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FX: When All Else Fails, Deleverage

Last updated 9/22/2011 5:16 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: WHEN ALL ELSE FAILS, DELEVERAGE
• EUR: HIT BY RISK AVERSION AND WEAK DATA
• GBP: EXTENDS LOSSES AGAINST USD
• CAD: BIG DISAPPOINTMENT IN CONSUMER SPENDING
• NZD: GDP GROWTH SLOWS TO 0.1 PERCENT
• AUD: OIL DOWN MORE THAN 6 PERCENT, GOLD DOWN 3 PERCENT
• JPY: MORE JAWBONING FROM FIN MIN AZUMI AS YEN HITS NEW HIGHS

EXPECTATIONS FOR UPCOMING FED MEETINGS

FX: WHEN ALL ELSE FAILS, DELEVERAGE

The general sentiment in the market today can be summed up in one sentence – When All Else Fails, Deleverage.  The lack of aggressiveness by central banks to tackle the financial crisis and to promote growth has investors thinking once again that policymakers have run out of options. They failed to invigorate the financial markets and the best that they may be able to achieve, if they are lucky is prevent recession. The general feeling of defeat in the financial markets has triggered a sharp sell-off in currencies, equities and commodities. The flight to quality and the desire for safety has sent investors into arms of the U.S. dollar. The Japanese Yen was also a big beneficiary of safe haven flows and in fact demand for the Yen was so strong that it rose to a 10 year high against the euro and a 2 year high against the British pound and Canadian dollar. The greenback reached significant levels as well, but not by the same token as the Yen. It rose to a 1 year high against the Yen and Canadian dollar and a 7 month high against the euro. Strong moves like the one that we have seen today usually has continuation but with G20 Finance Ministers meeting this weekend, the small but still realistic possibility of some type of coordinated support for the world could trigger a relief rally on Friday.

This morning's U.S. economic reports showed jobless claims improving slightly in the week ending September 17th. Weekly claims fell from 432k to 423k while continuing claims dropped to 3.727 million from 3.755 million. Although it is nice to see claims moving lower, as long as they remain above 400k, there is little reason to get excited. Hiring and not firing is the main problem in the U.S. economy and unfortunately unemployment claims have been a poor indicator of job growth in the U.S. for the past few months. Leading indicators and house prices also beat expectations but these reports matter little when no one including the Federal Reserve believes in the U.S. recovery. Also, the 0.3 percent growth in leading indicators still represents a slowdown in growth. House prices rose by 0.8 percent, up from 0.7 percent the previous month but the improvement in house prices does not little to detract from the Federal Reserve warning that “significant downside risks” lie ahead for the U.S. economy. If the central bank is worried, then investors realize that they should be as well. By talking about more stimulus back in August, they stripped away the element of surprise which could have been the key ingredient to making Operation Twist a success in stabilizing the market. Unfortunately Bernanke does not have the ability to go back in time to retract his warning but perhaps he will learn from this lesson – just because Trichet is a master of setting expectations does not mean that Bernanke will be as well. The economic calendar is devoid of any U.S. economic reports tomorrow, which means the focus will be on the G20 meeting, Greece and risk appetite in general.

EUR: HIT BY RISK AVERSION AND WEAK DATA

It has been another topsy-turvy day for the EUR/USD. Risk aversion and weaker economic data sent the currency pair tumbling in the early European trading session. When U.S. traders joined the fray, the EUR/USD stabilized and as the day progressed it started to trickle higher on the speculation that more support is on the way for Greece. The euro rebounded further following reports from the Financial Times that the European Union is looking to recapitalize the 16 European banks that came close to failure last summer quickly. Whether or not this materializes remains to be seen but it certainly reflects the desperation of European policymakers. The choppy trading in the EUR/USD after the news broke suggests that investors are not too hopeful that this will be remedy that the Eurozone needs because it doesn’t even come close to ending the Greek drama. The ECB is extremely worried about the sovereign debt crisis spreading according to Liikanen and they should be given the recent volatility in the markets. However before diving too deep into the pool of bears, the EU, IMF and ECB have made progress towards a deal with Greece and if one is reached in the near future, it could provide some relief for the EUR/USD. Meanwhile this morning’s Eurozone economic reports were weak all around with manufacturing and service sector activity slowing in the month of September. The Eurozone service sector PMI index dropped to 49.1 from 51.5 while the manufacturing index fell to 48.4 from 49. With both sectors of the Eurozone economy slowing, the composite index for the region contracted for the first time since July 2009. The greatest deceleration was seen in France but Germany also experienced slower manufacturing and service sector growth. It was no surprise that investor confidence in Switzerland deteriorated in the month of September because the strong Franc has taken a big toll on the Swiss economy. Even though the U.S. dollar and Japanese Yen benefitted significantly from safe haven flows, the Swiss Franc continued to slide as the SNB’s efforts to halt the currency’s rise succeeds in stripping the CHF of its safe haven status.

