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Dear Fed, Desperate Times Call for Desperate Measures?

Last updated 9/16/2011 5:20 PM ET (GMT -5) 1 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• DEAR FED, DESPERATE TIMES CALL FOR DESPERATE MEASURES?
• EUR: RISKS FOR THE EURO
• GBP: BOE MINUTES TO REVEAL LITTLE
• CAD: BIG BENEFICIARY OF DOLLAR DUMP
• NZD: Q2 GDP DUE NEXT WEEK
• AUD: GOLD PRICES REBOUND
• It has been a mixed day for the Japanese Yen which traded higher against the euro and Swiss Franc but weakened against all of the other major currencies. With no major economic data released last night, 76 continues to be rock solid support for USD/JPY as investors worry about the possibility of intervention. Earlier this week, there was chatter that the BoJ could be checking rates but with USD/JPY not seeing any fresh moves to the downside, the central bank could hold off on further intervention. However this may not b enough for general populous. The Japanese ruling party called on the Finance Ministry and the Bank of Japan to strengthen their ties and work together to address the Yen’s rise. They want the central bank to ease monetary policy appropriately and to establish a fund to address the problems caused by the Yen’s rise. The Cabinet is scheduled to release their monthly economic report next week and it will be interesting to see if their sentiment has changed. We also have leading indicators, department store sales, and the trade balance scheduled for release. Although these numbers are important in gauging the overall health of the Japanese economy, USD/JPY will take its cue from the FOMC meeting.

EXPECTATIONS FOR UPCOMING FED MEETINGS

DEAR FED, DESPERATE TIMES CALL FOR DESPERATE MEASURES?

Despite the abundance of U.S. data this week, investors have taken their eyes off the dollar. The focus over the past few trading days has been on Europe but this should change in the coming week with the Federal Reserve gearing up for one of the most interesting FOMC meetings in a very long time. For the past month and a half, Federal Reserve Chairman Ben Bernanke has been subtly hinting to the market that easier monetary policy is on the way. When the central bank last met on August 9 ^th , they pledged to keep interest rates at exceptionally low levels through at least mid 2013.  By slapping a time frame for how long rates will remain low, the Fed clearly wanted to make sure everyone realized how committed they are to keeping monetary policy easy. The minutes from the meeting revealed deep discussions about alternative ways to stimulate the economy which suggests that it is no longer a matter of if but only a matter of when the Federal Reserve will make another attempt to jumpstart the U.S. economy. The pessimistic tone of the FOMC minutes made it vibrantly clear that policymakers are warming to the idea of more QE. Considering that a few members sought stronger action immediately in August and central bank officials openly discussed different ways to stimulate the economy, the Federal Reserve just needed more time to weigh the cost and benefits of each policy tool.  They will have an opportunity to do so this week with policymakers spending 2 full days discussing options and when the doors are opened on September 21 ^st , investors will be looking for not only words, but also action. 

With the U.S. economy experiencing zero employment and retail sales growth in the month of August, desperate times call for desperate measures. The Federal Reserve has been preparing the market for more stimulus in some form or another since the last FOMC meeting and if they fail to deliver, investors will punish the Fed by liquidating out of risky assets, making financial and economic conditions even worse. However by preparing the market for more stimulus, the Federal Reserve has also given investors an opportunity to discount a move, which means if they want a big positive reaction from the markets, they may need to go above and beyond what investors already expect. The Fed’s options include:

1) Promising to not reduce their securities portfolio until 2013

2) Funding the purchase of long term Treasuries with the sale of short term ones (Operation Twist)

3) Lowering the interest rate on reserves

4) Announcing another round of asset purchases

Option number is far too inadequate to satisfy investors – all talk and no action is just not going to cut it. Operation Twist has been talked about extensively as the option the Fed will choose to stimulate the economy but the problem is that it has already been priced in by investors and may therefore elicit nothing more than a weak response by the market, wasting the central bank’s efforts. The same is true for lowering the interest rate on reserves. If the Fed wants to surprise the market and trigger a sharp rally in currencies and equities, they will need to be more aggressive which means introducing a number of changes (2,3 and 4 or 1,2,3, or 1,2,4 or 1,2,3,4) with the boldest move being a combination of all their options. With economists talking about the risk of another recession, desperate times calls for desperate measures and that may mean throwing in everything including the kitchen sink. Although this would be short term bearish for the U.S. dollar, it could help it significantly in the long term. 

