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US Dollar: Could Politics Derail the Greenback?

Last updated 2/3/2009 5:38 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: COULD POLITICS DERAIL THE GREENBACK?
• EUR/USD: ABOVE 1.30 BUT FOR HOW LONG?
• GBP/USD: STRONGER SERVICE PMI COULD DRIVE GBP/USD ABOVE 1.45
• AUD/USD: AUSTRALIAN DOLLAR SOARS ON STIMULUS PACKAGE AND RATE CUT
• NZD/USD: EMPLOYMENT NUMBERS ON TAP
• CAD/USD: OIL PRICES STABILIZE AT $40.97 A BARREL
• USD/JPY: JAPAN ANNOUNCES NEW PLAN TO BUY BANK SHARES

EXPECTATIONS FOR UPCOMING FED MEETINGS

US DOLLAR: COULD POLITICS DERAIL THE GREENBACK?

The US dollar traded lower today as safe haven demand subsided.  New fiscal stimulus has been announced in Australia and Japan leading US investors to hope that similar help is around the corner.  The full Senate is expected to vote on the $885 billion stimulus package this week and the prospect of a swift approval is having a big impact on the currency market.  Politics is overshadowing economics and in that same vein, any delays in getting the money into the hands of Americans could derail the greenback. In the meantime, let us take a look at the day’s positive and negative developments:

The Good News – Pending Home Sales, Daschle Withdrawal, Fed Announcement

For the first time since September, the number of contracts for purchasing new homes has increased.  Although the data can be fairly volatile, the rebound suggests that we could see a similar rise in existing home sales. The US housing market has experienced a serious beating and any improvements are certainly a welcome development.  However, given the state of the US economy and the recent layoff announcements, it would be unrealistic to believe that we have seen a bottom in the US housing market. Health care stocks led the S&P500 higher following news that Senator Tom Daschle has withdrawn his nomination to be secretary of health and human services.  The reforms that he had proposed would have hurt the profitability of health care companies and the rally in stocks drove the EUR/USD and GBP/USD higher.  The Federal Reserve also extended their liquidity facilities and swap lines from April 30 to October 30th.  These facilities make up the alphabet soup of initiatives announced by the Federal Reserve over the past few months including the Commercial Paper Funding Facility (CPFF) and the Term Securities Lending Facility (TSLF).   

The Bad News – Vehicle Sales

As for the bad news, Ford and General Motors announced that car sales remained very weak in the month of January.  Ford reported that only 93,506 vehicles were sold, which is a 40 percent drop from the prior year.  General Motors reported a 50 percent decline in car sales while Chrysler expects a 35 percent decline in sales.  Despite help from the government, the nation’s largest auto makers are surviving but not thriving.  GM and Chrysler have resorted to offering their employees cash and vouchers to buy new cars as incentives for them retire or leave the company.  Congress has set a Feb 17 deadline for the automakers to show that they can survive in this market as a part of terms of a $17.4 billion bailout.  

Shifting to Non-Farm Payrolls

The currency market’s focus should begin shift to Friday’s non-farm payrolls report as the leading indicators for NFPs start to come in. On Wednesday, payroll provider ADP will be reporting private sector employment change, Challenger will be reporting the amount of layoffs while the Institute of Supply Management (ISM) will be releasing their report on service sector activity.  If all 3 numbers point to a weaker non-farm payrolls report, there is a decent chance that more than 550k Americans may have lost their jobs in the month of January.  Since ADP has its flaws, we will be keeping our eye on the employment component of service sector ISM which has a very strong correlation with non-farm payrolls.  

EUR/USD: ABOVE 1.30 BUT FOR HOW LONG?

An improvement in risk appetite and the expectation that the European Central Bank will leave interest rates unchanged on Thursday has driven the EUR/USD above 1.30.  ECB President Trichet has been very vocal about his plans to delay the next interest rate cut to March and as a central banker who likes to prepare the markets for any imminent decisions, his warning should be heeded.  However inflationary pressures continue to fall and that will push the ECB to bring interest rates down to 1 percent.  Producer prices for the Eurozone fell 1.3 percent on a month to month basis, driving the annualized pace of PPI growth to 1.8 percent.  Rising unemployment is also pushing consumer demand lower and softer demand should translate into even lower prices.  Trichet’s comments on inflation or deflation on Thursday will provide some clues on how much further the central bank plans on lowering interest rates.  German retail sales fell 0.2 percent in the month of December.  The market had actually been looking for a rise, but consumer spending has taken a bit hit from the deterioration in the labor market.  Tomorrow’s Eurozone retail sales report is expected to follow German retail sales lower.  The Euro has recovered nicely after hitting a low of 1.27 yesterday, but the gains could be fleeting if Trichet makes some overly dovish comments or if developments in the US cause a turn in risk appetite.  

