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EUR: How Investors are Positioned Ahead of ECB

Last updated 10/5/2011 5:08 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

• HOW ARE INVESTORS POSITIONED AHEAD OF ECB
• USD: LABOR MARKET INDICATORS SHOW CONTINUED WEAKNESS
• GBP: NO CHANGES TO MONETARY POLICY EXPECTED
• AUD: SERVICE SECTOR GROWTH SLOWS, RETAIL SALES RISE
• CAD: OIL PRICES JUMP 5 PERCENT
• NZD: BOOSTED BY RISK
• JPY: BOJ STANDS READY TO ACT

EXPECTATIONS FOR UPCOMING FED MEETINGS

HOW ARE INVESTORS POSITIONED AHEAD OF ECB

In our ECB Preview, titled How Far will the ECB Go , we outlined the various scenarios for tomorrow’s monetary policy announcement. For the first time in a while, economists are divided on what to expect from the ECB which makes volatility a near certainty. The forecasts range from the central bank doing nothing to lowering interest rates by 50bp which would be the largest rate change by the central bank since March 2009. In order to understand how the market could react, it is important to know how traders are positioned. First and foremost, the euro has ended the day unchanged against the U.S. dollar which suggests that investors aren’t sure about what to expect from the central bank tomorrow. With that in mind however, the sharp sell-off in the EUR/USD in September and the overall weakness of the currency indicates that investors are positioned for easier and not tighter monetary policy. The most recent CFTC data for the week ending on September 27 ^th showed short EUR/USD positions at their highest level since June 2010. Considering that the EUR/USD was trading around 1.35 at the time, the latest sell-off in the currency pair could have further boosted short positions. In other words, speculators are aggressively short euros ahead of the ECB meeting. According to interest rate futures, bond traders also expect the ECB to lower rates. The market is currently pricing in approximately 20bp of tightening for tomorrow’s meeting and 30bp of tightening for the November meeting. This implies that a great deal of bond traders expect the ECB to ease tomorrow and if they do not, then the general thought is that a November rate cut is a done deal. Eighty percent of economists on the other hand expect the central bank to hold rates steady but this does not preclude the possibility of the ECB taking other measures to boost liquidity.  This includes extending the terms of their refinancing operations, restarting their covered bond purchase program and widening their interest rate corridor by cutting the deposit rate. Each of these scenarios is discussed in detail in our ECB Preview.

Given the ongoing uncertainty created with Greece, the volatility in the financial market and deterioration in the Eurozone economy, the ECB cannot necessarily afford to wait another month to ease the strains in the banking sector and the financial markets. As a result, there is a 70 percent chance that the ECB will announce new liquidity measures but stop short of lowering their main refinancing rate. By reintroducing a 12 month facility, the ECB would get cash into the hands of banks for a longer period of time. Restarting the covered bond purchase program would offload some of the chunkier elements on bank balance sheets and free up capital for them to lend while cutting the deposit rate would boost lending among banks and deter them from parking their excess funds with the ECB. Although helpful and to a large degree expected by the markets, these measures are not as bold as a rate cut and would therefore mildly positive for the euro. 

USD: LABOR MARKET INDICATORS SHOW CONTINUED WEAKNESS

The U.S. labor market is the focus this week but based upon the leading indicators for non-farm payrolls and how the economy has fared in general, investors do not have a good feel of what to expect for Friday’s report which may be part of the reason why NFPs have been overshadowed by developments in Europe. The U.S. dollar weakened against commodity currencies but held steady against the euro, British pound and Japanese Yen. According to Challenger Grey & Christmas, layoffs rose 212 percent in the month of September, which was the largest increase since January 2009. This sharp rise reflects more than 50k public sector job cuts (most of which are in the military) as well as 30k job cuts by Bank of America, the country's largest lender. Based upon the Challenger report alone, it is hard to imagine that there will be much of a recovery in the U.S. labor market. However losses in the dollar were mitigated by a rise in private sector payrolls. According to ADP Employer Services, U.S. companies added 91k jobs last month, up from 89k in August. Unfortunately given ADP's drastic overestimation of private sector payroll growth in August, investors have become skeptical of their rosy assessment of the U.S. labor market. The most reliable guide for NFPs tends to be the non-manufacturing ISM report which accurately forecasted the deterioration in job growth in August. The latest report showed service sector activity growing at a slower pace in September and companies shedding jobs for the first time in more than year. The ISM non-manufacturing index fell to 53 from 53.3 with the employment component dropping to 48.7, the lowest level since April 2010. The decline in service sector employment raises major red flags for Friday's non-farm payrolls report. Although economists expect a rebound in job growth, we are not as optimistic and caution traders against a downward surprise. No U.S. economic reports will be released tomorrow which means that for the next 12-24 hours, the price action of currencies will be dictated by the ECB and BoE’s degree of dovishness. 

