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FX: Beware Of Further Weakness

Last updated 9/30/2011 4:53 PM ET (GMT -5) 2 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• FX: BEWARE OF FURTHER WEAKNESS
• EUR: EZ FIN MIN AND ECB MEETINGS POSE BIG RISKS
• GBP: CONSUMER CONFIDENCE EDGES HIGHER
• NZD: EXTENDS LOSSES AS S&P MATCHES DOWNGRADE
• CAD: STRONGER GDP GROWTH IN JULY
• AUD: RBA MEETING NEXT WEEK
• JPY: PLANS TO BOOST INTERVENTION FUND

EXPECTATIONS FOR UPCOMING FED MEETINGS

FX: BEWARE OF FURTHER WEAKNESS

The U.S. dollar traded higher against all of the major currencies as investors pared back risk ahead of a very busy trading week. Europe has been the main focus throughout this week and will continue to command the market’s attention in the coming days. However with Federal Reserve Governor Ben Bernanke testifying before the Joint Economic Committee on the Economic Outlook and the non-farm payrolls report scheduled for release on Friday, it may be hard for investors to ignore the developments in the U.S. economy. Almost as quickly as the central bank launched Operation Twist this month, speculation started to build about the Fed’s next steps. A third round of Quantitative Easing is still on the table and next week’s economic reports will go a long way in determining how quickly the Fed needs to pull the trigger on more stimulus. The last two non-farm payrolls report were abysmally weak and unfortunately expectations for job growth this month remains low. Economists are looking for only 50k jobs to be created in September, which is far below the number needed to offset new entrants and keep the unemployment rate from rising.  For this reason, 50k job growth may not be enough to rally the markets. Also, given the lack of job growth last month, we would not rule out a weaker print that could trigger a sell-off in both currencies and equities. Aside from non-farm payrolls, manufacturing and service sector ISM numbers will also be released and these reports will provide a more updated look into the current state of the U.S. economy.

More importantly however, investors will be watching closely to see if other central banks around the world will follow in the footsteps of the Fed next week. The Reserve Bank of Australia, Bank of England, European Central Bank and the Bank of Japan have monetary policy announcements and even though no one is expected to change monetary policy, there is a very good chance that each one of them will grow more dovish which may be enough to put pressure on their currencies. Investors haven’t quite priced in a global easing cycle, the possibility of which is growing more likely by the day. It mattered little t hat this morning’s U.S. economic reports were mostly better than expected. Chicago PMI ticked up to 60.4 from 56.5 while consumer confidence was revised higher because personal income declined by 0.1 percent in August and personal spending growth slowed to 0.2 percent.  Investors have come to expect weaker U.S. economic data and given the weakness of the labor market and decline in retail sales, investors would have been more surprised by stronger data.

Before the focus shifts to the U.S. however, the week will start off with a bang as Eurozone Finance Ministers convene in Luxembourg to discuss ways to support Greece and prevent contagion. There are also reports that the Troika will release its assessment of Greek public finances by Monday while the government moves forward on approving more austerity measures.

EUR: EZ FIN MIN AND ECB MEETINGS POSE BIG RISKS

The euro traded sharply lower against the U.S. dollar as investors wonder how much longer it will take for European Finance Ministers to decide whether to release the next tranche of aid to Greece let alone unveil a grand master plan to save the euro. According to European officials, the EU, IMF and ECB could complete their assessment of Greece as quickly as Monday, which would pave the way for finance ministers to approve the release of the next bailout payment to Greece. In order to put the odds on their side, Greece will be holding a special meeting this weekend that will probably result in new proposals to meet the Troika’s requirements. With very little time between now and Monday’s Finance Ministers meeting, we are very skeptical of a deal being reached particularly since European leaders have told Greece time and again that they must put in place the savings and reforms that they have committed to. If there are no signs that European officials have come closer to announcing a broad rescue plan for Europe, investors will express their disappointment by punishing the euro.  Meanwhile the other big event risk for the Eurozone next week is the ECB meeting. After 8 years of defending the euro through thick and thin, Trichet will be delivering his very last post monetary policy meeting press conference. His straight-talking no nonsense attitude will be sorely missed and up until Thursday’s decision, investors will be speculating about the possibility of Trichet leaving investors with a rate cut as a parting gift. If he does, the euro will sell off quickly and aggressively. If instead he opts to leave his successor Mario Draghi with a clean slate by leaving rates unchanged, the euro could enjoy a relief rally. Given the surprisingly large decline in German retail sales, the Eurozone could benefit from easier monetary policy. Aside from the Finance Minister and ECB meetings, the Eurozone economic calendar is light with only EZ producer prices and retail sales on the calendar. Switzerland on the other hand will be releasing their retail sales, manufacturing PMI, inflation and employment reports. Leading indicators fell for the fifth consecutive month to a 2 year low, reflecting broad based deterioration in Switzerland’s economy and the damaging impact of a strong currency.

GBP: CONSUMER CONFIDENCE EDGES HIGHER

The British pound strengthened against the euro but held steady against the U.S. dollar. In early trade, the pound weakened against the dollar as reports on Chinese manufacturing and German retail sales added to evidence the world economy is faltering. However, a report by GfK showed U.K. consumer confidence rose for the first time in four months in September as Britons became more optimistic about the economic outlook and spending, causing the pound to pare losses against the greenback. The confidence index rose one point to minus 30. While the increase is not statistically significant, it is psychologically important as it stops a recent decline in sentiment. Yet the increase in September still leaves confidence 10 points lower than September of last year and the minus 30 reading is below the minus 25 average of the last three years. While nothing is expected, there is a slight chance that the Bank of England may reactivate its bond-purchase program next week. Recent indicators suggest that the economic outlook continues to deteriorate rapidly. Britons’ confidence has been undermined this year by inflation that is almost double wage growth and the largest government budget squeeze since World War II. A retail-sales index fell to its lowest level in 16 months. Furthermore, a report next week may confirm that the U.K. economy expanded just 0.2 percent in the second quarter after stagnating over the previous two quarters. The data, expected on Oct. 5, will include initial estimates of exports, company investment, and spending by consumers and the government. The deterioration in economic data has revived and intensified the debate on asset purchases, with most of the nine-member Monetary Policy Committee saying its “increasingly probable” more stimulus will be needed to salvage the recovery. Additionally, BoE policy makers are expected to leave the key interest rate unchanged at the record low of 0.5 percent.

