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USD: Fed Meeting Over, Back to Square One?

Last updated 9/21/2011 5:21 PM ET (GMT -5) 1 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• USD: FED MEETING OVER, BACK TO SQUARE ONE?
• EUR: ERASES EARLIER GAINS DESPITE PROGRESS FOR GREECE
• GBP: CRASHES AS BOE MULLS THE IDEA OF MORE QE
• NZD: RBNZ IN NO RUSH TO RAISE RATES
• CAD: RETAIL SALES ON TAP
• AUD: GOLD AND OIL DOWN
• JPY: EXPORTS SLOW

EXPECTATIONS FOR UPCOMING FED MEETINGS

USD: FED MEETING OVER, BACK TO SQUARE ONE?

The Federal Reserve meeting is now behind us and the central bank’s feeble attempt to stimulate the economy has proven to be a big disappointment for the markets. Not only has U.S. equities fallen sharply following the FOMC meeting, but risky currencies plunged across the board as investors piled back into the safety of U.S. dollars. Before the FOMC announcement, investors were concerned about the state of the U.S. recovery and risk of recession and unfortunately these fears have not been alleviated by the Fed’s announcement. The central bank took the rare step of twisting the yield curve by selling short term Treasuries to purchase long term ones. Based upon the reaction in the financial markets, investors don’t believe that this will be enough to promote growth in the U.S. economy. So in other words, with no major help from the Fed, we are back to square one. There are plenty of reasons for investors to be nervous and they will remain nervous until the uncertainty in the global economy subsides. In the U.S. in particular, a few strong non-farm payrolls reports could help but as things stand, we can see very little reason for payrolls to rise sharply. The only realistic hope for risk appetite is coordinated action by the G20 this weekend or some concrete solutions to the European sovereign crisis. 

In terms of the U.S., expect much of the same for the foreseeable future.  At $400 billion, the size of Operation Twist was slightly larger than what most people had anticipated but buying and selling the exact same amount of Treasuries, the balance sheet remains unchanged which means no additional money was pumped into the U.S. economy. Part of the reason why they were so conservative was because they are holding onto the blind hope that this will be enough to jumpstart the U.S. economy.  Even though the Fed acknowledged the significant downside risks to the economic outlook, they also expect a pickup in the recovery in the coming quarters which is an upgrade from their prior assessment for a somewhat slower pace of recovery.  However investors clearly do not share the central bank’s rosy sentiment especially after rating agencies lowered the credit rating for Citigroup, Wells Fargo and Bank of America.

At the end of the day, the most important question to ask ourselves is whether Operation Twist will be enough revive the U.S. economy. It could prevent a recession, but engineering growth is a far greater challenge that may require more than a twist of the yield curve.  Keeping yields low has done little to stimulate growth and the Fed’s attempt to drive long term rates even lower may end up being another exercise in failure that will force them to bite bullet and announce QE3. The problem for the U.S. economy is that corporate America is sitting on their cash and not spending it. By twisting the yield curve, the Fed hopes that lower rates will encourage corporate spending and invigorate the housing market, but the biggest roadblock to spending is not borrowing costs, but confidence. We saw this with President Obama’s latest jobs plan – even though many companies welcomed it, they said it won’t change their hiring plans.  Corporations won’t go on a hiring or spending spree until consumer spending increases, the stock market stabilizes and the economy gains momentum. Lower yields will help but only in a small way. There was also absolutely no talk of additional asset purchases which is encouraging for dollar bulls and discouraging for anyone hoping for more action from the Fed. By not mentioning QE3, it definitely appears that the central bank is saving their few remaining bullets in case the volatility in the financial markets intensifies or the U.S. economy falls into recession. 