GBP: EXTENDS LOSSES AGAINST USD

The British pound traded higher over the euro but continued to lose ground to U.S. dollar. The fall-out of risk currencies continue as IMF and World Bank leaders warned of the dangerous phase which the global economy has entered. According to a report by IMF, UK’s growth estimate for 2011 had been reduced to 1.1 percent from its projection of 1.5 percent in June. Meanwhile, inflation stays at 4.5 percent, more than twice of the central bank’s target rate which means the British economy could be hit by crippling stagflation. With the MPC shifting toward more dovish stance in their recent policy meeting, more stimulus could be forthcoming. Bank of England chief economist Spencer Dale reiterated the possibility of another round of QE. “If the economic situation continues to deteriorate, some additional loosening in monetary policy might be needed,” he said to manufacturers in South Shields. On the other hand, Andrew Sentence, a former member of MPC, argued against the effectiveness of another round of QE in the recent market environment. Mr. Sentence suggested that the economic growth is curbed as the high inflation squeezes consumers’ spending power. Therefore, he called on the BoE to contain inflation in order to have sustainable growth in the long term. Nonetheless, the market has started to price in more easing measures going forward as policymakers continue to talk of more QE. With only mortgage approvals from the UK tomorrow, the trading in pound would likely hinge on the risk flows in the currency market.

CAD: BIG DISAPPOINTMENT IN CONSUMER SPENDING

Commodity currencies were hit from all sides today with commodity prices falling, economic data weakening and risk aversion seeping through the markets. Of all the major currencies, the Australian and New Zealand dollars lost the most value against the greenback followed by the Canadian dollar. Aside from disappointing data, investors were also dismayed to see China report slower manufacturing activity. With Chinese and U.S. growth slowing, the Australian, New Zealand and Canadian economies face increased uncertainty that may necessitate easier monetary policies. This morning, Canada reported a sharp decline in retail sales in the month of July. Consumer spending fell after rising 0.8 percent the previous month. Excluding autos spending was flat for the second month in a row which certainly does not bode well for the Canadian economy. Consumer spending was very strong in the second quarter but if the deceleration in spending seen in July persists, GDP growth could pull back significantly in the third quarter. Last night New Zealand’s GDP numbers were a bit of a surprise. Growth was expected to be strong as the country recovers from the earthquake but the latest numbers show the economy growing by a mere 0.1 percent in Q2, which was the second weakest quarter of growth in 9 months. On an annualized basis, GDP growth slowed to 1.5 from 1.7 percent, which explains why the RBNZ has been so relaxed about raising rates. With economic data around the world deteriorating, more central banks may be forced to abandon policy normalization and move back into easing mode. The commodity producing countries have yet to do so and the price action in the comm. dollars today show that this is where investors believe the opportunities lie.

JPY: MORE JAWBONING FROM FIN MIN AZUMI AS YEN HITS NEW HIGHS

The Japanese yen strengthened versus all of the major currencies, reaching a ten-year high over the euro. As Fed and European Systemic Risk Board highlighted more downside risks in the global market, safe haven flows fueled the appreciation of the yen. With the Fed’s decision announced, the pressure is now again back on Bank of Japan and Finance Minister Jun Azumi. Although Azumi and other Japanese officials have made numerous verbal attempts to intervene in the currency market, the threat of double-dip recession has kept risk-averse market participants in the yen. While traders remain wary of intervention, the lack of action from BoJ has frustrated Japanese exporters. The March earthquake and yen’s late strength have prompted manufacturers to diversify risk by investing overseas. As the exporters such as Panasonic Corp. plan to shift operations abroad, the economic recovery in Japan remains vulnerable. Meanwhile, continuing political turnover within the government hinders the rebuilding efforts, which could boost the economy through fiscal stimulus. After a futile effort to intervene in August, a more drastic measure could be implemented by BoJ in containing strength in the country’s currency. Looking ahead, while the Japanese market will be closed tomorrow due to the Autumn Equinox holiday, traders will continue to speculate on the possible actions of the BoJ. With the market growing weary of verbal intervention, a “bold” action could be called for.

EUR/USD: Currency in Play for Next 24 Hours

EUR/USD will be our currency pair in play for the next 24 hours. While there is no significant economic data scheduled for both sides of Atlantic, Greek and G20 news flow could dictate the direction of the pair.

EUR/USD remains vulnerable to risk-aversion flows and is currently trading in a downtrend, which we determined using the Bollinger Bands. The first level of support is at 1.3408, the 50% Fibonacci retracement. The Fibonacci level was drawn from the low in June 2010 to the high in May 2011. Further down, the lower second standard deviation Bollinger band could provide significant support at 1.3308. On the upside, if EUR/USD reversed its course, the psychologically significant 1.4000 level could contain pair’s rally. If the pair broke that critical handle, the pair’s 50-day SMA of 1.4167 could provide further resistance.

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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.