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THE STORIES IN THE CURRENCY MARKET

• DOLLAR: IS BERNANKE IN DENIAL?
• EUR: FEARS RECEDE
• GBP/USD: NOT THE NEXT GREECE
• USD/CAD: BREAKS PARITY
• NZD/USD: RETAIL SALES DISAPPOINTS
• AUD/USD: CONSUMER CONFIDENCE SUBSIDES
• USD/JPY: VIX AND YEN CORRELATION REMAINS VOLATILE

EXPECTATIONS FOR UPCOMING FED MEETINGS

CURRENT US INTEREST RATE: 0.25%
	04/28 Meeting	06/23 Meeting
NO CHANGE	88.0%	81.9%
CUT TO 0BP	12.0%	11.1%
INCREASE TO 50BP	0.0%	7.0%
INCREASE TO 75BP	0.0%	0.0%

DOLLAR: IS BERNANKE IN DENIAL?

The U.S. dollar sold off against every major currency despite stronger than expected consumer spending in March.  Some people have blamed the weakness of the greenback on the rally in equities and the improvement in risk appetite but the sell-off in USD/JPY indicates that the real reason why the dollar is under pressure is because Bernanke refuses to turn hawkish.  Despite clear improvements in the labor market and retail sales, the Fed Chairman remains skeptical about their sustainability.  As result, we have seen the dollar slide against the euro, British pound, and all 3 commodity currencies.  It ended the day unchanged against the Japanese Yen but not before giving up earlier gains.  

Bernanke in Denial ?

In his Joint Testimony on the economy, Bernanke spent more time talking about the significant restraints on the economy, the potential for consumer spending to slow, the problems in the construction sector and the high level of unemployment.  His cautiousness may appear bizarre to many people who watched U.S. data consistently surprise to the upside.  Unfortunately we do not think that Bernanke’s denial is misplaced.  Like a good Fed Chairman, he wants to make sure that each improvement in the economy is sustainable before he decides to take another step to normalize monetary policy.  He is not questioning the trajectory of the U.S. economy but with the possibility of job growth being temporary and the difficulty of unemployed Americans to find jobs, he wants to see more positive reports before making another major announcement.  In fact, he even said “there is nothing that says the Fed couldn’t buy more mortgage backed securities.” For the time being, the Fed is committed to keeping interest rates at extremely low levels for an extended period of time.  Traders were hoping that Bernanke would telegraph a discount rate hike but instead, he suggested the Fed could still ease.  Interestingly enough, not all members of the FOMC share his dovish sentiments. The tone of the Beige book report was a bit more optimistic. Dallas Fed President Fisher also said there is way too much slack in the economy and so it is ready for a normalized discount rate.  Unlike Bernanke he believes that there is momentum in the economy but as a non-voting member of the FOMC, his views are far less meaningful than the Fed Chairman’s.  For the time being, rate hike expectations will be pared, limiting gains in the dollar.  

Beyond Retail Sales

With the U.S. economy returning to positive job growth and equities hitting 17 month highs last month, Americans celebrated by hitting the stores.  Retail sales rose 1.6 percent in March, against the market's 1.2 percent forecast. The March figures were not the only thing that gave the dollar its initial boost as consumer spending in February was also revised higher. Demand was particularly healthy for cars, auto parts, building materials, clothing and sporting goods.  In fact autos represented such a large part of last month's demand that retail sales less autos rose only 0.6 percent.  However the dollar gave up its gains despite the strong number as traders realized that even though consumer spending has grown 5 out of the last 6 months, retail sales in the first quarter was weaker than the fourth quarter which suggests that it will provide less contribution to Q1 GDP.  Inflationary pressures are also low to nonexistent, giving the Fed room to keep monetary policy easy.  Consumer prices rose only 0.1 percent, with CPI ex food and energy stagnating in March.  Tomorrow is another busy day for U.S. traders with jobless claims, the Empire State manufacturing survey, the Treasury International Capital flow report and industrial production scheduled for release.  Given that China turned its first monthly trade deficit in 6 years and their reserve growth is slowing, tomorrow’s TIC data will be particularly important in gauging Chinese demand for U.S. Treasuries.  Speculation of a Chinese Yuan revaluation has continued to escalate.  Yesterday Nouriel Roubini predicted revaluation as early as May and today, Goldman Sachs economist O’Neill predicted revaluation in a matter of days.  A fall in Chinese demand for Treasuries would be an example of what to expect when China revalues their currency.  

