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WHAT IS BEHIND THE DOLLAR RECOVERY?

Last updated 12/18/2008 5:31 PM ET (GMT -5) 0 Comments - Add your comment

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• USD: WHAT IS BEHIND THE DOLLAR RALLY?
• EUR/USD: SURPRISED BY THE ECB
• GBP/USD: SHARP REVERSAL DESPITE STRONGER SPENDING
• USD/CAD: LARGEST DECLINE IN RETAIL SALES SINCE SEPT 2006
• AUD: WEAKER ECONOMIC DATA, LOWER GOLD PRICES
• NZD: OIL PRICES AT $36 / BARREL
• USD/JPY: MARKET DIVIDED ON RATE CUT OR INTERVENTION

EXPECTATIONS FOR UPCOMING FED MEETINGS

USD: WHAT IS BEHIND THE DOLLAR RALLY?

After seeing the US dollar sell off for 5 straight days against the Euro and Japanese Yen, we were not entirely surprised to see today’s recovery, especially on the heels of better than expected economic data.  The market has become accustomed to disappointments so good news was a welcome change.  The European Central Bank has also reduced the interest rate that it offers to banks that deposit with them in order to encourage lending.  The 15 percent rally in the Euro has led many to people to believe that the ECB may reconsider their plan to hold interest rates steady in January and the deposit rate cut was seen as a step in that direction.  Thin market conditions near the holidays have exacerbated the volatility in the currency market.  However even though the greenback is higher today, we had both positive and negative news impacting the dollar.  

The Good News: Better Data, Oil at $36, More Stimulus on the Way

The Philly Fed index and jobless claims were better than expected, but the improvements still masked underlying weakness.  New orders singlehandedly drove the Philly Fed index higher as sharp deteriorations were seen in the other 8 subcomponents.  Even though the number of people claiming unemployment benefits still rose by more than 500k last week, the rise was less than the previous period, which suggests that the hemorrhaging in the labor market is slowing.  However that has not stopped weekly claims from hitting a new high.  There was also news that Obama’s economic team is looking to push through a stimulus package worth up $775B over the next two years.  This package should play a big role in helping to turn the US economy around.  Oil prices have also fallen to a 4 year low of $36 a barrel, which represents a 75 percent decline from its record high. In may not be long before we see gasoline prices at $1.50 a gallon.  Lower oil prices acts as a tax cut for consumers and should help to improve consumer spending.  

The Bad News: GE AAA Rating at Risk, Pessimistic Comments from Fed Official

Aside from the fact that the good news masked underlying weakness, more worrisome reports have hit the corporate sector.  Leading indicators fell to the lowest level in 4 years on the back of a sharp rise in jobless claims and decline in US equities.  Standard & Poor’s revised General Electric’s rating outlook from stable to negative, which suggests that GE’s AAA credit rating may be at risk.  A company’s credit rating is directly tied to their cost of borrowing and their overall health.  GE’s problems center on their financial unit which was hit hard by the credit crisis.  All Big 3 automakers have also announced that they will idle a number of their plants over the next month, reflecting the severity of their financial situation.  Despite the recent rate cut, Fed officials remain very pessimistic about the outlook for the US economy.  Fed President Fisher expects the US economy to continue to contract in 2009, driving the unemployment rate past 8%.  Having leaned towards hawkishness in the past, Fisher’s dovish comments are particularly alarming.  However Greenspan expects the economy to rebound in 6 to 12 months, but of course he is no longer involved in US monetary policy.

EUR/USD: SURPRISED BY THE ECB

In Wednesday’s Daily Currency Focus, we talked about the consequences of the Euro rally.  More specifically, we argued that the Euro’s rally over the past 2 weeks was driven by the possibility that the ECB may leave interest rates unchanged in January but now that the Euro has appreciated more than 14 percent, they may reconsider holding interest rates.  The surprise announcement by the ECB today fueled the dramatic reversal in the Euro as it suggests that the central bank may indeed be toning down their recent hawkishness.  The central bank cut the deposit rate that they offer to commercial banks who stash their cash at the central bank while at the same timing increasing the interest rate on emergency loans.  These tactics are aimed at getting banks to lend and suggests that they are still very worried about the credit markets. They should also be worried about the economy as German business confidence plunges to the lowest level in more than 25 years.  Overall, the Eurozone economy is still very weak and the strength of the Euro will only shave growth further.  If the exchange rate remains above 1.40 going into next month’s rate decision, then the ECB may have to cut interest rates again. Meanwhile German producer prices are due for release on Friday.  Given the sharp drop in wholesale prices, we continue to expect inflationary pressures to ease.

