USD: RATES TO RISE TO NORMAL LEVELS

The commodity currencies are in recovery mode after yesterday’s losses. The Canadian dollar in particular, managed to close in on new monthly highs, thanks in part to a 1.0 percent gain in crude. RBA Governor Glenn Stevens continued the worldwide hawkish frenzy by proclaiming that rates have not yet reached normal levels. Stevens says that “further adjustments to monetary policy will probably be needed.” The RBA is officially switching its focus to “managing an economic expansion”, an approach that puts preventing prices from overheating at the top of the RBA’s list of concerns. However, Stevens still notes that the high currency is managing to offset some of the inflationary pressures that would otherwise be seen. Overall, however, today’s comments were distinctly bullish and signals that rates may be on the mend in the not too distant future. Australia has Private Capital Expenditures and Construction Work Done on tap for next Thursday. In Canada, a climb in Retail Sales presents new evidence in the resiliency of the Canadian Consumer. Sales rose 0.4 percent after falling 0.3 percent the prior month. We also saw the release of Leading Indicators which rose for the eighth straight month but failed to meet expectations. Data for next week is surprisingly limited, with only Current Account to fill the empty schedule on Friday. New Zealand is preparing the release of the RBNZ’s Inflation Expectations Index on Wednesday and their Trade Balance on Thursday.

USD/JPY: SHIRAKAWA FIGHTS BACK

USD/JPY breaks a three day rally as traders take profits after one of the strongest weekly gains since December. Bank of Japan Governor Masaaki Shirakawa fought back earlier attempts at more government involvement in the bank’s decisions by saying that officials should put more focus on getting fiscal conditions in order. Shirakawa finds that “it’s important to gain the trust of financial markets by showing a path for financial consolidation.” Finance Minister Naoto Kan, who originally proposed that the bank follow an inflation target, backed down, stating that both government agencies are “pointing in the same direction”. However, it remains clear that the government is interested in affecting monetary policy as putting into place strict fiscal controls would abandon voters who were promised more spending. Japan currently has one of the highest debt-to-GDP ratios of the industrialized world. Economic data came in the form of the All Industry Activity Index, which fell -0.3 percent, offering negative implications for growth. Next week opens with the release of the BoJ’s Minutes from this week’s rate decision and will be followed by the Merchandise Trade Balance on Tuesday, Consumer Price Index on Thursday, and Housing Starts on Friday.

USD/JPY: Currency in Play for Next 24 Hours

The currency in play for Monday is USD/JPY. Japan’s Supermarket Sales are due at 5:00GMT or 12:00AM EST, followed by Convenience Store Sales at 7:00GMT or 2:00AM EST.  The U.S. will release Dallas Fed Manufacturing Activity at 15:30GMT or 10:30AM EST. USD/JPY is trading well within the Buy Zone which we determine using Bollinger Bands. The pair is on a verge of testing the 200-day SMA at 92.30, if the level is breached the price could climb to the next level of resistance which is represented by the 78.6% retracement of this year’s low and high at 92.65. Any decline in USD/JPY should be limited to 90.90 which is the first standard deviation Bollinger Band and the 50-day SMA.  

The information, including Commentary and Trade Ideas, provided on FX360.com should not be relied upon as a substitute for extensive independent research which should be performed before making your investment decisions. Global Forex Trading and FX360 .com is merely providing this information for your general information. The information and opinions presented do not take into account any particular individual’s investment objectives, financial situation, or needs. All investors should obtain advice based on their unique situation before making any investment decision and should tailor the trade size and leverage of their trading to their personal risk appetite. Any projections or views of the market provided by FX360.com may not prove to be accurate.

The views of the authors and analysts are not necessarily those of Global Forex Trading, its owners, officers, agents or other employees. FX360.com and the currency research team will not be responsible for any losses incurred on investments made by readers and clients as a result of any information contained on FX360.com. Global Forex Trading and the currency research team do not render investment, legal, accounting, tax, or other professional advice. If investment, legal, tax, or other expert assistance is required, the services of a competent professional should be sought.

• Share this:

Comments (11)

rmsuleman

February 19, 2010 at 10:25 PM ET

K, what is fixed @ 12:00 EST in NY?

klien

February 22, 2010 at 09:51 AM ET

A Fix is when banks set an official reference price, often on a daily basis, for the trading of a particular commodity or currency. This fixed price is used for anything that requires exchange rate transactions.