GBP: NO CHANGES TO MONETARY POLICY EXPECTED

The British pound weakened against both the U.S. dollar and euro as final GDP showed the economy grew less than expected. U.K. economic growth slowed more than estimated in the second quarter as consumer spending fell the most in more than two years, adding pressure on Bank of England policy makers to provide more stimulus. GDP rose 0.1 percent from the first quarter, instead of the 0.2 percent previously published. The data comes as BoE officials meet to decide whether they’ll revive their bond-purchase program as the government’s fiscal squeeze and Europe’s debt crisis hamper growth prospects. The Bank of England could very well expand their asset purchase program by 50 billion pounds, as policy maker Posen has called for. Given the deterioration in growth of the U.K. economy, more stimulus seems necessary but there have also been some bright spots and for this reason, the central bank may not be ready to pull the trigger. Mixed economic data came out today with September services PMI printing stronger than expected, but with a poor outlook. The purchasing managers’ index rose to 52.9 in September from 51.1 in August, bouncing back from its biggest one-month fall in a decade and moving away from the 50 line that separates growth from contraction. However, firms’ expectations for the next 12 months are bleak. U.K. shop price inflation was unchanged as stores cut prices to lure consumers. Retail prices rose 2.7 from a year earlier in September, the same as in August, as supermarkets absorbed costs to attract shoppers squeezed by rising fuel and utility prices. The Bank of England has predicted that inflation will accelerate to 5 percent before slowing next year as the impact of higher commodity prices, a declining pound, and an increase in sales tax earlier their year fade. Business investment picked up from last quarter, increasing 11.6 percent in the second quarter. Businesses are building their infrastructure as they try to attract consumers in the depressed economic climate. As for the BoE rate decision, we believe there is a 70 percent chance that the central bank will delay increasing their asset purchase program to November. If the BoE leaves policy unchanged, the British pound will probably enjoy a minor relief rally because a small group of investors are looking for the BoE to boost asset purchases. If they follow through with more stimulus, it would be a big surprise to the market and will most likely send the British pound sharply lower.

AUD: SERVICE SECTOR GROWTH SLOWS, RETAIL SALES RISE

The Canadian, Australian, and New Zealand dollars all strengthened against the greenback today as risk appetite returned to the market.  Oil rose from its lowest level in a year after a surprise drop in crude stockpiles. Commodities as a whole rebounded from their lowest level in 10 months after Federal Reserve Chairman Ben Bernanke said the central bank may take further steps to sustain an economic recovery. No new economic data was released from Canada as their equities fell for a third day on signals that Greece may revert to a bailout. Australia’s dollar received a boost from its retail sales report. Official retail sales jumped by 0.6 percent in August, showing shoppers continued appetite for spending despite growing global economic worries. The August increase followed a 0.5 percent increase in July. Prior to August consumers were expecting rate hikes, but with the increased global volatility investors now expect a rate cut which may have encouraged consumers to spending. Australian lawmakers called on the government to investigate claims senior central bank officials suppressed evidence of corruption at the bank’s note-printing units that sought contracts in Nepal and Malaysia. The allegations may increase the scrutiny of the Reserve Bank of Australia after Treasurer Swan said last month it will lose its sole power to set compensation for its board and executives for the first time. Australian government debt turnover grew last financial year at more than three times the pace of the previous period as federal and state authorities sold more bonds and overseas central banks became more active. Australian bond yields tumbled to the lowest level in 20 months relative to U.S. Treasuries after central bank Governor Glenn Stevens indicated he’s willing to cut the key interest rate. Stevens, who held rates earlier this week, signaled slowing inflation may give him scope to lower borrowing costs. Service sector activity also slowed which may be a cause for concern.

JPY: BOJ STANDS READY TO ACT

The Japanese yen weakened against all the major currencies with the exception of the U.S. Dollar, British pound and Swiss franc on optimism that European leaders may reach an agreement. No new economic data was released today and the Bank of Japan is set to keep monetary policy unchanged at the end of a two-day meeting on Friday. However, the central bank has said it stands ready to act if slowing global growth and adverse market conditions threaten to derail Japan’s fragile recovery from March’s earthquake and tsunami. European officials would be unlikely to welcome any Japanese currency-market intervention to bolster the euro, even if the aim is to fund the Eurozone’s efforts to end its debt crisis. The U.S. and Europe want weaker currencies to fight their economic woes. Market participants view the yen’s upward trend against the euro and the dollar as reflecting economic fundamentals and it can’t be reversed by the kinds of sporadic solo interventions conducted by Tokyo over the past year. The strong yen is helping some Japanese companies go on shopping sprees as they seek global growth. Rakuten, an online shopping mall operator has bought several overseas businesses in the last year and is not the only Japanese company on an acquisition spree. Businesses from pharmaceutical companies to toy makers have been empowered by the increased purchasing power that the strong yen gives them. Japan’s three largest banks also received a combined $43 billion credit line from the government to help finance domestic companies’ overseas takeovers. Prime Minister Yoshihiko Noda is under pressure to help Japanese companies weather the yen’s 11 percent rise against the dollar in the past six months, which has dampened the economic recovery. The deal is aimed at helping banks to acquire dollars and offer loans to companies planning acquisitions abroad. Leading indicators for Japan will be released on Friday. The index should help the market gauge the strength of Japan’s recovery.

EUR/USD: Currency in Play for Next 24 Hours

Our currency pair in play for the next 24 hours is the EUR/USD. The European Central Bank is scheduled to release its rate decision at 7:45 AM ET / 11:45 GMT followed by Trichet’s press conference at 8:30 AM ET / 12:30 GMT. From the United States, we expect jobless claims at 8:30 AM ET / 12:30 GMT. Also from the U.S. we expect ICSC chain store sales for the month of September at 10:30 AM ET / 14:30 GMT.

EUR/USD has been paring some of its losses in the past few days, but still remains in a down trend which we determine using Bollinger bands. First support is at 1.3145, the 9-month low reached on October 4 ^th .  If the pair continues to slide, more significant support will be found at 1.3040, the 61.8% Fib level. We drew our Fibonacci retracement from the low on June 7 ^th , 2010 to the high on May 4 ^th , 2011. If the currency starts to rise, the first level resistance will be at 1.3400, the 50% Fib and lower first standard deviation Bollinger band. If the pair breaks out from that level, nire resistance will be encountered at 1.3580, the 20-day SMA and a previous price of contention.

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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.