USD: Expect More Housing Weakness

Last updated 7/19/2010 5:20 PM ET (GMT -5) 0 Comments - Add your comment

Forex Trading involves high risks, with the potential for substantial losses and is not suitable for all persons. Past performance is not necessarily indicative of future results.

Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• USD: EXPECT MORE HOUSING WEAKNESS
• EUR: SHRUGS OFF IRISH AND HUNGARIAN WOES
• GBP: WHY IT IS UNDERPERFORMING EUR
• CAD: BANK OF CANADA SET TO RAISE RATES
• AUD: RBA MINUTES ON TAP
• NZD: SERVICE ACTIVITY ACCELERATES
• JPY: STRONG YEN HURTS ECONOMY

EXPECTATIONS FOR UPCOMING FED MEETINGS

USD: EXPECT MORE HOUSING WEAKNESS

It has been a quiet start to a busy trading week with equities consolidating after Friday’s sharp losses and the dollar trading mixed against other major currencies. The greenback strengthened against the pound, Japanese Yen, Canadian and New Zealand dollars but weakened against the euro and Australian dollar. The lack of market moving economic data explains the lack of follow through and reversals in forex market. However traders should consider this the calm before the storm because with a heavy earnings week, two testimonies by Federal Reserve Chairman Ben Bernanke and the EU stress test results set for release on Friday, it should be anything but quiet.

Expect More Weakness in Housing

At the onset of the U.S. recovery, the housing market and the manufacturing sector, which were the first to be hit by the recession were also the first to recover. However the recovery has been uneven and recent data indicates that without the government tax credit, the real estate sector would still be in the red. Many people will beg to differ and argue that the sector remains very depressed, which is true in many ways but the point that we want to make is that this week’s data will most likely show additional signs of weakness. The National Association of Home Builder confidence survey (NAHB) was the only piece of U.S. data released today and unfortunately the report showed confidence slipping to the lowest level in 15 months. Readings below 50 indicates that pessimism exceeds optimism which means this month’s reading of14 from a downwardly revised reading of 16 the previous month is exceptionally bad. According to the NAHB Chairman “We continue to see a lull in home buying activity following the expiration of the federal home buyers tax credit program as many of the sales that would have occurred this summer were likely pulled forward to meet the program’s deadline.” “In addition, builders are reporting continuing hesitancy regarding home purchases due to uncertainty in the overall economy and job markets.” The softness in housing is expected to be confirmed by tomorrow’s housing starts and building permits numbers. Even though the Obama Administration extended the home buyer tax credit to September 30 ^th , this only applies to closings. The contracts still needed to be signed by April 30 ^th .

The stability in the forex market and the rally in U.S. equities can also be attributed to optimism about this week’s earnings reports. IBM is scheduled to announce this evening followed by Apple, Yahoo, Goldman Sachs, Morgan Stanley and Pepisco on Tuesday. Coca-Cola and Ebay’s reports are scheduled for Wednesday followed by earnings from companies such as American Express, Caterpillar, AT&T, Microsoft and Amazon on Thursday. So far earnings reports have not been as weak as many had feared and so investors are optimistic ahead of these key releases.

