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FX: The Window is Closing

Last updated 9/28/2011 5:19 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: THE WINDOW IS CLOSING
• USD: DATA PROVIDES LITTLE CAUSE FOR OPTIMISM
• GBP: REMAIN OPPOSED TO FUTURE BAILOUTS
• NZD: RBNZ IN WAIT AND SEE MODE
• CAD: OIL DOWN MORE THAN 4 PERCENT
• AUD: JOB VACANCIES ON TAP
• JPY: LOOKING TO INCREASE SPENDING ON RECONSTRUCTION

EXPECTATIONS FOR UPCOMING FED MEETINGS

FX: THE WINDOW IS CLOSING

The window to prevent another meltdown in the financial markets is closing. At the start of the week, investors were very optimistic that the Europeans would get their act together and alleviate the pressure on the market by coming up with an ambitious plan to contain Greece’s debt crisis and prevent contagion. Initially it appeared that a deal was in the works but as the week progressed and European politicians denied that an agreement is in the works, investors started to lose their patience and confidence. This explains why currencies and equities moved lower throughout the North American trading session, giving up all of its earlier gains. The pullback in of itself is worrisome but the chart patterns signal the possibility of an even stronger reversal in risk appetite and high yielding currencies. 

Despite the turn in the euro, there was more good news than bad news out of the region today. Finland lived up to their end of the bargain and passed the amendments to the European Financial Stability Facility while the European Union approved tougher budget rules for Eurozone countries. The six pack rules contain the same 3 percent budget deficit limitation and 60 percent debt to GDP targets that currently exists but the difference is that this time the consequences are clearer, making it more difficult for Eurozone nations to ignore the rules. There will be an automatic warning system with costs and consequences. A warning is first issued if a government fails to meet its own medium term budgetary objective and if action is not taken to fix the problems after 7 months, the Commission could levy a fine of at least 0.2 percent of GDP. Increased governance will help to prevent future crises but does not little to resolve the current one and perhaps this is why investors are disappointed. The next step in the slow process is for Germany to vote on the EFSF expansion tomorrow (the results are expected around 7 AM NY Time or 11 GMT). The bill is expected to pass but the question is whether the Chancellor will be able to pass the bill without opposition support.   Three out of four Germans oppose the move and Merkel will be challenged to convince at least 311 of her coalitions 330 MPs to vote for the bailout. Anything short of that would mean that she is losing control, making it more difficult to get future bailout commitments from Germany. In other words, if Merkel fails to gain a “Chancellor’s Majority,” the odds of the EFSF being increased beyond EUR440 billion will decrease significantly, at the expense of the euro. 

Inflationary pressures in Germany were also not as weak as economists had anticipated. CPI rose 0.1 percent in the September, driving the annualized rate of growth up to 2.6 from 2.4 percent, the fastest pace in 3 years. Talk of a rate cut from the European Central Bank has gained momentum over the past week and the latest CPI numbers will lead investors to reconsider whether the ECB will really pull the trigger on a rate cut with inflation on the rise. German unemployment is scheduled for release tomorrow along with Eurozone confidence numbers.  According to the PMI reports, there was robust employment growth in the manufacturing and services sectors but sentiment in Europe could have been negatively affected by the ongoing sovereign debt crisis.

USD: DATA PROVIDES LITTLE CAUSE FOR OPTIMISM

The pullback in U.S. equities has coincided with a return in demand for U.S. dollars. The greenback traded higher against all of the major currencies with the exception of the Japanese Yen. This morning’s U.S. economic data provided little cause for optimism.   Durable goods fell 0.1 percent in the month of August which may have been slightly better than expected but still a negative print.  After rising sharply in July, the moderation in demand for big ticket items is not surprising.  Capital goods on the other hand rose 1.1 percent, the sharpest in 3 months.  Demand for computers and communications equipment rose strongly thanks to persistent demand from China and India.  This uptick is encouraging and shows that U.S. companies are not completely averse to spending - they just have no interest in hiring. For the past week we have heard nothing but dovish comments from Federal Reserve Presidents in support of more stimulus. Today, Fed President Hoenig, who is normally one of the more hawkish members of the central bank voiced his skepticism of the Fed’s ultra-easy monetary policy. He believes that it is dangerous to take their eyes off inflation because the “poor would suffer greatly under a high inflation” environment. The Fed’s policies could bring about unintended consequences that risk triggering further imbalances. Hoenig however is not a voting member of the FOMC which means that his skepticism has a limited impact on the central bank’s final decisions. Revisions to second quarter GDP will be released on Thursday along with jobless claims and pending home sales. Growth is expected to be revised slightly higher but pending home sales is expected to decline for the second month in a row. 

GBP: REMAIN OPPOSED TO FUTURE BAILOUTS

The British Pound weakened against both the euro and greenback. The Bank of England released its financial policy committee statement from its policy meeting on September 20 ^th . The statement says dealing with the international financial system would require long-term reforms to tackle unsustainable debt positions and the loss of competitiveness in a number of euro-area countries. Additionally, UK banks have made progress over the past two years in building up their capital and liquidity, which places them in a stronger position going forward. The statement also underscores that UK banks are now prepared so as to increase their capacity to absorb flexibly any future shocks, without constraining lending to the wider economy. UK Foreign Secretary William Hague said his 1998 comment that the euro area was “a burning building with no exits” has been proved right that member countries will have to live with the consequences for decades. His comments reflect the UK government’s hostility to being involved in any rescue and may irritate other European ministers trying to persuade their own voters to back bailout programs. As for riskier assets, UK stock retreated for the first time in four days, paring yesterday’s biggest rally for the FTSE 100 in 16 months. On the docket tomorrow is a host of economic releases, but most impact will be given to the nationwide house price index. Expectations for September are 0.1 percent, following a decline of 0.6 percent in August. A positive surprise could show that industry activity is starting to pick up again.