GBP/USD: STRONGER SERVICE PMI COULD DRIVE GBP/USD ABOVE 1.45

Like the Euro, the British pound has rebounded against the US dollar but the difference with the British pound is that the UK reported an improvement in construction sector PMI.  Although the index increased from 29.3 to 34.5, the construction sector is still contracting, albeit at a slower pace.  After falling to the lowest level in 11 years, a rebound is not surprising but unless we have a recovery in the overall economy, we may not see a meaningful bottom in the housing market.  Nonetheless positive data has been bullish for the British pound and a rebound in service sector PMI on Wednesday could drive the currency pair above 1.45.  So far, we have already seen an improvement in manufacturing and construction sector PMI and that increases the odds of an improvement in the service sector index.  The UK consumer has also been surprisingly resilient.  Retail sales were positive 2 out of the last 3 months as Britons took advantage of discounts and incentives.  

AUD/USD: AUSTRALIAN DOLLAR SOARS ON STIMULUS PACKAGE AND RATE CUT

The Australian government is taking no chances with the economy.  In addition to cutting interest rates by 100bp to 3.25 percent, they announced a $42 billion stimulus package aimed at creating jobs and reviving the housing market.  The Australian dollar has performed strongly today as the government’s aggressive fiscal and monetary measures help to bolster confidence.  Although Australia has been less affected by the global slowdown, they are in no way immune. The trade balance narrowed significantly in the month of December as exports declined.  The Reserve Bank of Australian will continue to cut interest rates to prevent the country from falling into a downward spiral but the size of the rate cuts may start to get smaller.  Retail sales and service sector PMI are due for release this evening.  The smaller decline in employment and the rebound in the sales component of December service PMI suggests that consumer spending may have actually increased in December.  Meanwhile the New Zealand and Canadian dollars also gained strength despite the lack of economic data.  New Zealand has employment numbers due for release on Thursday which should be weak given the decline in the Manpower index.

USD/JPY: JAPAN ANNOUNCES NEW PLAN TO BUY BANK SHARES

The rally in the Dow drove all of the Japanese Yen crosses higher except for USD/JPY which suggests that the recovery in risk appetite is mild at best.  In another step to boost the domestic economy, the Bank of Japan announced that they will buy ¥1 Trillion or $11.1 Billion of financial institution shares in order to increase their capital. The purchase plan is expected to last until April 2010 and the shares are planned to be held until mid-2012. The purchase plan, which has been used before is aimed at getting banks to lend. The program is a safety net for banks, which have seen their balance sheets erode during the global recession. The BoJ stated clearly that they are not expecting to boost up the stock market which has depreciated over 40% last year, but instead their goal is to increase lending within the economy. The program proved to be efficient before when their share-buying program helped to stabilize the financial system between 2002 and 2004. Yet, with the industrial sector still struggling as demand plunges and economic indicators showing no sign of relief, the BoJ is allocating most of its resources to stop the economy from deteriorating further. The program is coming at an opportune time as domestic spending continues to weaken as corporations start to lay-off workers, Labor Cash Earnings support the claim as it declined for the third consecutive month. Japan has no important announcements until the end of the week.

EUR/GBP: Currency in Play for Next 24 Hours

The currency in play for the upcoming 24 hours will be EUR/GBP.  U.K. PMI Services is scheduled for released at 9:30GMT or 4:30AM EST, followed by Euro-zone’s Retail Sales at 10:00GMT or 5:00AM EST. After an impressive rally in the second half of last year, the pair rebounded lower and seems to be in an intermediate downtrend, currently lingering in the Range Trading Zone established through Bollinger Bands.  If the down trend persists, a break of 1st Standard Deviation of Bollinger Bands will place the pair within the Sell Zone and below current support, originating at 0.8945. Nevertheless, the trend will be negated upon the break of resistance which is a 20-day SMA at 0.9120. With an increase of volatility in past year, either of the levels could be tested with tomorrow’s economic figures.

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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.