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Bernanke: Doom and Gloom Means More Room

Last updated 10/4/2011 5:32 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

• BERNANKE: DOOM AND GLOOM MEANS MORE ROOM
• EUR: REVERSES SHARPLY BUT HAS OUTLOOK FOR GREECE REALLY CHANGED?
• GBP: OSBORNE PROPOSES LENDING MONEY TO BUSINESSES
• AUD: RBA OPEN TO CUTTING RATES
• CAD: OIL AND GOLD JOIN REBOUND
• NZD: STRONGEST PERFORMER AGAINST USD
• JPY: AZUMI TALKS EURJPY

EXPECTATIONS FOR UPCOMING FED MEETINGS

BERNANKE: DOOM AND GLOOM MEANS MORE ROOM

Volatility ripped through the financial markets today with risk rebounding sharply in the last hour of trading. Before the markets reversed, U.S. stocks had fallen to their lowest levels in more than a year. However the EUR/USD and other high yielding currency pairs soared after the Financial Times reported that European Finance Ministers are working on coordinating bank recapitalizations. This story is not entirely new but it was enough to trigger a more than 350 point intraday reversal in the Dow and a major short squeeze in the EUR/USD. Considering that the previous sell-off in the euro was largely caused by investors being disappointed in European policymakers, any hint of a deal in the works was enough to get the market buzzing again (more on this in the euro section of our commentary). 

Yet for most of the day, the doom and gloom scenario painted by Bernanke made investors realize that there is more room for the Federal Reserve to ease. The dollar traded higher up until the FT report and the pullback in the greenback proves that its prior strength was a reflection of flight to quality and not optimism about the U.S. economy. Investors are starting to believe that the longer the status quo continues – which includes both the uncertainty in Europe and sluggish growth in the U.S., the more likely other central banks will have to follow by openly consider easing monetary policy alongside the Fed. The reversal in the markets today does not change this risk. In terms of the U.S., Bernanke left very little to the imagination when he said the central bank is ready to take further action when necessary. This Friday’s non-farm payrolls report will play a major role on how quickly the Fed decides to increase stimulus. Tomorrow’s ADP, Challenger and Service Sector ISM reports will help to set expectations for Friday’s release. Although these leading indicators for NFPs have not been perfect, they are still relied on for estimating job growth. A total of 73k jobs are expected to be created in September, but service sector activity is projected to slow which does not bode well for service sector employment. If all 3 of tomorrow’s labor market reports surprise to the upside, the relief rally in equities and currencies would continue but if there is any pronounced weakness, risk appetite could retreat quickly. 

Federal Reserve Chairman Ben Bernanke admitted to the Joint Economic Committee and the world for that matter that Operation Twist was essentially a failure because it did not have an enormous effect on the economy when a strong dose of stimulus was desperately needed. There was a general sense of defeat in the Chairman’s voice which disappointed investors because the U.S. relies on its central bank to use monetary policy to jumpstart the economy.  Although Bernanke said they are ready to take further action when necessary, he also admitted that his hands are tied because monetary policy is “not a panacea for the U.S. economy.” Yet even if the impact of monetary policy is limited, it is the Federal Reserve’s obligation to exhaust all of their options.  Bernanke spent most of his testimony outlining all the risks to growth and inflation including the weak labor market, the European crisis and government cuts.  It was depressing to listen to the Fed Chairman say that job growth will remain sluggish and that the U.S. is still a long ways from recovery.  Based upon the pessimism in Bernanke voice, it will only be a matter of time before the Fed announces another asset purchase program. 

EUR: REVERSES SHARPLY BUT HAS OUTLOOK FOR GREECE REALLY CHANGED?