NZD: RBNZ IN WAIT AND SEE MODE

The Canadian, Australian, and New Zealand dollars all weakened against the greenback amid growing concerns a global economic slowdown may worsen. Of all the major currencies, kiwi experienced the sharpest decline against the U.S. dollar as the Reserve Bank moves into a wait and see mode. It was only a few months ago that investors were looking for a rate hike from the RBNZ, but as the global economy continued to slow, the central bank retreated in its call for tighter monetary policy. This afternoon, RBNZ Governor Bollard made it clear that New Zealand “has time to wait and watch on NZ interest rates.” He feels that the country is in a sweet spot because they can still move on rates and this comment is certainly in reference to easier and not tighter monetary policy. Meanwhile demand for Canadian exports may suffer as the U.S., Canada’s largest trading partner, reported an unexpected decline in durable goods orders. Deputy Governor Macklem of the Bank of Canada gave a speech last night on managing risks in the new global economic landscape. He noted that “low-for-long” interest rates are changing behaviors and straining some business models. He also called for more action to contain sovereign risks, promote a rebalancing of global demand, and implement financial regulatory reform. He does have a note of optimism in calling the distant horizon of the new economic landscape “bright.”  Oil fell today, heading for the biggest quarterly decline since 2008, on speculation that fuel demand will drop as the global economy slows. Other commodities also dropped, on reduced material demand, widening their second quarterly loss.  Gold has also taken a beating, falling for the fifth time in six sessions. Australian banks increased their advantage in credit-default swaps over global peers this quarter by the most in two years as bad loans fell and lenders cut overseas borrowing. However, Australian bonds didn’t fare so well. Australian state bonds are set for the worst quarter relative to sovereign debt since 2008 as investors dump declining stocks and choose federal government assets above all else. Focus for Australia is on next Tuesday’s central bank meeting. As of right now, the bank is in no haste to move rates, as suggested by two speeches by RBA’s Battellino and Lowe.

JPY: LOOKING TO INCREASE SPENDING ON RECONSTRUCTION

The Japanese yen strengthened against all the major currencies as signs of a global economic slowdown increased demand for safety. Japan’s ruling party proposed selling the government’s majority stake in Japan Tobacco Inc., the world’s third-largest publicly traded cigarette maker, to help fund reconstruction efforts after the March 11 earthquake. The government could raise as much as 1.8 trillion yen ($24 billion) by selling its 50.01 percent stake in the company at the stock’s current price. A sale may produce dual benefits: Japan Tobacco would operate with fewer constraints and the government would raise critical funds to help rebuild the nation. The government is currently looking to impose more taxes, including on cigarettes, to fund recovery from the earthquake and tsunami and the nuclear disaster. In October 2010, the government raised tobacco taxes 40 percent, and Japanese Health Minister Yoko Komiyama said September 20 ^th that tobacco taxes should go up again. The Democratic party of Japan also proposed a 9.2 trillion yen overall tax increase yesterday. Japan plans to spend 19 trillion yen over the next five years to rebuild after the record natural disasters. While the government has already approved two aid packages totaling about 6 trillion yen, the economy has shrunk for three straight quarters. Pressure to raise money now may have pushed the government to propose selling more of its stake faster than planned. Consequently, the government would need to rewrite a law that requires it to hold at least half of the tobacco company. In the equity markets, Japanese stocks rallied for a second day as investors seek safety from euro-area contagion. On the docket tonight is Japanese retail sales for the month of August. Expectations are for a -0.6 percent print, while July’s figure was 0.7 percent. Given the slowdown in economic growth, consumer demand remains under pressure and could cause a larger-than-expected contraction in the sales number. 

EUR/USD: Currency in Play for Next 24 Hours

The EUR/USD is our currency pair in play for the next 24 hours. Economic data we expect for release from Germany are the September unemployment numbers at 3:55 AM ET / 7:55 GMT. Then, from the Eurozone we expect the September business climate indicator, consumer, economic, industrial, and services confidence numbers at 5:00 AM ET / 9:00 GMT. From the United States, we expect Q2 GDP numbers, personal consumption and expenditure, and jobs numbers all at 8:30 AM ET / 12:30 GMT. Also, from the U.S. we expect pending home sales at 10:00 AM ET / 14:00 GMT.

EUR/USD appears to have formed a short term bottom as it is now trading in a range, which we determined using Bollinger bands. Nearest support is at the psychologically significant 1.3500. This price is also an area of closing prices over past sessions. Should the pair continue to fall, significant support will be found at the 20-month low of 1.3362 reached on September 26 ^th . To the upside, nearest resistance is at 1.3770, which is psychologically significant and where the 20-day simple moving average lies. Should the pair break through that level, heavy resistance will be found at 1.3960, the 38.2% Fibonacci retracement. We drew our Fib from the high on May 4 ^th to the low on September 26 ^th .

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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.