EUR: FEARS RECEDE

For the fifth trading day in a row, the euro extended its gains against the U.S. dollar.  Although nothing new has transpired in Greece over the past 24 hours, Greek bond spreads have fallen, indicating that the fears are beginning to recede.  Economic data was also better than expected with Eurozone industrial production rising 0.9 percent in February.  Despite a decline in German industrial production and no growth in France or Italy, faster manufacturing activity in smaller countries within the region has helped to drive Eurozone IP higher.  The ECB Monthly Bulletin is due for release tomorrow and we believe that the report will echo the overall cautiousness of the European central bank.  We would be very surprised if the EUR/USD managed to break its resistance level of 1.38 without the Greece situation being completely resolved.  So far, we are still hearing German officials downplay Greece’s need for aid but with their debt servicing costs at levels higher than what they would have liked, we believe there is still a very strong risk that Greece will activate the aid.  The EU has said they are ready to provide Greece the support if they ask for it.  ECB member Wellink admitted today that the change in their collateral rules was directly influenced by the developments in Greece.  The rule was changed to include debt rated down to BBB- so that Greek bonds would remain eligible.  If the nation’s debt is downgraded by one more notch, they would become ineligible.  

GBP/USD: NOT THE NEXT GREECE

The British pound rose strongly against the U.S. dollar despite a lack of economic data.  The currency pair has been lifted both by rising stock markets and easing concerns over the U.K. becoming the next Greece. The FTSE index shot higher to reach a 22-month high on much better-than-expected earnings releases. Furthermore, some economists have pointed out that the UK has been unfairly targeted as a potential candidate for the next debt crisis. A former-BoE official said that since “every political party has signed up for an austerity plan,” such that a hung parliament would not necessarily reduce government’s ability to pass through cost cutting measures. At this point, the party that resists will most likely suffer from political backlash. Therefore, since the Conservatives and Labour Party candidates have secured their platform as being one based on cost cutting, it is unlikely that a hung parliament will be as much of a calamity as some expected.

USD/CAD: BREAKS PARITY

All of the three commodity currencies rallied today, with special focus on the Canadian dollar which has unofficially closed below parity for the first time since July 2008.  This has been a long time in the making and the latest push to the downside will definitely serve to challenge recent rhetoric that indicates the Canadian government is comfortable with the rise in the loonie. Even though the currency broke parity, it gave back some gains after reaching 22-month highs earlier in the day. Since Canada released no economic data, the loonie’s rise has been facilitated purely by brighter US prospects and the risk tolerance that followed. In Australia, Westpac Consumer Confidence declined slightly but remained very close to last month’s three year high. This signals to many that consumers will remain resilient even in the face of higher interest rates. The number, which reached 63.6 percent, has risen more than 25 percent in the past year alone, mainly thanks to a strong job market. Australia has inflation expectations on tap for tomorrow.  Meanwhile New Zealand released Retail Sales fell short of expectations indicating that consumer spending declined significantly last month. Even though RBNZ officials have said that mid-year will mark the first rate hike, their timing looks overly optimistic at this point. The Business Performance of Manufacturing Index is being readied for tonight.

USD/JPY: VIX AND YEN CORRELATION REMAINS VOLATILE

USD/JPY is virtually unchanged on the day as the pair’s rally continues to stall. Yen weakness was apparent elsewhere, with AUD/JPY hitting a 19-month high. The yen has been gradually sliding as volatility levels subside to mid-2008 lows, a relationship that tends to hold in normal markets since lower volatility reduces safe haven demand. However, the VIX has declined more than 80 percent since its highest levels were hit during the worst of the financial crisis, and yet USD/JPY has failed to extend its gains. Even though the correlation has broken down, the question is if it will strengthen once again, an event that could mean big losses in the currency. Data has been extremely light so far this week, which probably explains the sideways price action in USD/JPY. Nevertheless, we have more in the pipelines in the form of Industrial Production and Capacity Utilization for tomorrow. The two indices could have critical implications for growth while excess slack indicated by capacity utilization could mean more deflation is on its way.

USD/JPY: Currency in Play for Next 24 Hours

USD/JPY will be the currency pair in play for the next 24 hours. Japan is set to release Industrial Production and Capacity Utilization at 12:30 am ET or 4:30 GMT. This will be followed by many events in the U.S. that include Jobless Claims and the Empire State Manufacturing at 8:30 am ET or 12:30 GMT, Industrial Production and Capacity Utilization at 9:15 am ET or 13:15 GMT, and the Philly Fed Survey at 10:00 am ET or 14:00 GMT.

USD/JPY has been relegated to a tight trading range in the past few days, keeping the pair firmly within the Bollinger band range trading zone. If today’s pullback results in a larger move to the downside, support rests at the 38.2% retracement from the early-March lows to the April highs at 92.24. For resistance, we are looking at the upper one-standard deviation Bollinger band at 93.91. The next level is not until 94.78, which is the high from April 4th. This is the resistance to really keep an eye on, since a break would signal that the USD/JPY rally has grown new legs. In addition, the recent doji candlestick formations that have formed with the past couple of days may signal the end of the USD/JPY retracement.

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.