US Dollar: Acts of Desperation?

Last updated 1/27/2009 5:06 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

• US DOLLAR: ACTS OF DESPERATION?
• EUR/USD: STRONGER ECONOMIC DATA KEEPS EURO BID
• GBP/USD: ABOVE 1.40
• NZD/USD: 100BP RATE CUT EXPECTED
• CAD: OIL PRICES DROP 8%
• AUD: BUSINESS CONFIDENCE IMPROVES
• USD/JPY: JAPAN ANNOUNCES PLAN TO BUY SHARES

EXPECTATIONS FOR UPCOMING FED MEETINGS

US DOLLAR: ACTS OF DESPERATION?

The Federal Reserve is currently holding a two day monetary policy meeting and it will be interesting to see whether they are desperate enough to introduce radical programs that can incite the enthusiasm of investors. With interest rates virtually at zero, a rate cut is not expected, but the central bank is under pressure to take further action. So far, their effort which includes 500bp of easing has helped to prevent the recession from turning into a depression but it has yet to stabilize the economy. The latest string of economic data indicates that the US economy is still on a downtrend and headed lower. The FOMC rate decision tomorrow could be a nonevent for the US dollar, but if the Federal Reserve is desperate enough, they still have the power to surprise the markets.

FOMC Rate Decision - 2 Analogies

There are two analogies that can help us understand the potential outcome for tomorrow’s rate decision. The Federal Reserve’s current position is similar to their situation in 2003, when interest rates were lower to 1 percent. At that time, rates were not expected to break the 1 percent level and the central bank made it known that their easing cycle had come to an end. From there on forward, until the market started speculating about the possibility of a rate hike, traders started to become indifferent to the Fed’s rate decisions since no changes were expected from the central bank. No changes are expected this time around so there may not be the same type of volatility that we have seen with past rate decisions. The second analogy is the Bank of Japan rate decision which investors hardly bat an eye at. For the FOMC meeting to matter, we will need to see acts of desperation from the Federal Reserve. Read our full FOMC Preview and see charts of previous FOMC price action at FX360.com .

Growing Problems in the US Economy

Incoming economic data certainly calls for acts of desperation. Consumer confidence fell to a record low in the month of January while house prices according to S&P/Case-Shiller dropped by the largest amount on record. The only way to move inventory in the housing market is to lower prices and even then, sales are exceptionally sluggish. It was not particularly surprising to see consumer confidence continue to weaken because job security is a major concern. Weak earnings have forced companies to continue to tighten their belts which have meant more layoffs or pay cuts. According to the Wall Street Journal, the unemployment rate of some states has hit or is close to hitting 10 percent. This includes Michigan (10.6%), Rhode Island (10.0%), South Carolina (9.5%), California (9.3%) and Nevada (9.1%). The nationwide unemployment rate is currently 7.2 percent and with the recent layoff announcements, there is a realistic chance that the unemployment rate could hit 9 percent. As former Fed Chairman Paul Volcker has warned, the US recession could enter extra innings. Therefore any rallies in US equities could be short-lived and we may soon see another wave of risk aversion.

EUR/USD: STRONGER ECONOMIC DATA KEEPS EURO BID

The Euro has held onto its recent gains thanks to a surprising rebound in German business confidence. Despite a recession in the Eurozone, the IFO index rose from 82.7 to 83.0. The Belgium Business Confidence index, which reported an improvement last week has once again proved itself to be a strong leading indicator for the German IFO report. The German government has announced an EUR80 billion stimulus plan which will help to stabilize the German economy while the European Central Bank cut interest rates in January. It may not be long before German business confidence resumes its downtrend however it will be difficult for German businesses to escape the same fate as their US counterparts. Global demand will continue to slow forcing many German corporations to cut costs and possibly even eliminate workers. The only saving grace is the fact that the EUR/USD has weakened materially since the beginning of the year. Seasonal factors are playing a big role in the weakness of the currency. In the beginning of the month, we talked about how the EUR/USD has fallen 8 times in the past 11 years during the month of January. So far, that trend appears to be repeating itself once again.

