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THE STORIES IN THE CURRENCY MARKET

• USD: COUNTING DOWN TO FOMC
• EUR: SHRUGS OFF ITALY DOWNGRADE, SNB REPEGGING CHF?
• GBP: BEWARE OF BOE MINUTES
• CAD: DOVISH COMMENTS FROM CARNEY
• AUD: RBA MILDLY HAWKISH
• NZD: GOLD AND OIL UP, CA DATA ON TAP
• JPY: NODA UNVEILS PLAN TO OFFSET YEN STRENGTH

EXPECTATIONS FOR UPCOMING FED MEETINGS

CURRENT US INTEREST RATE: 0.25%
	09/21 Meeting	11/02 Meeting
NO CHANGE	72.0%	72.0%
CUT TO 0BP	28.0%	28.0%
HIKE TO 50BP	0.0%	0.0%

USD: COUNTING DOWN TO FOMC

The Federal Reserve has shut its doors to begin its two-day monetary policy meeting and the clock is ticking.   Although stocks traded higher in anticipation of more stimulus, the dollar’s performance was mixed.   After much intraday volatility, the greenback ended the North American session virtually unchanged against the euro, Japanese Yen and British pound, higher against the Swiss Franc and lower against the commodity currencies.   In our FOMC Preview, we talked about how Quantitative Easing is not necessarily negative for the U.S. dollar , which is important to keep in mind as we near the FOMC announcement.   With the U.S. economy experiencing zero consumer spending and job growth in the month of August, there is no question that the U.S. needs help.   However for anyone hoping that Bernanke will ride in like a white knight carrying a cart load of stimulus, the risk of disappointment is greater than the risk of a surprise because even the central bank has warned that their ability to stimulate the economy is limited.   With the U.S. economy experiencing zero employment and retail sales growth in the month of August, desperate times call for desperate measures but just how desperate does the Fed feel? The Federal Reserve has been preparing the market for more stimulus in some form or another since August and in doing so, they have given investors an opportunity to discount the move, which means if they want a strong and positive reaction from the markets, they need to overwhelm and not underwhelm.   Operation Twist has been talked about extensively as the option that the Fed will most likely 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, wasting the central bank’s efforts.   The same is true for lowering the interest rate on reserves.   Operation Twist with no enhancements could underwhelm the market and may even trigger a buy the rumor sell the news type of reaction.   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 combining different options and perhaps taking an even bolder step by tying interest rates to a piece of economic data like the unemployment rate, an idea suggested by Fed President Evans.   Doing nothing would be the worse thing that the Federal Reserve could do and would most certainly send currencies and equities plunging.   The reasons why the central bank could do nothing is because inflation is high and every effort that they have taken so far has failed to stimulate growth.   Unfortunately inaction is inexcusable because preventing recession is just as important as promoting growth and the U.S. economy stands the risk of falling back into recession without more support from the Fed.

 

Yet the market is dead set on more stimulus because the recovery in the U.S. has come to a screeching halt and everyone including the Fed agrees that the economy desperately needs help. The IMF downgraded global growth today and unfortunately their pessimistic assessment is an accurate reflection of the global economy.   Aside from zero consumer spending and employment growth, the housing market and manufacturing sector remains weak. This morning's U.S. economic reports showed housing starts falling 5 percent and building permits rising 3.2 percent. Everyone had expected the housing market numbers to be weak all around but the rise in building permits was a bit of a surprise and provides a little hope of stabilization in the real estate sector. Yet the lack of consistency in the housing data makes their impact on the dollar and the Federal Reserve's monetary policy decision tomorrow limited. Existing home sales is scheduled for release tomorrow and even though a rebound is expected, the focus will remain on the FOMC meeting.   For more on how the dollar could respond to more QE, read our FOMC Preview.

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EUR: SHRUGS OFF ITALY DOWNGRADE, SNB REPEGGING CHF?

