FX: GDP Not Likely To Help Dollar

Last updated 7/29/2010 4:48 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

• FX: GDP NOT LIKELY TO HELP DOLLAR
• EUR: FINALLY SUSTAINS ABOVE 1.30
• GBP: CURTAILED BY WEAKER HOUSING DATA
• NZD: RAISES RATES BY 25BP
• CAD: SURPRISE DECLINE IN PRICES
• AUD: GOLD AND OIL PRICES RISE
• JPY: BIG NIGHT IN JAPAN

EXPECTATIONS FOR UPCOMING FED MEETINGS

FX: GDP NOT LIKELY TO HELP DOLLAR

The recent price in the foreign exchange markets indicate that investors really want to sell U.S. dollars. Who can blame them when most economic reports show continued weakness in the U.S. economy, the central bank is sounding dovish while policymakers in other parts of the world are raising interest rates. Despite a better than expected jobless claims report, the dollar weakened against every major currency. In fact, on an intraday basis, the greenback fell to fresh 2 month low against the euro, 5 month low against the British pound and 6 month low against the Swiss Franc. Over the next 24 hours, the dollar could see additional weakness as we expect another round of weaker economic data.

Q2 GDP Report Not Likely to Help to Dollar

Second quarter GDP is scheduled for release on Friday along with Chicago PMI and the final University of Michigan Consumer Sentiment survey. The pace of growth is expected to slow slightly between the months of April and June but we believe that it may be weaker than the market’s current forecast of 2.5 percent. The second quarter was a particularly difficult time for consumer spending with retail sales falling two out of the three months. The first quarter in contrast saw a consistent increase in consumer spending. More than seventy percent of the U.S. economy is driven by consumer consumption and therefore the drop in retail sales should have taken a big bite out of growth. At the same time, in the month of May, the U.S. trade deficit ballooned to its largest level in 18 months. As a result, we do not expect the Q2 GDP report to help the dollar. Instead we expect it to add additional pressure on the greenback. Given the decline in manufacturing activity in the New York and Philadelphia regions, there is reasonable cause to believe that manufacturing activity in Chicago also slowed in the month of July. Another round of weaker economic data would only confirm the increasing pessimism within the Federal Reserve. Although the latest jobless claims report showed improvement in the U.S. labor market, it was cold relief as the amount of continuing claims rose by 1.8 percent to 4.565 million. The unemployment roll remains massive and it will take some time before it comes down from the stratosphere.

Not only are Fed officials growing more pessimistic, but an increasing number of policymakers within the central bank believe that deflation is a serious risk. One of the biggest stories in the financial markets today was the comments from Fed President Bullard, who is a voting member of the FOMC. He warned that the Fed’s current policies put the U.S. at risk of becoming “enmeshed in a Japanese-style deflationary outcome within the next several years.” He urged the Fed to increase asset purchases (Treasuries in particular) if deflation risk grows and called for a sharper departure from rate targeting. If there are any new shocks in the global economy, it may dampen inflation expectations even further, which could be very difficult to shake off. Bullard pointed to Japan who has tried “a lot of things that haven’t worked well.” In plain English, Bullard is calling for more quantitative easing to drive up inflation.   This view is also shared by Fed Presidents Rosengren, Yellen and Dudley. Yet, they are the minority and not the majority within the Federal Reserve. Fisher, who is a nonvoting member of the FOMC says that he does not see any deflationary net pressure and even Bullard agrees that the “most likely possibility from where we sit today is that recovery will continue through the fall, inflation will start to move up and this issue will all go away.” However his call for more stimulus is a backup plan in case the U.S. economy faces another negative shock.

Month-end Flows to Drive the Dollar Lower?

Finally Barclays put out an interesting report on month end flows that showed a significant jump in the capitalization of the U.S. equity market due to strong earnings and upbeat guidance. Bond market capitalizations also increased over the past month as yields fell to a record low on the more pessimistic outlook from the Federal Reserve. As a result, portfolio managers rebalancing existing currency hedges will need to sell dollars, particularly against the pound, Canadian and Australian dollars as the market capitalization in those countries saw little change. The market cap in the Eurozone and Japan increased but not as much as the U.S. which means that rebalancing flows still favor the dollar against those currencies.

EUR: FINALLY SUSTAINS ABOVE 1.30

The euro moved according to plan this morning, rising well above 1.30 and its prior resistance level of 1.3040 on the heels of a stronger than expected German labor market report. In yesterday’s daily, we talked about how this particular piece of economic data could be the driving force behind a sustained break above 1.30 and not only did the currency reach a new 2 month high, but it rose as high as 1.3107 intraday. However it did not take much to push the EUR/USD to current levels. All investors needed to see was the 13 ^th month of falling unemployment rolls and for the unemployment rate to dip to 7.6 percent, the lowest level since November 2008. It also helped that business, economic and services confidence improved in the Eurozone. German retail sales are scheduled for release tomorrow and we believe that the trend of positive surprises in economic data will continue with Friday’s report. According to Retail PMI, which was released by Markit earlier this morning, consumer spending saw its sharpest rise in month on month sales in July since November 2006. June was the first monthly rise in retail sales since May 2008.  Better weather conditions and World Cup spending were widely cited as factors that boosted retail sales. The fact that sales exceeded initial targets has made German retailers optimistic that next month’s sales will also be strong.  If the data surprises to the upside like we expect the EUR/USD should extend its gains to its next resistance level of 1.3135. Meanwhile the Swiss Franc rose sharply against the U.S. dollar and euro ahead of the KoF Swiss Leading indicator report. The better than expected UBS Consumption report favors strength in tomorrow’s release.