The sharp rebound in the euro this afternoon shows just how much investors are hoping for a grand sweeping rescue plan from European officials. Recapitalizing banks will help to alleviate the pressures on the region but this is not a particularly innovative development because bank recapitalization was discussed throughout the month of September. The idea lost momentum over the past week as investors started to sense more conflict than cooperation in the Eurozone.  Nonetheless, based upon the price action in the euro, any progress appears to be better than no progress at all. However with this in mind, there is still plenty to be worried about. Rating agency Moody’s downgrade Italy’s sovereign debt rating to from Aa2 to A2 with a negative outlook that means their rating could be cut even further. Moody’s decision brings their rating of Italy in line with that of Standard & Poor’s who jumped the gun and lowered the country’s rating in mid-September. The euro had very little reaction because Moody’s followed the leader. The big story this morning still centers on Greece. Both Greek and European officials are now saying the country has until November to receive aid before they run out of money.   The report by the Troika will probably not be prepared in time for the October 13 ^th Eurogroup meeting which means European officials will not be able to make a decision on releasing Greek aid. As a result, Greece remains at risk of default and in fact, the haircuts being discussed suggests that many people in Europe are preparing for a default. ECB President Trichet also spoke this morning and based upon his comments, he may not be a fan of lower interest rates.  Trichet started his speech by saying that the central bank’s primary aim is price stability and for the time being, inflation is expected to stay above 2 percent until next year.  Although he admits that the risks to the economic outlook are to the downside, he also sees moderate growth in the second half of the year. Most importantly, he is not in favor of bailout funds refinanced by the ECB which shows that he too is challenging the bailout structures cited by various media agencies last week. With no end to the Greek Saga in sight, we believe that the rebound in the EUR/USD will be limited. Revisions to service sector PMI numbers are due for release tomorrow. The only piece of Eurozone data released today was Producer Prices which declined 0.1 percent in the month of August.

GBP: OSBORNE PROPOSES LENDING MONEY TO BUSINESSES

The British pound rebounded against the dollar but weakened against the euro as growth of UK construction activity slowed to near-stagnation levels. The construction purchasing managers’ index posted 50.1 in September, only fractionally about the 50.0 no-change threshold that separates expansion from contraction. The index read 52.6 in August and this month’s reading was the lowest since January 2011. Work on existing contracts helped support output, but was largely offset by a fall in new orders. Employment rose for the first time in four months, but only a by a marginal amount. Lastly, input price inflation eased sharply, keeping the index on the edge. British confidence remains relatively subdued, with uncertainty over future economic conditions weighing on optimism. Two of the three board categories that make up the index – housing and civil engineering – recorded lower output in September. While growth for the third quarter was modest, it was slower than the expansion recorded in the second quarter, adding to worries that the overall UK recovery has lost its momentum. Chancellor of the Exchequer George Osborne responded to the mounting concerns over the economy by proposing to lend billions of pounds of public money directly to British companies struggling to obtain credit from banks. The proposal outlined yesterday, would see the Treasury buy bonds issued by small and mid-sized companies in a program known as credit easing. The purchases would be financed from the sale of Treasury bills or government bonds. One possibility would be to instruct the Bank of England to buy corporate bonds. Osborne is refusing to slow the pace of deficit reduction and is being called to find ways to stimulate an economy that hasn’t grown in a year. On the docket for tomorrow is the Halifax house price index, current account, services PMI, and Final GDP. Expectations are for continued deterioration in the readings as global growth concerns intensify.

AUD: RBA OPEN TO CUTTING RATES

The reversal in risk helped all to lift all of the major currencies out of negative territory including the Australian, Canadian and New Zealand dollars. Having marked a fresh one year low against the greenback prior to the relief rally, the turn in the comm. dollars have been impressive. The big story last night was the RBA rate decision.  The uncertainty in the global economy and the volatility in the financial markets is finally catching up to the Reserve Bank of Australia. For the past few months, investors had been discounting a 50 to 100bp rate cut before the end of the year but up until today, the RBA has not been willing to even consider lower interest rates. In this month's RBA statement however, the central bank is clearly telling us that they are open to the idea of easier monetary policy which is why investors sold the Australian dollar following the RBA announcement. In the monetary policy statement, the central bank said "an improved inflation outlook would increase the scope for monetary policy to provide some support to demand, should that prove necessary."  In other words, if inflation declines due to weaker economic conditions, the RBA will be ready to cut interest rates.  This represents a major shift for the central bank because they are finally acknowledging the concerns of investors who are discounting 70bp of easing by year's end.  Although the RBA still feels that the terms of trade in Australia are very high and investment in the resources sector is picking up, the deterioration in the labor market, cautious spending behaviors and the earlier rise in the exchange rate has  led the central bank to admit that "near-term growth is unlikely to be as strong" as they previously expected.  They are also beginning to share the inflation concerns of other central banks.  According to the RBA statement "recently revised data show a pick-up to date in the underlying pace of price rises that was less sharp than initially indicated." Back in September, the central bank was still worried about the medium term inflation outlook but now they are far less concerned about price pressures getting out of hand. Yet it is also important to realize that even though the RBA reduced their degree of hawkishness, they are still waiting for more signs of weaker growth before pulling the trigger on lower rates. The latest economic reports has not added to their concerns. The country’s trade balance jumped to 3.1B from 1.817B while building approves surged 11.4 percent in the month of August. Australian retail sales are scheduled for release this evening along with service sector activity and these reports will help the RBA decide how soon they need to lower rates.