GBP/USD: ABOVE 1.40

The British pound was the best performing currency today, having rallied against the US dollar, Euro, Japanese Yen and Swiss Franc. We have long argued that the pound will be one of the best performing currencies when the dust settles and the global economy stabilizes because the UK government has been at the forefront of monetary and fiscal stimulus. Although the dust has far from settled and the UK economy remains weak, today’s better than expected economic data and the mild recovery in risk appetite has helped to drive the British pound back above 1.40. The CBI distributive trades survey rose from a record low of -55 in December to -47 for January. The gains in the survey were propelled by an increase of retail sales which were largely influenced by large discounts during the holiday season alongside cuts in the VAT tax rate. However, the confidence still remains bleak for the upcoming months as the majority of retailer’s expect a contraction in sales. The manufacturing sector, which has been hit the hardest is expected to receive some support from the government who announced that they are willing to lend approximately £2.3 Billion ($3.2 Billion) to automakers in order to cope with the recession. Another positive for the pound was the announcement from Barclays bank assuring that they will not be in need of a bailout from the government as record revenue will cover the write downs. There is a lack of economic indicators coming from UK until Thursday when House Prices are set to be released which are projected to decline. Yet, the housing prices are expected to contract at a slower pace than in previous months as a lower supply due to reduction in completions and starts will play a part in the recovery.

NZD/USD: 100BP RATE CUT EXPECTED

The commodity pairs were virtually unchanged against the dollar as prices of oil fell due to continuing weakness in the U.S. economy. The Reserve Bank of New Zealand is projected to lower its interest rates by 100 basis points tomorrow, reducing the rates by 425 basis points since June 2008 to 4.00%. An aggressive reduction in the interest rates has not been very effective for New Zealand as the economy is still projected to contract by 1.3% this year. The New Zealand economy is continuing to sink into a deeper recession as dampening exports hurt the labor market. Further, earlier in the month Standard & Poor’s revised the outlook on the credit rating to negative for New Zealand. The eroding situations within the country are likely guidelines that Reserve Bank Governor Alan Bollard could bring rates to 3% by the early summer. Australian business confidence rose from the lowest levels on record, yet still remaining in a negative territory for 12th consecutive month as further contraction in industries are expected to continue. Business confidence rose as a direct effect of aggressive rate cuts alongside a stimulus package focusing on reviving confidence within the country. The Producer Price Index rose stronger than anticipated as prices of imports were higher, reflecting the weakness in the Australian Dollar. The following might have a surprising effect on the CPI which is set to be released tomorrow. Deputy Prime Minister Julia Gillard stated that the government is ready to do more if the global recession will continue to deepen. So far, the government distributed A$8.7 billion ($5.8 billion) to families in order to supplement the rise in unemployment and a slump in consumer spending, while RBA is projected to lower its rates by additional 50 basis points in next week’s decision. Meanwhile the Canadian government has announced that they will post the first budget deficit in decades. The hope is that stronger spending will jolt the economy out of the recession as cuts in taxes and an increase in spending on infrastructure will boost the economy. Finance Minister Jim Flaherty stated that the fiscal plan will contribute to easing of credit markets as more funds will be available to businesses, building on guarantees of corporate debt and buying of mortgages from banks.

USD/JPY: JAPAN ANNOUNCES PLAN TO BUY SHARES

The Japanese yen was mixed today despite an announcement from the Japanese government that they proposing a plan to acquire stakes in companies that are struggling to raise capital. The plan is instrumented to purchase common and preferred shares in companies, while guaranteeing a portion of the investments if the companies file for bankruptcy. The goal is to slow the rise in the unemployment rate and possibly even help turn some struggling companies around. The policy is coming on the midst of a struggling economy which is expected to shrink by 1.8% this year, the biggest contraction in the economy since 1945. Further, talks of intervention in foreign exchange markets by Bank of Japan are continuing to remain as a possibility if the yen falls below 87.00 against the dollar. The Bank of Japan stated in the latest release of policy meeting minutes that they will continue to ease credit for companies, especially focusing on longer-term borrowing. The bank stated that it is considering taking steps to put a downward pressure on the corporate debt for which interest rates still remain high. Tomorrow, Japan is set to release its figures for Retail Trade which is expected to contract as consumer confidence and consumption are continuing to be affected by deepening recession.

AUD/USD: Currency in Play for Next 24 Hours

The currency in play for the upcoming 24 hours will be AUD/USD due to Westpac Leading Index from Australia released today at 23:30GMT or 6:30PM EST, followed by CPI at 00:30GMT or 7:30PM EST. Tomorrow, the Federal Reserve is expected to announce its interest rate decision around 19:15GMT or 2:15PM EST. After exiting the Sell Zone established through the Bollinger bands the day prior, the pair is on the verge of entering it once again, yet it still trades within Range Trading Zone. Current resistance is originating at the high of the day around 0.6720, which coincides with 20-day EMA. While support is placed at 0.6490, which is a 61.8% retracement of the lowest point reached in 2008 and the highest point reached in 2009. The pair might propose a continuation in a downward trend if it enters and closes within the sell zone which is structured below 0.6570. With a key economic release on the agenda for the upcoming 24 hours, it is likely that the pair will test either of the levels.

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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.