GBP: CURTAILED BY WEAKER HOUSING DATA

The British pound also extended its gains against the greenback despite weaker than expected U.K. housing market data. Nationwide reported the same drop in house prices as the Rightmove and RICS survey. According to their analysis, house prices fell 0.5 in the month of July, pushing the year over year rise down to 6.6 percent, the weakest since the beginning of the year. Net consumer credit also fell while lending on dwellings and mortgage approvals increased less than the previous month. The housing market data may not have prevented the pound from rising, but most likely held the currency back from enjoying the same degree of gains as the euro and Aussie. The only piece of U.K. economic data left to be release this week is the consumer confidence report scheduled for this evening. The market is looking for deterioration in sentiment which is possible but the pickup in retail sales means that even if confidence declines, it probably has not fallen by much. Next week will be a much busier one in the U.K. with enough economic data to determine if the pound will able to reach 1.58.

NZD: RAISES RATES BY 25BP

The New Zealand, Canadian and Australian dollars rose against the U.S. dollar despite the pullback in equities. As we wrote in last night’s daily, the Reserve Bank of New Zealand raised interest rates by 25bp but warned that they could forgo a rate hike at their next meeting. In his statement, Governor Allan Bollard noted that “the pace and extent of further official rate increases is likely to be more moderate than projected in the June statement.” This caused the NZD/USD to plunge immediately after the rate announcement but it made back all of its losses during the European and U.S. trading session. Although the RBNZ is slowing down and not likely to raise interest rates in September, at the end of the day, they are still one of only three major central banks normalizing monetary policy at this time. They are simply pausing and not ending their tightening cycle, which is in stark contrast to the U.S. central bank, who plans on sitting on its hands for the rest of the year. The smaller New Zealand trade surplus and surprise decline in Canadian raw material and industrial product prices left the kiwi and loonie completely unfazed. New Zealand building permits and Canadian GDP are scheduled for release tomorrow and we believe that Canadian growth slowed in the month of May.

JPY: BIG NIGHT IN JAPAN

The Japanese Yen strengthened against the U.S. dollar, British pound, Canadian and New Zealand dollars but weakened against the euro, Aussie and Swiss Franc. This mixed price action suggests that the recent concerns over a global economic slowdown and a possible double-dip recession have investors still seeking the safety of the Yen. Retail Sales rose 0.4 percent in June after the largest drop in five years in May. After spending 16 months in negative territory, Retail Sales have been on the rise since January of this year, mainly in response to the government’s stimulus measures for electronic appliances, energy-efficient automobiles and other durable goods. The upcoming expiration of the incentives in September and December pose a threat to the consumer spending rebound and ultimately to the nation’s fragile recovery from its worst post-war recession. The Japanese government has recently pledged to cap its spending for the next fiscal year at this year’s levels and the Cabinet has approved the budget guidelines yesterday. Many market watchers are now concerned that wages and employment seem to be lagging even though exports and growth forecasts have jumped ahead. Trade Balance figures released Sunday by the Ministry of Finance indicated that exports beat forecasts and that the trade surplus increased. The Bank of Japan recently increased its growth projection for the fiscal year which began in April up from its previous estimate of 1.8 percent to 2.6 percent, lining its view with that of the nation’s government, which raised its Gross Domestic Product projection from 1.4 percent earlier this year to 2.6 percent last month. In addition, the central bank estimated next year’s pace of growth to slow 1.9 percent, a sharp contrast with the 2 percent rise predicted earlier, and vowed to “maintain the extremely accommodative financial environment,” with the benchmark interest rate at 0.1 percent. Over the next 24 hours, we expect an array of economic data including Manufacturing PMI, Household Spending, the Core CPI, Industrial Production and Housing Starts figures. Household Spending fell for the past two months, and is forecast at its lowest point in 11 months. The Unemployment Rate has risen consecutively since March is expected to remain at last month’s reading of 5.2 percent in July.

EUR/USD: Currency in Play for Next 24 Hours

EUR/USD will be our currency pair in play for the next 24 hours. From the Euro-Zone, we expect German Retail Sales at 2:00 ET or 6:00 GMT, followed by the Eurozone Unemployment Rate and Consumer Price Index Flash Estimate at 5:00 ET or 9:00 GMT. The U.S. is set to release its 2 ^nd quarter Advance Gross Domestic Product at 8:30 ET or 12:30 GMT, followed by the Chicago Purchasing Managers’ Index at 9:45 ET or 13:45 GMT.

For the sixth straight day, the EUR/USD is trading within the Buy Zone, which we established using Bollinger Bands. The pair is currently in another upward channel. This recent rally can be seen as a minor correction to the major decline from earlier on this year. The most significant near-term support level is the psychologically important 1.3000, which the pair broke above today for the sixth time in the past two weeks. If the pair dips below this point, it can see support at the 1.2885 level, which held for the most part over the last two weeks and coincides with the 100-Day Simple Moving Average. The nearest level of significant resistance is at 1.3130, which is the pair’s 38.2% Fibonacci Retracement drawn from the November high of 1.5143 to the June low of 1.1876 and corresponds to the Upper Two-Standard Deviation Bollinger Band. If this level is broken, further resistance is expected at the 1.3275 level, which is both trendline resistance and a point at which previous lows were established.

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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.