EUR: RISKS FOR THE EURO

After rallying for 3 straight trading days, the euro weakened against the U.S dollar. The Ecofin meeting of European Finance Ministers is still underway and we stick our belief that no fireworks are expected from the meeting even after ECB President Trichet said there could be very significant improvement in the six pack laws. The six pack laws are governance laws to prevent future debt crises and do not resolve the current one. So far it seems that U.S. Treasury Secretary Geithner’s attendance has backfired for the U.S. with European officials criticizing the U.S. for telling them what they should do when they cannot even get their own house in order. After day one of the two day meeting, little has been accomplished. The Germans remain opposed to euro bonds and the decision to release the next much needed tranche of aid to Greece has been delayed until October. The decision to delay the aid suggests that Germany and France may not be as “behind” Greece as they would like the world to believe.  If Greece does not receive further bailout funds by mid-October, they will have effectively run out of money and the possibility of default could become a reality. Adding fire to their burning problem, less than 75 percent of private sector creditors agreed to participate in the country’s buyback program, which was far less than the 90 percent they had anticipated. The shortfall will have to be filled by official support from other nations and the insufficiency has not gone over well with EUR/USD investors. In all likelihood, the Ecofin meeting will only result in talking points for the G20 leaders meeting that will begin at the end of next week. Aside from the FOMC meeting and outcome of the Ecofin meeting, we will continue to be on the lookout for any comments from Moody’s who has finished their 3 month review of Italy’s sovereign debt rating. Given Berlusconi’s decision to water down the country’s austerity program, a downgrade or at least a warning could be warranted. The German ZEW survey is also scheduled for release next week along with the advance September PMI numbers. Unfortunately further deterioration is expected due to the volatility in the financial markets and the slowdown in global growth which means the euro could remain under pressure next week. 

GBP: BOE MINUTES TO REVEAL LITTLE

The volatility in the British pound this week has been centered in EUR/GBP not the GBP/USD. While sterling fluctuated within a 180 pip range against the U.S. dollar, the euro fell to a 6 month low against the pound, taking the EUR/GBP cross below 0.8550. However the sell-off in the cross was short-lived with the currency pair bouncing back towards 0.88 over the next 3 trading days. Despite the abundance of market moving U.K. data this past week, the volatility in EUR/GBP can be blamed entirely on the euro. This week’s U.K. economic reports show both weakness and recovery in the U.K. economy. Consumer spending declined, but not as severely as economists had feared while the number of people filing for jobless benefits rose by the smallest amount in 3 months. U.K. officials continued to talk about the need for more stimulus but so far there is little clarity on how ready and willing they are to increase stimulus. It was only recently that the two monetary policy committee members who had previously voted for a rate hike switched camps and since then, economic data has been choppy. Next week’s BoE minutes will provide more information on just how close the central bank is to increasing asset purchases and in our opinion, the MPC will not be pulling the trigger anytime soon. Bank of England member Bean said inflation is expected to come down next year but right now consumer prices still remain well above the central bank’s target. Aside from the minutes, public sector finances, consumer confidence and the CBI Total Trends survey are the only numbers scheduled for release. This means that in all likelihood, the pound will continue to take its cue from U.S. and Eurozone developments.  

CAD: BIG BENEFICIARY OF DOLLAR DUMP

The Canadian, Australian and New Zealand dollars extended their gains against the greenback. Although the improvement in risk appetite can be credited for part of the move, the real reason why the commodity currencies have performed so well is profit taking on long dollar positions. With the Federal Reserve gearing up to announce more stimulus, the U.S. dollar stands to suffer and the currencies whose central banks are the most willing to raise interest rates or leave them steady stand to benefit. This explains why the New Zealand dollar has outperformed all other high yielding currencies because the RBNZ has delayed and not eliminated their plans to raise rates. The kiwi charged higher even as consumer confidence declined – the ANZ Consumer Confidence Index fell 0.6 percent in the month of September. No Australian economic data was released but gold prices rebounded by 1.20 percent or $21. Canada proved to be a big beneficiary of asset allocation out of U.S. dollars. The latest International Securities Transactions report showed foreign purchases of Canadian dollar denominated assets rose C$11.78B which included a record C$5.91B of federal money market paper purchases. This came as foreigners sold US$36.5B worth of short term U.S. securities. In July, concerns about the U.S. debt ceiling and downgrade intensified as the deadline for raising the ceiling neared. The U.S. also reported very weak non-farm payrolls growth, sparking speculation about a return to recessionary conditions. As a result foreign investors sought safety in other currencies and based upon today’s reports, the Canadian dollar was a big beneficiary. The CAD will remain in focus next week with consumer prices, leading indicators and retail sales scheduled for release. No major data is expected from Australia but New Zealand has GDP numbers on tap.