EUR: ERASES EARLIER GAINS DESPITE PROGRESS FOR GREECE

The euro sold off aggressively against the U.S. dollar but its weakness is more a function of risk aversion than growing problems in Europe. In fact up until the FOMC announcement, the EUR/USD had been performing quite well, rising to a high just shy of 1.38.  By the end of the NY trading session, EUR/USD was trading below 1.36 but the sell-off was triggered almost entirely by the FOMC announcement. Progress for Greece was a big reason why the euro rallied during the European session. Last night, the European Commission, IMF and ECB said they were making “good progress” towards reaching a deal to release the next bailout tranche to Greece. Today, Greece announced a number of accelerated measures that would help the country meet their deficit reduction targets, making the EU/IMF more comfortable about releasing their next aid payment. The European Central Bank also eased their collateral requirements by abolishing the requirement that the debt instruments be traded on a regulated market. This is great news for Greece but not so good news for the Eurozone and European investors because it suggests that the central bank is willing to accept defaulted or “worthless” government bonds. This is also another attempt by the ECB to manage the expectations of the market by letting them know that they stand behind Greece even if they are forced into default. Italy will be releasing its revised growth forecasts tomorrow and given the IMF’s recent actions, there is a good chance that the government will be slashing growth forecasts substantially. The IMF expects virtually zero growth from Italy this year and next. More specifically, they look for the economy to grow by 0.6 percent in 2011 and 0.3 percent in 2012, down from a prior forecast of 1 and 1.3 percent. The last time the Italian government released its forecast was back in April and at the time, they expected the economy to grow by 1.1 percent this year and 1.3 percent next year. Eurozone PMI numbers are scheduled for release tomorrow and the decline in the ZEW survey along with retail sales and factory orders point to softer numbers all around. Meanwhile the Swiss Franc fell to a 5 month low against the U.S. dollar and 2 month low against the euro as investors give up on their battle with the SNB. 

GBP: CRASHES AS BOE MULLS THE IDEA OF MORE QE

The British pound sold off aggressively against the U.S. dollar and euro after the Bank of England minutes revealed a hearty discussion about the different ways to invigorate the U.K. recovery. Although none of the members of the Monetary Policy Committee joined Adam Posen’s call for more stimulus, the fact that at least four different options to stimulate the economy were discussed was enough to get sterling bears excited about the possibility of more QE. There is no question that the central bank is getting closer to increasing asset purchases and based upon recent economic reports, the economy certainly needs it but it still remains to be seen whether the central bank will be ready to pull trigger next month.  Also none of the options considered were particularly ground breaking. The MPC discussed restarting asset purchases, implementing their own version of Operation Twist, cutting interest rates, and changing the language of the BoE statement to provide explicit guidance about the likely path of interest rates. The MPC minutes drove the British pound to an 8 month low against the U.S. dollar and as reported by our colleague Boris Schlossberg, “adding to cable’s woes was the latest release of the Public Sector Net Borrowing figures which showed that UK government borrowed a record amount in August as revenue waned while spending increased. The PSNB rose to 15.9B versus a surplus of -5.2B the month prior. The market was anticipating an increase of 13.2B. The data suggests that despite the vaunted efforts at austerity by Cameron government UK budget deficits are likely to widen if growth does not pick up in the last quarter of 2011.” Looking ahead, more weakness is likely for sterling with the one year low of 1.53 being the next level of support for the GBP/USD. 

NZD: RBNZ IN NO RUSH TO RAISE RATES

The Canadian, Australian, and New Zealand dollars all weakened against the greenback amid concerns for slower global growth. Of all the major currencies, the New Zealand dollar dropped the most due to the comments from Reserve Bank Governor Bollard who talked positively about the New Zealand economy but said point blank that “there is no rush to raise rates.”  The reason why rates were left unchanged at their last meeting was because of global growth risks. New Zealand has not yet been impacted by the problems in Europe and the U.S. but the possibility of contagion was enough for the RBNZ to hold back. New Zealand GDP numbers are due for release this evening and the data should show a continued recovery from the earthquake. Meanwhile  a quarter of Australian homeowners are experiencing mortgage stress and rental vacancies remain “tight,” driven by higher interest rates, rising costs, and a shortage of rental properties in some cities. The number of homeowners facing mortgage stress jumped from 21 percent in March, Genworth Financial Inc. said. As the market slows, people are starting to take their properties off the market and delaying their decision to move, rather than renting it. Reserve Bank of Australia Deputy Governor Ric Battellino made a speech in New York. The highlights are that China now has a large influence of the Australian economy and that it is too early to judge with any degree of certainty whether Australia will catch a cold from the U.S. The Canadian dollar weakened for a third straight day on concern that economic growth is slowing outweighed data showing higher-than-forecast inflation, discouraging the demand for risker assets. The currency fell to parity with the greenback after briefly paring losses after Statistics Canada said the consumer price index rose in August. Inflation in Canada rose in August to an annual rate of 3.1 percent, well up from the 2.7 percent rate recorded in July. Higher prices of gasoline and for food purchased from stores were the main contributors. Retail sales numbers are scheduled for release tomorrow and given the recent deterioration in the labor market, a pullback is expected.