The euro ended the day unchanged against the U.S. dollar but not before some serious volatility.   During the Asian trading session, the EUR/USD sold off aggressively on the heels of S&P’s decision to downgrade Italy’s sovereign debt rating from A+ to A with a negative watch.   However the sell-off was short-lived because once European traders returned to their desks, they bought euros aggressively. The downgrade of a country like Italy is a very big deal and in any other environment where investors have not become accustomed to bad news from Europe, it would have probably triggered a sharp decline in the currency.   However in the case of Italy, investors had expected the country’s sovereign debt rating to be downgraded – the only difference is that it was expected to be from Moody’s and not S&P.   As reported by our colleague Boris Schlossberg, “ The downgrade could increase Italy’s borrowing costs just as the country embarks on large refinancing program that entails nearly 30 Billion euros of gross issuance in October and November. These upcoming bond auctions could become the true test of country’s credit strength and if investors balk at rolling over its debt the downward pressure on the euro could quickly accelerate.” The euro extended its gains when EUR/CHF shot higher on talk of the Swiss National Bank re-pegging EUR/CHF to 1.25 from 1.20. The rumor has not been substantiated but given the success of the 1.20 peg in halting the Franc's rise, the SNB could very well be aiming for the stars with a 1.25 peg.   The State Secretariat for Economic Affairs downgraded their GDP forecasts for 2011 and 2012 to 1.9 and 0.9 percent respectively down from 2.1 and 1.5 percent for this year and next.   Much of the weakness can be credited to the strength of the Franc as exports decline by 7 percent in the month of August, driving the Swiss trade surplus down to 0.81B from 2.81B, the lowest level in more than a year.   The 1.20 peg stemmed the rise in the Swissie but in order for the Franc to contribute to growth rather than subtract from it, EUR/CHF needs to be trading at a much higher level and for this reason we would not be surprised if the SNB is really interested in a higher peg.   

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GBP: BEWARE OF BOE MINUTES

The biggest event risk for the British pound this week is the release of the minutes from the most recent Bank of England meeting.   The British pound traded slightly higher against the euro and U.S. dollar but these gains could evaporate if the minutes reveal more willingness to increase stimulus within the ranks of the central bank. When the monetary policy committee last met in early September, they left their asset purchase program and interest rates unchanged.   Back in August we learned that the 2 remaining hawks dropped their call to raise rates and voted in favor of steady policy.   This month, we will be looking to see if any MPC members joined Adam Posen in his call to increase the asset purchase program by GBP50 billion to GBP250 billion.   Based upon recent comments from policymakers, there is a good chance that other members may have grown more dovish. Weale, who had previously voted for higher interest rates said last week that the risk of recession has increased in July and more Quantitative Easing is possible if consumer prices undershoot substantially and one of the ways to implement QE would be to buy bonds on the long end of the market. Blanchflower, a former BoE member predicts the BoE will move to QE by November and Business Secretary Vince Cable said QE is the best way to maintain stimulus if needed.   As you can see, more people are warming to the idea of QE and if the central bank shows any increased willingness to offer more stimulus, the British pound could extend its losses and perhaps even slip to a fresh 7 month low against the U.S. dollar.   Aside from the BoE minutes, public sector finances are also scheduled for release and the public sector net cash requirement is expected to increase significantly in the month of August.    @import url(/css/cuteeditor.css);

