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Dollar Unfazed By Fed Timeline For Rate Hike

Last updated 2/26/2010 5:34 PM ET (GMT -5) 3 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• DOLLAR UNFAZED BY FED TIMELINE FOR RATE HIKE
• EUR/USD: SHORT POSITIONS HIT RECORD HIGH
• GBP/USD: BOE MEETING NEXT WEEK
• USD/CAD: CURRENT ACCOUNT DEFICIT NARROWS
• AUD/USD: RBA COULD RAISE RATES NEXT WEEK
• NZD/USD: GOLD AND OIL PRICES UP
• USD/JPY: NO RELIEF IN DEFLATIONARY SPIRAL

EXPECTATIONS FOR UPCOMING FED MEETINGS

DOLLAR UNFAZED BY FED TIMELINE FOR RATE HIKE

Based upon the price action in the foreign exchange market today, the snow storm in the Northeast has not kept U.S. traders away from their desks.  There were some decent sized moves in the forex market throughout the North American trading session with the euro rallying aggressively against the U.S. dollar following the existing home sales report only to give back those gains around lunchtime.  Although the rally in equities was relatively mild, it was enough to improve risk appetite in the forex markets.  As a result, the dollar traded lower against the every major currency except for the British pound which has not been able to rally for the past 8 trading days.

Fed President Gives Timeline for Possible Rate Hike

We were a bit surprised that the currency market completely shrugged off Federal Reserve President Evan’s comments on monetary policy.  The central bank has said repeatedly that interest rates will remain low for an extended period of time but no one was willing to put a timeframe on when they would actually raise interest rates.  For the first time however, Evans gave us something to work with. In an interview with CNBC, Evans said an “extended period of time (to him) means 3 to 4 FOMC meetings.”  Considering that Evans is generally perceived as one of the more dovish members of the FOMC, his timing for rate hikes should not be ignored. Three to four FOMC meetings from now puts us in June.  This means the Fed could be looking to raise rates at their June, August or September meeting.  This is in line with our internal timeframe for an end of the third quarter, beginning of the fourth quarter rate hike.  Although any rate hike from the Fed will be very nimble at first, they will still be one of the more aggressive central banks this year.  Before raising interest rates, more normalization will have to occur which will probably be accompanied by hawkish comments. We expect the dollar to continue to rise in the coming months.  

Big Week Ahead for the Forex Market, Watch out for EUR/USD Short Squeeze

In the meantime, it will be a very busy trading week in the forex market with 4 central bank meetings, the non-farm payrolls report and a variety of manufacturing and service sector data on the calendar.  This means that relative growth or economic divergence should become a leading driver of the forex markets.  Based upon the rise in jobless claims, February should have been another month of net job losses.  The labor market is Bernanke’s biggest concern and unfortunately his fears may not be alleviated by next week’s report.  With the Beige Book also due for release, we will get a lot of updated information on the state of the U.S. economy.  Meanwhile short euro positions hit another record low on the futures market according to the Commitments of traders report.  With short positions at such extreme levels, the risk of a reversal or short squeeze is very high.  At this point, any piece of good European news or bad U.S. data could cause EUR/USD bears to square their shorts, take profits and run.   

Weakness beneath the Headlines, China is Still World’s Top Holder of Treasuries

Hopefully today's U.S. economic reports will not be sign of what is in store for next week. Fourth quarter GDP was revised up from 5.7 to 5.9 percent, the strongest pace of growth since Q3 of 2003. Chicago PMI also rose from 61.5 to 62.6, the highest level since April 2005. Although manufacturing activity in the Chicago region may appear to be booming thanks to a strong backlog of orders and increase in supplier deliveries, weakness beneath the headlines is the story of the day.  For GDP, personal consumption was revised down along with the price index. According to the Chicago PMI report, employment growth slowed materially in February along with production and new orders Also, not all news was good news. The University of Michigan consumer confidence survey was revised down from 73.6 to 73.7 and existing home sales plunged 7.2 percent in January to 5.05 million units, the lowest level since June. With new and existing home sales falling sharply in the first month of the year, the tightness of credit has become a serious issue for prospective home buyers.  On a side note, the Treasury released revisions to its Treasury International Capital flow report and according to the numbers Japan did not surpass China as the world’s largest holder of U.S. Treasuries after all.  In December, China’s holdings of Treasuries totaled $894.8B (compared to a prior estimate of $755B) while Japan’s holdings totaled $765.7B (compared to a prior estimate of $755B.  

EUR/USD: SHORT POSITIONS HIT RECORD HIGH

For the third trading day in a row, the euro recovered against the U.S. dollar as the lack of positive Eurozone economic data failed to stop the euro from rising.  Instead, weaker U.S. economic reports and overstretched short euro positions triggered end of week profit taking.  As we mentioned earlier, short euro positions are at record highs. The data was from Tuesday and chances are that positioning has not changed all that much considering that the EUR/USD came within a whisker of its 9 month low on Thursday.  Consumer prices were soft with CPI in the Eurozone falling 0.8 percent in January.  It appears that consumer price pressures also remained muted in Germany with CPI rising only 0.2 percent.  On an annualized basis, CPI growth slowed from 0.8 to 0.3 percent but nonetheless inflation has increased, which is in line with the rise in German producer prices.  The big event next week is the European Central Bank meeting. Interest rates will be left unchanged at 1.00 percent but as usual, ECB President Trichet’s comments could trigger volatility in the EUR/USD.  When the ECB met earlier this month, Trichet attempted to downplay the situation in Greece by saying they are on the right track but it failed to pacify investors because he also admitted that EU deficits could “burden” or influence monetary policy. If he over emphasizes this message, it will reflect on their reluctance to raise interest rates.  Aside from the rate decision, German and Eurozone retail sales are also due for release.  According to the retail PMI report, February was an ugly month for retailers.  

