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FX: How to Position for Upcoming Event Risks

Last updated 9/19/2011 5:26 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: HOW TO POSITION FOR UPCOMING EVENT RISKS
• EUR: A POSITIVE CHAPTER IN GREEK SAGA?
• GBP: TOUTING THE BENEFITS OF QE
• AUD: WHAT TO LOOK FOR IN RBA MINUTES
• NZD: SERVICE PMI DECLINES
• CAD: GOLD AND OIL DOWN CLOSE TO 2 PERCENT
• JPY: GBPJPY NEARS RECORD LOW

EXPECTATIONS FOR UPCOMING FED MEETINGS

FX: HOW TO POSITION FOR UPCOMING EVENT RISKS

The rollercoaster like price action in the foreign exchange market today gives everyone a taste of what to expect this week. There is a reasonable amount of global economic data on the calendar but these reports will most likely take a backseat to the meetings of policymakers around the world. In the front of the week, the big focus is on the Federal Reserve’s monetary policy meeting and towards the end of the week all eyes will be on the G20. In between Greece and the Troika (EU, IMF and ECB) have another conference call and the minutes from the most recent Bank of England and Reserve Bank of Australia meetings will also be released. Add to that the IMF and World Bank meetings and a lot could happen this week if only policymakers would muster up the courage to take the bold steps needed to jumpstart the global economy and put an end to the crisis of confidence in Europe and the U.S. Clearly there are no shortages of event risks to trigger volatility in currencies and higher vol is probably the only outcome that investors can be certain of this week. Positioning for the FOMC announcement and the other meetings will be difficult because policymakers have the habit of underwhelming when they need to overwhelm which can explain why deleveraging or reducing exposure is the main theme in the markets. President Obama announced a larger than expected deficit reduction plan this morning that elicited nothing more than yawn from the market and unfortunately this same type of response could occur if the Troika, FOMC or G20 meets and fails to beat expectations. The problem is that Obama is standing firm on tax hikes, pledging to veto any deficit plan with no tax increases and to investors this means more confrontation than compromise that will draw out the uphill battle in Congress and challenge the President’s approval ratings. In other words – when it comes to politics, it could much of the same for the next few months.

The greatest risk for the U.S. and global economy is that the same will be true for the Federal Reserve, Bank of England, Reserve of Bank of Australia and the G20. Everyone hopes that policymakers can band together and give their own economies along with the global economy the shot of momentum that it really needs but we have been down this road before and investors have grown use to policymakers coming up short. There is a great deal of hope that the Federal Reserve will announce another round of stimulus but with the market having plenty of time to discount “Operation Twist,” which everyone believes will be the Fed’s preferred choice, ceding to market expectations may not be enough to trigger a risk rally. However with this in mind, the FOMC meeting is too large of an event risk for most traders to ignore and with the dollar appreciating significantly since the beginning of the month against higher yielding currencies, we expect profit taking on long dollar positions going into the FOMC announcement. We have already seen intraday profit taking on short EUR/USD positions on the hope that Greece has reached a deal with the Troika and the prospect of coordinated action by G20 leaders will probably lead to profit taking on risk off trades going into the weekend. Yet blind hope has not served anyone well since the beginning of the year and the real risk is for a disappointment. 

The NAHB Housing Market Index was the only piece of U.S. economic data released this morning and according to the report, builder confidence fell to a 3 month low. This is not surprising considering that the housing market in general remains weak. Tomorrow’s housing starts and building permits are expected to show the same softness in demand. The recent volatility in the financial markets has made banks weary of lending and potential homeowners weary of buying.

EUR: A POSITIVE CHAPTER IN GREEK SAGA?

Although the euro ended the North American trading session sharply lower against the U.S. dollar, the currency pair is well off its intraday lows.  Fear about a Greek default weighed on the currency and equity markets throughout the day and it was not until the end of the U.S. session was there some hope that Greece is close to reaching a deal with the Troika (EU, IMF and ECB). In a sign of potential progress, a teleconference held today will now be continued tomorrow, giving international inspectors an opportunity to craft a deal with Greece that will allow the release of the next installment of bailout funds. Without the next tranche of aid, Greece could default on its debt by the middle of October. The market is currently pricing in a 95 percent chance of a Greek default and economists polled by Reuters see a 65 percent chance of default. The possibility of a Greek default has become so real that concerns about a Euro break-up has also resurfaced. Germany has shoved off speculation by saying it be a disastrous political message if euro countries could be thrown out of the bloc because they had trouble. This suggests that Germany will do all they can to support Greece and avoid the dissolution of the euro. Unfortunately there is very little agreement in the private sector about whether Greece will actually be able to avoid default. Many leading economists are saying no but based upon the price action in the markets this afternoon, traders are hopeful that a deal will be reached. Another press conference is scheduled tomorrow, leaving investors at the edge of their seats for yet another day. German producer prices are scheduled for release tomorrow along with the ZEW survey. Investor confidence is expected to decline to its lowest level in more than a year as the sovereign debt crisis continues to threaten growth in the region.  Meanwhile the State Secretariat for Economic Affairs will be releasing its September 2011 economic forecasts and their commitment to fighting Swiss Franc strength tells us that they are worried about the outlook for the Swiss economy. Downgraded forecasts could weigh on the Franc, keeping EUR/CHF firmly above 1.20.