Keith Jones

February 20, 2010 at 02:21 AM ET

Hi Kathy,

Just to slightly fine tune your analysis; the bulk of the move in EUR/USD (and other pairs), occured at 11:00 EST. This is exactly the time that Tiger Woods got up to make his apology, live on CNBC. Any connection do you think? (LOL).

Semaj

February 20, 2010 at 03:43 PM ET

Usd/Jpy, a run to 97.50 in the upcoming weeks?

MoneyManager

February 20, 2010 at 07:24 PM ET

I wouldn't expect that much in "in the upcoming weeks", but I would expect it before the end of the year. It's a matter of probabilities of course, and the way I see the situation at the moment is range bound between about 89 and 93. The interesting thing about the pair to me is that I think the bottom half of that range represents excellent risk/reward. I do not see the November low being reached, let alone broken. I believe in order for my opinion to be proven wrong, we would have to see risk aversion on a truly massive scale, a scale as great or greater than we saw at the end of '08 and early in '09. Even with that once-in-a-generation flight away from risk a year ago, 88 held with the exception of a single close. The recent low in November appears to have been a climax event, and even then it was two big (albeit very big) daily bars down, followed by an immediate snap right back above 88.

For the medium to longer TFs, 88 is a *key* number, and only a violation followed by a failure swing below 88 can invalidate this. For all the growling from the bearish side on this pair, they haven't been able to penetrate this number *and* *make* *it* *stick*. The sell offs on the rebounds are simply trend followers making what has been at least until now the obviously correct play.

But no trend lasts forever, and this one is showing obvious signs of evaporation. In fact, there has really been zero long term trend in the pair since late September or early October. Yes, you can zoom out and still visualize a downtrend, but newer bars have more significance than older bars, IMHO, the reason concepts like WMA and EMA were developed in the first place. A six-month view of this pair can produce only a range-bound conclusion. A six-month consolidation prior to a resumption of the downtrend? It's possible. But the proof is more and more shifting to the bearish camp, as they increasingly seem unable to make that downtrend resume.

All that said, the US economy probably has better prospects going forward than that of Japan. US rates, as many already suspect, *should* elevate before Japanese rates, which will probably be among the last on planet Earth to be raised. The US dollar can lose ground continually among the other majors, as it has over the past decades, but still gain ground against the yen.

The defensive line should be clear at 88. You have to be prepared to lose to that level, and below. You can't discount the possibility of being wrong completely. There is still risk of course, and if you believe, as I do, that the pair has the potential to approach 100 in 9 to 15 months, to get that reward you need to avoid being blown out of the water by taking on too much risk.

Exactly how this will unfold is impossible to know of course. We could still see a number of range-bound swings, or if sentiment more quickly comes to the conclusions I have reached, it could move to the mid or upper 90s rather quickly. And of course, I could be absolutely wrong on the direction here.

I like the pair here because I really think that if I'm wrong, the pair just scrapes along near present levels, rather than resumes a stark downtrend. So I like the risk/reward, as I've said. Doesn't mean I'm right, but obviously I like my chances here.

MoneyManager

February 20, 2010 at 11:19 PM ET

I meant to add one more thing: Most Japanese companies close their books for the fiscal year on March 31, which is coming up fast. Prior to that, you may see yen buying as companies repatriate earnings, which reduces the likelihood of an affirmative answer to your initial question.

maibinglong

February 20, 2010 at 11:55 PM ET

It seems that when there is an excessively one sided position in the futures maket that you provide regular warnings regarding the potential of a reversal. For the Euro, it appears some unwinding likely took place on Friday based on the increase - what is the likelihood of this bullish pullback continuing before becoming a bear again - where are the key resistance levels that will promote a trend change and resume the decline?

FXDragon

February 22, 2010 at 01:58 AM ET

Funds are still selling yen. And will probably continue until further notice.

Sincerely,

hsbc

February 22, 2010 at 03:58 AM ET

but usdjpy is falling ...

FXDragon

February 22, 2010 at 06:27 AM ET

Good morning,
Patience please. Monday morning profit taking in progress....

Semaj

February 22, 2010 at 07:41 AM ET

A series of lower highs & lows on a daily chart was broken in early Jan. If the recent low of 88.54 holds @ a 61.8 fib then sometime in mid March we could see 97.50 as a higher low will be in place on a long term plan.

Add Your Comment

Please login to post a comment or sign up for an FX360® account.

Loading...

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.