JPY: AZUMI TALKS EURJPY

The Japanese Yen traded lower against all of the major currencies as safe haven flows eased. Japanese Finance Minister Jun Azumi told reporters today “in order to halt the extreme strength in the yen and weakness in the euro, Europe should make the process of rescuing Greece more transparent to the markets.” The euro fell today against the yen to its weakest level since June 2001. The drop to a decade low could be a sign of more pain to come for the Japanese economy. Japan’s exporters have struggled for many months with the yen near a record high against the U.S. dollar; the recent euro weakness is just compounding their problems. Many companies count on sales in Europe for a considerable chunk of their earnings, so the euro’s steep fall has added salt to the wounds. Japanese finance ministers have traditionally refrained from commenting on other nation’s policies. This instance underscores the notion that this strong of a yen could derail Japan’s economic recovery. Azumi said he told Bank of France Governor Christian Noyer during a Tokyo visit yesterday that Europe needs to implement Greece’s rescue measures “as soon as possible.” Azumi also called the yen’s rise against the euro “extreme” and said the government would deal with it “with full force,” a signal that Tokyo may be closer to intervening again in the foreign-exchange market. Japanese wage earners' total cash earnings fell 0.6 percent in August from a year earlier, dropping for the third month in a row, the labor ministry said on Tuesday. Japanese consumers will be unable to increase final demand without a growing income, exacerbating the economic slowdown. Ten-year yields on Japanese government bonds will continue to slide as global economic growth concerns intensify. Currently the bonds are yielding less than 1 percent, marking a gain for a seventh month in September, the longest streak since May 2003. Japanese stocks fell as well, dropping to their lowest levels in a week, reflecting the risk-averse environment. Tokyo Electric Power Co. plans to raise as much as 2.4 trillion yen ($31 billion) selling bonds to repay debt securities due by March 2021, according to a government panel. The company may have a funding shortfall of 8.6 trillion yen during the next ten years because of higher costs to generate power from fossil fuel. Investors won’t buy the bonds unless the utility clearly shows it can survive on its own with strong support from the government. The Bank of Japan will announce it interest rate decision on Thursday.

GBP/USD: Currency in Play for Next 24 Hours

Our currency pair in play for the next 24 hours is GBP/USD. U.K. PMI services and the final GDP report will be released at 4:30 AM ET or 8:30 GMT followed by the U.S. ADP Employment Change at 8:15 AM ET / 12:15 GMT and the ISM Non-Manufacturing Index at 10:00 AM ET or 14:00 GMT.

GBP/USD has been on the slide over the past month and despite today’s reversal continues to trade in a down trend which we determine using Bollinger bands. With that in mind, today is a strong reversal candle in the currency pair.  Resistance is at 1.5490, where the 50% Fib, lower first standard deviation band, and 10-day SMA converge. We drew our Fibonacci retracement from the low on May 20, 2010 to the high on April 28, 2011.  If GBP/USD breaks above that level, it should find stronger resistance at 1.5715, the high reached on September 29 ^th . Should the currency pair trickle lower, the first area of support is at 1.5305, where the lower second standard deviation Bollinger band lies and below that, 1.5190, the 61.8% Fib.

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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.