GBP: TOUTING THE BENEFITS OF QE

Concerns that more Quantitative Easing could be coming down the pipeline in the U.K. along with risk aversion has driven the British pound lower against the U.S. dollar. Even though the BoE is not as close to increasing stimulus as the U.S., the minutes from the most recent BoE meeting is expected to show a growing willingness within the central bank to turn the spigots on again. This morning, the Bank of England published its 2011 Q3 Quarterly Bulletin which talked about the benefits of QE. The central bank concluded that Quantitative Easing boosted GDP by 1.5-2.0 percent and CPI by 0.75 to 1.50 percent at its time of maximum impact. Although the report is prepared by staffers and not by policymakers, it is reviewed extensively by the monetary policy committee prior to rate decisions. If the report found positive benefits to QE, it provides a stronger argument for additional stimulus. Even without this report, recent economic data show the recovery grinding to a halt and more easing was already on the minds of investors and policymakers. According to Rightmove, property prices in the U.K. increased 0.7 percent in the month of September after falling by 2.1 percent the previous month. Consumer confidence numbers are scheduled for release this evening and based upon the decline in retail sales, economists expect confidence to fall for the third consecutive month. 

AUD: WHAT TO LOOK FOR IN RBA MINUTES

With oil and gold prices falling approximately 2 percent and risk aversion driving flows in the foreign exchange market, the Canadian, Australian and New Zealand dollars weakened across the board. New Zealand was the only country with any economic data on the calendar and the reports only added pressure to the kiwi. Although consumer confidence held steady in the third quarter, service sector activity slowed for the second straight month in August. Economic activity accelerated in the beginning of the year as the country recovered from the earthquake. However since then, the global economy has slowed and New Zealand has not been spared.  In fact, last week the Reserve Bank decided to leave interest rates unchanged due primarily to slower global growth and the longer service sector activity retreats, the longer the RBNZ may hold out on raising rates. The minutes from the most recent RBA meeting will be released this evening and any dovish inclinations could drive the AUD/USD to a fresh one month low. The RBA left rates unchanged at their last meeting and made it clear that they are worried about the impact that global uncertainty and financial volatility could have on consumer confidence and spending. The RBA is firmly on hold but the market expects the central bank to start easing this year and if the expectations are accurate, the RBA minutes would need to contain a more dovish tone. Canadian leading indicators are also scheduled for release tomorrow along with wholesale sales – though important, the impact of these two reports on the Canadian dollar tend to be limited.

JPY: GBPJPY NEARS RECORD LOW

Not only did the Japanese Yen strengthen against all of the major currencies, but it rose to a 2 year high against the British pound. Two years may not seem like a significant amount of time but the 2 year low in GBP/JPY also happens to be a record low. A strong Yen may have become a way of life in Japan but policymakers are under growing pressure from the corporate sector to stop the Yen from rising. Japanese markets were closed for trading last night because of holiday but with the Yen trading at such a high level, investors need to be wary of intervention. Although we believe that the Bank of Japan will hold out until after the G20 meeting to intervene in their currency, anything can happen and therefore we caution investors against holding excessive long Yen positions. Japanese policymakers know that the only type of intervention that the market responds positively to is coordinated intervention and for this reason, they will be working hard to convince their peers to join them in a coordinated effort this weekend. Considering the recent coordinated action with the ECB to boost the flow of dollars, coordinated action with the Bank of Japan may not be out of the question. We believe that 76 remains the line in the sand for the BoJ which means that if the currency pair were to break below that level, the central bank could come sweeping in to sell yen and buy dollars. As for economic data, the Cabinet will also be releasing their monthly economic report this evening along with leading indicators and department store sales. 

EUR/USD: Currency in Play for Next 24 Hours

EUR/USD will be our currency pair in play for the next 24 hours. German producer prices are scheduled for release at 2:00 AM ET / 6:00 GMT followed by the German ZEW survey at 5:00 AM ET / 9:00 GMT. From the U.S., we have housing starts and building permits at 8:30 AM ET or 12:30 GMT. 

The EUR/USD is currently in a downtrend which we determine using Bollinger Bands. The first level of support in the currency pair is at 1.3600 which is today’s low and the low from last Wednesday. If this level is broken, the next level of support would be the September and 6 month low of 1.3495. On the upside, resistance is at the first standard deviation Bollinger Band at 1.3800 followed by 1.39 where we have the 50% Fibonacci retracement of the January to May rally. 

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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.