JPY: EXPORTS SLOW

The Japanese yen strengthened against all the major currencies with the exception of the U.S. dollar, against which it held steady. With the Yen at such high levels, the longer the Bank of Japan does not intervene, the more the yen will behave like the old safe-haven currency. Japanese Finance Minister Jun Azumi told reporters in Tokyo today he’s closely watching markets and will take “bold” action on currencies if needed. Japan’s exports increased less than expected as shipments of electronic parts fell, an indication that slowing growth abroad and a rising yen may weigh on the economy’s recovery. Overseas shipments increased 2.8 percent in August from the same month a year prior, the first increase since the March 11 earthquake. Expectations were for an 8.0 percent increase. Exports have been recovering since the earthquake, but they are losing momentum. This slowing of exports hints that the recovery will be modest in Japan. Companies are also struggling with the strong yen. Nissan CEO Carlos Ghosen said Japan’s industrial strategy may need to be rethought if the yen continues at its current level. A few companies have already announced plans to shift operations overseas, and a continued strong yen will cause more to follow suit. Typhoon Roke is moving across central Japan, flooding streets and disrupting travel on a path toward the nuclear power plant in Fukushima stricken in last March’s tsunami. Japan’s weather agency issued warnings for landslides and flooding throughout the main island, with high waves in coastal areas.  The slump in exports and unexpected rise in imports led to a 775.3 billion yen trade deficit in August, much larger than the 218.8 billion yen expected. Japan continues to struggle on the road to recovery. With no new economic data on the docket for this week, focus will be on next week’s retail sales and CPI numbers.

EUR/USD: Currency in Play for Next 24 Hours

EUR/USD is our currency pair in play for the next 24 hours. Economic data scheduled for release from the Eurozone includes the September purchasing managers index for composite, manufacturing, and services at 4:00 AM ET / 8:00 GMT. Following is the Eurozone industrial new orders for the month of July at 5:00 AM ET / 9:00 GMT. From the United States, we expect jobless claims numbers for this week at 8:30 AM ET / 12:30 GMT. Then at  10:00 AM ET / 14:00 GMT we expect the U.S. the July house price index and August leading indicators. 

EUR/USD has been falling in the past week with losses accelerated by the Fed’s FOMC decision.  The pair is currently trading in a down trend, which we determine with Bollinger bands. Nearest support is at 1.34494, the recent low reached on September 12 ^th . Should the pair continue to slide, significant support will be found at 1.3404, the 50% Fib retracement and near the key 1.3400 handle. We drew our Fibonacci from the low on June 7, 2010 to the high on May 4, 2011. To the upside, nearest resistance is at 1.4000, the 20-day simple moving average and price of recent lows. Above that, significant resistance should be found at 1.4210, where both the 50-day SMA and 23.6% Fib retracement lie.

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Comments (1)

strat

September 21, 2011 at 10:05 PM ET

I look forward to your email articles and find them most valuable trading currencies. Your technical and fundamental coverage is the best. Your article on Feds twist only plan and its effects on the USD aided my decesion to short the Euo/usd once the gap was filled and feds made their statement. So thank you and please continue to print your easy to understand straight forward timely articles. Joan

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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.