CAD: DOVISH COMMENTS FROM CARNEY

The Canadian, Australian, and New Zealand dollars all strengthened against the greenback.  Governor Mark Carney of the Bank of Canada gave remarks in Saint John on recent economic developments.  In his remarks, he said the direct impact of a renewed slowdown in the U.S., Canada’s largest trading partner, is more material.  He noted that activity in important sectors such as autos and housing has taken a further hit.  He continued to say that Canada is not experiencing a normal recovery, and the considerable external headwinds faced in recent years are blowing harder.  Another headwind came after the IMF lowered growth projections for Canada.  Canadian net exports are expected to remain a major source of weakness, reflecting more modest global demand and ongoing competitiveness challenges, in particular the steady strength of the Canadian dollar.  The Bank of Canada does expect growth to resume in the second half of this year.  The Reserve Bank of Australia released its minutes of the Monetary Policy Meeting of the Board today.  The minutes shed light on the significantly more clouded data that caused the board to leave the cash rate unchanged at 4.75 percent.  Conditions in global financial markets have deteriorated since their last meeting and uncertainty continues to roil market participants.  However, prices for key Australian commodities have remained very high, with growth in China continuing to be strong.  While measures of inflation have fallen in line with the bank’s target of 2 to 3 percent, readings have been picking up lately.  Holistically, financial and economic indicators were consistent with monetary policy already in place.  The minutes caused the Aussie to extend gains as there was no talk of lowering interest rates.  New Zealand’s dollar erased earlier losses against the greenback from Italy’s downgrade as stocks rallied.  A flat correction could materialize if current account and GDP numbers scheduled for release later this week do not prop up the kiwi.  New Zealand is the last of the majors to release its GDP reading, and the market is expecting growth of 0.5 percent in the previous quarter which will be significantly influenced by the rebuilding effort.  There is a possibility of a miss with expectations so high from reconstruction efforts.

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JPY: NODA UNVEILS PLAN TO OFFSET YEN STRENGTH

It was a mixed day of trading for the Japanese yen as it strengthened against the greenback, Swiss franc, and Canadian dollar, while weakening against the other major currencies.   There was no new economic data released from Japan today.   Japanese Prime Minister Yoshihiko Noda unveiled his first plan as premier to lessen the pain of a yen near postwar highs, including a pledge to grant “large” subsidies for domestic construction of factories.   The strong yen has dealt a blow to the export-driven economy, causing firms to announce plans to shift operations overseas.   The Japanese government’s plan will “take decisive steps when necessary” to deal with “excessive moves in the currency market.”   It also said the government expects the Bank of Japan to pursue “appropriate, resolute monetary policy management” to support the economy.   The plan, which essentially coordinates recently floated proposals, had little impact on the currency market.   The yen continued to strengthen after the announcement.   Investors have also pushed the yields on Japan’s 10-year bonds to the lowest since November relative to five-year notes, signaling increasing concern about the world’s third-largest economy’s ability to emerge from recession.   The bonds are pricing in another slowdown and recession, judging from narrowing spreads.   Additionally, long-term yields are reflecting expectations of further monetary easing.   Japanese stocks also fell following the announcement that Standard & Poor’s downgraded Italy’s credit rating.   This news sparked fresh concerns that Europe’s debt crisis is spreading.   With a strong yen, a flattening yield curve, and possible European debt contagion, the Japanese economy faces many headwinds on the road to recovery.   Tonight, Japanese trade balance figures are scheduled for release.   Expectations are for a deficit of 0.01 trillion yen following a deficit of 0.13 trillion yen in July.   A surprise to the upside would indicate increased demand for Japanese exports and could provide a positive sign for Japan to climb out of recession.   

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GBP/USD: Currency in Play for Next 24 Hours

GBP/USD will be our currency pair in play for the next 24 hours.   The Bank of England minutes and public sector net finances will be released at 4:30 AM ET or 8:30 GMT.   This will be followed by existing home sales from the U.S. at 10:00 AM ET or 15:00 GMT and the FOMC rate announcement at 2:15 PM ET or 16:15 GMT.  

 

GBP/USD will be our currency pair in play for the next 24 hours. The pair is currently trading in a down trend, which we determine using Bollinger bands.   Nearest support is at 1.5600, a psychologically significant level and price of contention in the past.   Should the pair continue to fall, significant support will be found at 1.5485, the 50% Fibonacci retracement.   We drew our Fibonacci from the low on May 20, 2010 to the high on April 28, 2011.   If the pair reverses, first resistance will be found at 1.5782, the convergence of the lower first standard deviation Bollinger band and the 38.2% Fib retracement.   If it breaks out from there, heavy resistance will be found at 1.5900, which is psychologically significant and a price of past lows.

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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.