EUR: SHRUGS OFF IRISH AND HUNGARIAN WOES

The euro extended its gains against the greenback despite a breakdown in talks between Hungary and the IMF and news that Moody’s downgraded Ireland’s debt rating from Aa1 to Aa2. The resilience of the euro in the face of weakness in other currencies suggests that hedging related exporter demand continues to support the currency. Concerns about the effectiveness of Hungary’s austerity programs caused the IMF to pull out of bailout-loan talks which have put at risk their ability to tap into the EUR20 billion rescue package negotiated in 2008. If the IMF and Hungary do not come to agreement by September, Hungary could face further downgrades. After this news broke, rating agency Moody’s said their rating for Hungary assumes an agreement later this year and this is “bad news.” They still believe that an agreement will be achieved but at least we are aware of consequences in case it doesn’t. Over in Ireland, rising debt, weaker growth and the risks in the banking sector have caused Moody’s to downgrade Irish debt. The outlook is stable which means further downgrades are not being considered at this time. Part of the reason why the market shrugged off the news is because the downgrade brings Moody’s rating in line with Standard & Poor’s and is slightly above Fitch’s levels. Considering that Moody’s rating for Italy is 2 notches higher than that of S&P, we would not be surprised if they were the next one to fall under the knife. Meanwhile the latest current account numbers showed deterioration in trade. The current account deficit rose from –EUR5.6B to –EUR5.8B with the nonseasonally adjusted deficit doubling in the month of May. Construction output also fell significantly, indicating weakness in the housing sector. German producer prices are scheduled for release tomorrow. According to Bloomberg, Hypo Real Estate Holdings in Germany is said to have failed the government’s stress test. They are expected to be the only German bank to fail, but they will not collapse because they have been taken over by the government who will not let them fail.

Impact of EU Stress Tests on Euro

For the better part of this year, the exacerbation and settling of concerns surrounding balance sheet problems in Europe has commanded the volatility in the financial markets. This Friday, it is believed the EU bank stress test results will give euro bulls the green light to take the currency above 1.30 and perhaps as high as 1.35. In fact, risk appetite in general hinges upon the outcome of the stress tests.   For currency traders, the most important question is how the results will impact the EUR/USD. The hope is that it will provide the same support to European Financial markets as the U.S. tests did for the U.S. Yet it is important to realize that the results of the U.S. bank stress tests did not help the U.S. dollar. In fact, the greenback has sold off aggressively against both the euro and Japanese Yen since May 7 ^th , 2009. Of course, the weakness of the dollar was a reflection of easing safe haven flows and not concerns about the U.S. banking sector exacerbating. In fact, the performance of U.S. stocks confirms that the stress tests were a big success. Therefore as long as the results provide sufficient answers to the top 5 questions outlined above, the EUR/USD should receive a nice boost following the announcement. However if any of the 5 questions are insufficiently addressed and we think this is a significant risk, there could be a classic buy the rumor sell the news move in the EUR/USD that causes it to give up recent gains.

GBP: WHY IT IS UNDERPERFORMING EUR

Unlike the euro, the British pound extended its losses from Friday, pushing the currency to a fresh 6 week low against the euro.  EUR/GBP is currently flirting with 85 cents and a meaningful close above that resistance level would pave the way for a move to 86 cents. Since the end of June, EUR/GBP has been in a persistent uptrend that reflects more aggressive short covering in euros versus pounds. In fact, the latest IMM data from the CFTC shows that as of last Tuesday, futures traders were net short 27,050 EUR/USD contracts versus 34,671 GBP/USD contracts. Compared to the prior week, EUR/USD shorts decreased by 30 percent while GBP/USD shorts declined by only 9 percent. This relative change in positioning explains why the British pound has underperformed the euro. It also suggests that at some point, the trend will reverse as euro net shorts become net longs and pound traders cover their positions more aggressively. No economic data was released this morning but Rightmove reported on Sunday that for the first time this year, house prices decreased. The country’s largest online property website also forecasted a 7 percent drop in prices in the second half of the year, which would wipe out the entire year’s gains. This dismal forecast is the main reason why the pound continued to give up its recent gains. Public sector finances, mortgage approvals, CBI business optimism and Trends Total orders report are scheduled for release tomorrow and the market expects mixed results.