It has been a mixed day for the Japanese Yen which traded higher against the euro and Swiss Franc but weakened against all of the other major currencies. With no major economic data released last night, 76 continues to be rock solid support for USD/JPY as investors worry about the possibility of intervention. Earlier this week, there was chatter that the BoJ could be checking rates but with USD/JPY not seeing any fresh moves to the downside, the central bank could hold off on further intervention. However this may not b enough for general populous. The Japanese ruling party called on the Finance Ministry and the Bank of Japan to strengthen their ties and work together to address the Yen’s rise. They want the central bank to ease monetary policy appropriately and to establish a fund to address the problems caused by the Yen’s rise. The Cabinet is scheduled to release their monthly economic report next week and it will be interesting to see if their sentiment has changed. We also have leading indicators, department store sales, and the trade balance scheduled for release. Although these numbers are important in gauging the overall health of the Japanese economy, USD/JPY will take its cue from the FOMC meeting.

It has been a mixed day for the Japanese Yen which traded higher against the euro and Swiss Franc but weakened against all of the other major currencies. With no major economic data released last night, 76 continues to be rock solid support for USD/JPY as investors worry about the possibility of intervention. Earlier this week, there was chatter that the BoJ could be checking rates but with USD/JPY not seeing any fresh moves to the downside, the central bank could hold off on further intervention. However this may not be enough for general populous. The Japanese ruling party called on the Finance Ministry and the Bank of Japan to strengthen their ties and work together to address the Yen’s rise. They want the central bank to ease monetary policy appropriately and to establish a fund to address the problems caused by the Yen’s rise. The Cabinet is scheduled to release their monthly economic report next week and it will be interesting to see if their sentiment has changed. We also have leading indicators, department store sales, and the trade balance scheduled for release. Although these numbers are important in gauging the overall health of the Japanese economy, USD/JPY will take its cue from the FOMC meeting.

NZD/USD: Currency in Play for Next 24 Hours

NZD/USD will be our currency pair in play for Monday. New Zealand has consumer confidence scheduled for release at 6:00pm ET / 22:00 GMT followed by PMI Services at 6:30pm ET / 22:30 GMT. This will be followed by the NAHB Housing Market Index from the U.S. at 10:00 AM ET or 14:00 GMT.

The NZD/USD is currently in the range trading zone which we determine using Bollinger bands. A closer look at the chart reveals 2 possible head and shoulder formations. One from a longer term perspective and the second from a shorter time frame. In order for the  head and shoulders pattern to materialize, a break of the second standard deviation Bollinger Band at 81 cents Is needed. However the first level of support in the NZD/USD will be at 0.82 where we have the 38.2 percent Fibonacci retracement of the March to August rally. Below that is 80 cents which is a psychologically significant level as well as the 50 percent Fib retracement of the same move. The first level of resistance is at the 50-day SMA at 0.8400 followed by the August 31 ^st swing high of 0.8572.

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Comments (1)

Theratiotrader

September 16, 2011 at 09:20 PM ET

What if Bernanke fixed the rate on the short bond? The housing market needs a jumpstart. With rates at 0% people are scared to commit to a homeloan for fear that interest rates will rise. If Bernanke fixed the rate on the shortbond for a specific amount of time this may draw in new home buyers. There have been 2 years of QE which did nothing more than keep the banksters rich. Inflation is starting to show up in CPI and labor costs, should Bernanke kill the dollar anymore we will eventually see rates swing wildly in the opposite direction and the dollar will certainly see another downgrade.

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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.