GBP/USD: BOE MEETING NEXT WEEK

The British pound is once again the weakest link in the forex market.  It was the only currency that failed to rally against the U.S. dollar and it even hit a record low against the Aussie.  We have written at length about why the British pound is underperforming and next week, we will get confirmation on whether the aggressive selling is warranted.  Like the ECB, the Bank of England is scheduled to deliver a monetary policy decision.  Interest rates will be left unchanged at 0.25 percent and the Quantitative Easing Program at GBP 200 billion.  However there is a tiny risk of more QE and a big risk of dovish comments from the central bank.  Earlier this week, BoE officials were exceptionally dovish and who can blame them?  Unemployment hit 12 year highs and retail sales fell by the most since February 2009.  According to the Confederation of British Industry, consumer spending recovered in February but with policy members talking about the softness of the economy and more QE earlier this week, there is no reason why their outlook would have changed in such a short period of time.  Fourth quarter GDP was revised from 0.1 to 0.3 percent thanks to higher private consumption and government spending.  Considering that the U.S. economy grew by 5.9 percent during the last 3 months of the year, these figures are far from impressive.  If anything, they raise more questions about the relative performance of the U.K. economy.  House prices also dropped 1.0 percent in February which is a bit worrisome considering that housing is supposedly the strongest part of the economy.  In addition to the BoE rate decision, PMI numbers are also due for release along with producer prices.  

USD/CAD: CURRENT ACCOUNT DEFICIT NARROWS

The Canadian, Australian and New Zealand dollars recovered against the greenback thanks to the improvement in risk appetite.  Although Canada’s current account deficit narrowed slightly, the decline was less than the market had anticipated and the data confirms that trade could hinder growth this year just as Bank of Canada Governor Carney predicted last month.  Australian private sector credit increased by 0.4 percent which is not surprising considering that the Australian economy has performed extremely well.  Both Canada and Australia have monetary policy meetings next week and vastly different outcomes are expected.  Bank of Canada officials have been cautious since the last meeting where they left interest rates unchanged and announced that a strong currency and weak U.S. demand will keep QE intact.  The central bank also revised down their GDP and inflation forecast.  They have no plans to raise interest rates until June at the earliest.  Based on the recent comments from RBA Governor Battelino, Australian policy makers could raise interest rates next week.  According to Battelino, the economy is still running on all cylinders and the rise in Australian dollar is a good thing for the economy.  More specifically, he said the mining boom that is currently underway could last beyond 2020 and the boom is expected to lift investment and terms of trade more than in the past.  He also believes that the growth potential of China and India suggests that the demand boom will last longer.  Therefore monetary policy needs to be extremely disciplined at this time because every past mining boom has fueled inflation.  As a result, the rise in the Australian dollar is important because it is helping to contain inflation.  In other words, not only will the RBA raise interest rates again but they also want the Aussie to rise.   There is no meaningful data from New Zealand, but aside from the rate decisions, Canada has GDP and IVEY PMI numbers due for release while Australia has PMI and retail sales on tap.  

USD/JPY: NO RELIEF IN DEFLATIONARY SPIRAL

USD/JPY is quickly approaching new 2-month lows as the pair declines for the fifth out of the last six trading days. However, the release of Consumer Prices makes the yen’s rally a bit questionable on a fundamental basis. Prices have fallen consistently for the eleventh month as core inflation shrank by the most on record. Of course, the stubbornness in the yen is only aggravating the situation. As expected, Finance Minister Kan took the opportunity to push for more BoJ support in the government’s deflation fighting efforts, saying that they should do what they can and “make an effort.” Kan promises that he is stepping up plans on his own end. It remains questionable how long the BoJ will be able to fend off government prodding, especially with the yen reengineering its descent. Nevertheless, as bad as the inflation data looks, currency and equity markets seemed to overlook it in favor of the more optimistic data that was released today. Retail Sales unexpectedly gained for the first time in a year and a half while Industrial Production posted its eleventh straight gain. In addition, Construction Orders rose strongly for the second straight month while Housing Starts beat expectations. Next weeks schedule is highlighted by Monday’s Jobless Rate and Household Spending.

USD/CAD: Currency in Play for Next 24 Hours

The currency in play for Monday is USD/CAD. Canada will announce its Gross Domestic Product numbers at 13:30GMT or 8:30AM EST. The U.S. will release personal spending and income data at the same time.  Shortly thereafter, the ISM Manufacturing report will be released at 15:00GMT or 10:00AM EST. USD/CAD has been trading in relatively tight range for the past few months. Without a consistent trend, the currency remains in the Range Trading Zone which we establish using Bollinger Bands. Current support looms at lower first standard deviation at 1.0460; if the level is broken we can expect a move towards this year low. Meanwhile, resistance hovers at upper first standard deviation at 1.0660; a break above will push the pair to test the highs of the year.  

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Comments (3)

FXDragon

February 27, 2010 at 02:53 AM ET

You say eur could rise on short squeeze. I guess i'll short it then:)

alexjbrandt

February 27, 2010 at 09:25 AM ET

For the last 3-4 days, the EUR/USD short squeeze rallies have been happening around 15:00 GMT and usually runs out of steam around 15:55 GMT. Then eventually reverses...just my observations.

hsbc

March 01, 2010 at 12:41 AM ET

congrats. finally u get it right. but i am thinking if u have been actually buying ... hahah

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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.