NZD: EXTENDS LOSSES AS S&P MATCHES DOWNGRADE

The Canadian, Australian, and New Zealand dollars all weakened against the greenback. The Reserve Bank of Australia is set to announce its rate decision next week on Oct. 4. The bank is unlikely to move the interest rate at this meeting and could keep the interest rate unchanged until early 2012 even as investors hope for a rate cut. However, the bank is somewhat torn between doubts about global economic growth and the high inflation driven by rising prices for Australia’s mining commodities. Recent RBA commentary indicates that they might be comfortable to remain inactive until the balance of risks shifts clearly one way or the other. Total Australian credit provided to the private sector by financial intermediaries rose by 0.2 percent over August 2011, after rising by 0.3 percent over July. Year-over-year total credit rose by 3.0 percent. The Canadian dollar slid lower for a third day against the greenback, falling to the lowest in more than a year. The currency was headed for weekly, monthly, and quarterly losses even after a report showed Canada’s gross domestic product rose for a second month in July on gains in manufacturing and wholesaling. GDP figures showed the Canadian economy expanded at 0.3 percent in the second quarter, following a 0.2 percent expansion in the first quarter. Commodities have been weighing down on the higher-yielding currencies as gold and silver lead the monthly declines. Commodities as a group, are heading for the biggest quarterly drop since the end of 2008, as bearish data on economies in Europe and China added concerns that the world will slip into another recession. New Zealand’s dollar slumped to a six-month low after Fitch Ratings and S&P reduced the country’s credit rating, adding concern borrowing costs will increase. Government bond yields rose by the most this year. New Zealand is the first Asia-Pacific nation in a decade to have its local-currency debt cut from AAA.  The outlook is stable after the long-term local-currency rating was reduced one level to AA+ and foreign-currency debt was cut to AA from AA+, S&P said in a statement. New Zealand’s dollar extended its biggest quarterly drop since 2008 after Fitch announced similar moves yesterday. Both credit assessors cited concern that government and household debt is expanding.

JPY: PLANS TO BOOST INTERVENTION FUND

Trading was mixed for the Japanese yen today. While USD/JPY hovered around the 77.00 handle, the yen strengthened to a six-month high over the New Zealand dollar. The appreciation of the country’s currency remains at the forefront of Japan’s concern as the Finance Minister announced plans to bolster funds needed to intervene in the foreign-exchange market. The manufacturing PMI dropped to 49.3 in September falling below the critical level of 50. The industrial production reported printed at 0.8 percent in August marking another rise for the fifth-straight month. While output nearly returns to levels before the March earthquake, the future outlook is clouded by uncertainty. The global economic turmoil could affect production negatively with exporters troubled by shrinking demand. On the labor front, the unemployment rate edged lower to 4.3 percent in August from 4.7 percent in July. Nonetheless, this better than expected jobless rate was mainly due to the contraction in its labor force as discouraged workers gave up looking for jobs. According to the report from Statistics Bureau, Japan’s labor force shrank to the smallest size since October 1987. The economic recovery in Japan continues to be burdened by its major trading partners – U.S. and Europe. Furthermore, the global retreat to yen could put much more pressure on the Japanese economy as major manufacturers make major shifts in operations. Panasonic Corp., a major electronics manufacturer, announced its plan to move the headquarters of its $57 billion procurement operation to Singapore from Osaka in the year starting April 2012. The sustained appreciation in yen could have hollowing-out effects prolonging the stagnating recovery in Japan. Looking ahead, the Tankan report will be released on Sunday. The market could have one of the most comprehensive look on the Japanese economy in Q3. Nevertheless, the report could show more downside risks in Japan’s outlook amid the uncertainty in global economy.

USD/JPY: Currency in Play for Next 24 Hours

USD/JPY will be our currency pair in play for Monday. From the U.S., we expect ISM Manufacturing and Construction Spending at 10:00 AM ET/ 14:00 GMT. From Japan, we expect the Tankan Manufacturing Index and Non-Manufacturing Index at 7:50PM ET/ 23:50 GMT on Sunday.

Despite the recent strength in the U.S. dollar, USD/JPY remains in range-trading zone. The nearest resistance could be found at 77.63, the pair’s upper second standard dev. Bollinger Band. Once that level was broken, USD/JPY ’s rally could be further contained at 78.76 (100-day SMA). On the downside, the lower first standard dev. Bollinger Band could support pair’s decline at 76.49. USD/JPY ’s further collapse could see major support at 75.94 – the postwar record for the pair.

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Comments (2)

Kozel

September 30, 2011 at 06:09 PM ET

Dear Kathy,

You articles are always very informative and useful. I bought the Candian dollar vs. the USD over two weeks ago and have watched it go againt me almost every day for the last two weeks. What is the problem, the Canadian economy is in better shape the the U.S. economy? I think the sell off is excessive. If I wait a few weeks will I be able to make at least a small profit on my trade?

FXTC

October 03, 2011 at 05:23 PM ET

Youd be lucky to break even. I’ll sell that pair next week. I wanna see some oil and stock strength.

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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.