CAD: BANK OF CANADA SET TO RAISE RATES

The Canadian and Australian dollars appreciated against the greenback while the New Zealand dollars gave up more gains despite a rise in service sector activity.  International Securities Transactions was the only piece of Canadian data this morning and typically this is a number that does not receive much attention from the market, except for the fact that foreigners bought Canadian dollar denominated securities at a record pace in May.  Net purchases totaled CAD$23.156B compared to CAD$12.361B the previous month.  Demand for stocks, bonds, and government securities were particularly strong in Canada following the record amount of job growth in April.   The Bank of Canada is scheduled to make a monetary policy announcement tomorrow and everyone expects the BoC to raise rates.  Since the last monetary policy meeting in June, when the BoC raised rates by 25bp which was the first move since April 2009, the economy has stabilized and concerns about the European debt crisis have receded.  This should give the central bank confidence to normalize monetary policy. Aside from solid job growth that has taken the unemployment rate down to 7.9 percent, the lowest since Jan 2009, there is still evidence of weakness in the Canadian economy.  Yet the data still indicates that the economy will grow above trend and that uncertainty is receding, which reduces the need to leave monetary policy at emergency levels.  Signs of slower growth outside of the labor market suggest the BoC will remain cautious. Even if they raise rates by 25bp to 0.75 percent like the market expects, they will most likely err on the side of caution and warn that a September rate hike is still undecided.  Further gains in USD/CAD will probably be limited ahead of tomorrow's rate decision.  There is an outside risk of the BoC leaving rates unchanged and if that occurs, the Canadian dollar could come under aggressive selling.   The Reserve Bank of Australia will also release the minutes from their July monetary policy meeting. The tone of the minutes will play a big role in the sustainability of the gains in the Aussie.

JPY: STRONG YEN HURTS ECONOMY

Although the Japanese Yen gave up some gains against the U.S. dollar, Euro and loonie, it appreciated against the British pound, New Zealand dollar and Swiss Franc. This mixed price suggests that with the recent uncertainty sparked by disappointing economic data from the United States and tension over the Euro-zone’s bank stress test results, investors are still seeking the safety of the Yen. On Friday, the Bank of Japan released its monthly report of recent economic and financial developments. The BOJ noted that economic conditions are “severe” but maintained its positive view that the Japanese economy is likely to recover at a moderate pace. The central bank stated that the nation’s recovery is “induced by improvement in overseas economic conditions” and that “the uptrend in exports and production is expected to continue, although the pace of increase is likely to moderate gradually.” There is increased speculation today that the Bank of Japan may intervene in the Forex markets to stop the Yen from reaching its highest level against the dollar, in an effort to prevent any interference with the nation’s recovery from its worst postwar recession. A stronger Yen leads to increased costs for Japanese goods to other nations, which, in turn, would result in decreased demand, ultimately hurting Japan’s largely export driven economy. A stronger currency would also hinder efforts to tackle the world’s largest public debt, at 883 Trillion Yen or 9.7 Trillion Dollars. A BOJ official stated today that the Yen’s recent uptrend against the Dollar and the Euro are due to “growing fears about the outlook for the U.S. and European economies.” The unnamed official added “If the Yen keeps rising, BOJ officials may become more concerned over whether exports will really continue to grow and prop up the economy” and mentioned that the central bank may take action if the yen hovered “around the 85 level against the dollar for one or two months.” Policymakers eased policy back in December through a fixed-rate lending scheme due to political pressure and a sudden surge in the Yen’s strength against the dollar above the 85.00 level. The Yen neared this level on Friday, hitting a high of 86.26 and continues to remain below the 87.00.

USD/CAD: Currency in Play for Next 24 Hours

USD/CAD will be our currency pair in play for the next 24 hours. The United States is set to release its June Building Permits and Housing Starts figures at 8:30 ET or 12:30 GMT. From Canada, we expect the Bank of Canada’s Interest Rate decision and statement at 9:00 ET or 13:00 GMT.

Falling for the first time in three sessions, USD/CAD is currently trading within our Range Trading zone, which we established through the Bollinger Bands. Near term resistance for the pair is placed at 1.0580, the pair’s 61.8% Fibonacci Retracement drawn from the May high of 1.0853 to the June low of 1.0138. If this level is broken, the 1.0700 level would provide further resistance as it is the 78.6% Fibonacci Retracement which proved efficient in May. The closest level of support is at the 1.0411 level, the pair’s 38.2% Fibonacci Retracement which coincides with its 200-Day Simple Moving Average. If this support is broken, the 1.0300 level which held last week should hold as it is also the pair’s 100-Day Simple Moving Average.

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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.