GBP/USD: SHARP REVERSAL DESPITE STRONGER SPENDING

The British pound plunged against the both US dollar and Euro today.  The worst performing currency pair was the GBP/USD which fell more than 3 percent or close to 500 pips. Having rallied for 9 consecutive trading sessions, EUR/GBP continued to hit new a record high.  Interestingly enough, the weakness in the currency came despite the fact that retail sales rose for the first time in 3 months. The market had expected consumer spending to contract, but instead it rose by 0.3 percent thanks to demand for food and discount goods.  The retail sales numbers can be volatile – we would need to see at least 2 consecutive months of positive retail sales to believe that positive consumer spending is here to stay.  Meanwhile, the Times of London has reported that UK Chancellor Darling may announce a major stimulus package for the banking sector next month.  The UK government has been at the forefront of monetary and fiscal stimulus and because of that, we would not be surprised to see new measures aimed at thawing the UK credit markets.

USD/CAD: LARGEST DECLINE IN RETAIL SALES SINCE SEPT 2006

The Canadian, Australian and New Zealand dollars plummeted as the dollar rises and commodity prices fall.  Oil and gold prices are down sharply with the former falling to the lowest level in 4 years.  Canadian economic data was weak with leading indicators falling for the third month in a row and by the largest amount since 1991.  Retail sales also dropped 0.9 percent, which was the largest contraction in consumer spending since September 2006.  Earlier this week, Bank of Canada Governor Carney said that the country has entered its first recession since 1992 and today’s data certainly confirms that.  The only good news was that foreign investment into Canada rebounded in the month of October after falling for 3 consecutive months.  Demand was particularly strong for government bonds. Prime Minister Jim Flaherty also stated that he is intending to cut taxes further in the upcoming fiscal year, along with increasing pressure on banks to lend more credit.   Consumer prices are due for release tomorrow and given the sharp decline in industrial and raw material prices, inflation should ease as well.  Meanwhile Australia reported a weak Westpac Survey of Industrial trends suggesting that manufacturing sector is feeling the pressure of a global recession. New Zealand’s government along with the central bank announced an agreement to keep the goals of lifting incomes and living standards in place. In order to achieve the goal, the central bank is setting an objective to keep the inflation between 1% and 3% annually. Business Sentiment in New Zealand has also continued to weaken reflecting current state of the economy.   

USD/JPY: MARKET DIVIDED ON RATE CUT OR INTERVENTION

It has been a while since so much attention has been paid to the Japanese Yen.  With the Bank of Japan monetary policy announcement due this evening, the market is divided on whether the BoJ will cut interest rates and if they will physically intervene in their currency.  There is about a 50/50 chance of a rate cut from the BoJ. Interest rates are already very low, but the strength of the Yen and the weakness of the economy may encourage them to take the drastic measure of cutting interest rates to 0.15 or 0 percent.  Physical intervention is only a minor possibility because it would counterproductive to global efforts.  Japan’s problems are not something that they can fix by simply weakening the Yen.  US demand for Japanese exports will not recover until the US economy recovers.  For the Japanese to artificially weaken the Yen and strengthen the dollar may hurt the US and Japanese economy more than it helps.  They are beginning to try verbal intervention, but so far it hasn’t seen strong results.  Therefore cutting rates could be a way to weaken the Yen without resorting to physical intervention.  

USD/CAD: Currency in Play for Next 24 Hours

The currency in play for the upcoming 24 hours is USD/CAD. Consumer prices are due for release from Canada at 7:00AM or 12:00GMT. After a drastic sell-off from triple top, the pair still remains within the Sell Zone of the Bollinger Bands. Current support level is forming at the bottom of previous day’s close which is around 1.1820. The resistance is placed between 1.2200 and 1.2245, which are 2nd Standard Deviation of the Bollinger Band and 50-day SMA, respectively.  Further, the resistance is a 50% retracement of October high and November low.  With a bias to the downside, a break of key resistance level will negate the downtrend, and possibly reverse the pair. While a break of the support will generate a further deterioration in the price.

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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.