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FX: Global Easing Intact Despite Stronger NFP

Last updated 10/7/2011 5:24 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: GLOBAL EASING INTACT DESPITE STRONGER NFP
• EUR: HIT BY FITCH DOWNGRADES
• GBP: BUSY WEEK AHEAD
• CAD: VERY STRONG JOB GROWTH
• AUD: EMPLOYMENT NUMBERS ON TAP IN COMING WEEK
• NZD: NO MAJOR CHANGES IN GOLD AND OIL
• JPY: BOJ WORRIED ABOUT ECONOMIC HEADWINDS

EXPECTATIONS FOR UPCOMING FED MEETINGS

FX: GLOBAL EASING INTACT DESPITE STRONGER NFP

What a week! With four central bank rate decisions and the non-farm payrolls report on the calendar, there has been no shortage of volatility in the financial markets. After selling off aggressively over the past month, recovery was the main theme in the markets. The dollar retreated as safe haven flows eased and investors slowly put their money back into higher yielding currencies. Although we are skeptical of the rebound in the EUR/USD, AUD/USD and other currency pairs from a fundamental basis, we must respect the technical reversals which have and could continue.  These currency pairs have become extremely oversold in recent weeks and were due for a relief rally. More stimulus from a central bank is normally bearish for a currency but with no severely negative news from Europe (up until today) and better than expected economic data from many parts of the world, the improvement in risk appetite reflects the hope that more stimulus would ease the tensions in the financial markets. Unfortunately hope can only do so much when the stimulus fails to resolve the core problems of Greece being at the brink of default and afflicting its problems on its Eurozone neighbors. The pullback in the euro today is an example of Europe’s sovereign troubles coming back to haunt the currency. In no way shape or form did the problem disappear this week which was why we believed that the rally in the euro would not last. 

The main take away from this past week’s developments is that central banks are moving into a new phase of global monetary easing. Despite the better than expected U.S. non-farm payrolls report, QE3 is still on the table. Non-farm payrolls rose by 103k in the month of September with private sector payrolls rising by 137k. The August NFP report was also revised up from zero to 57k. As good as these numbers may be however, one month of stronger job growth does not draw away from the fact that 3 out of the past 5 months, payrolls were less than 60k.The U-6 unemployment rate which is the government’s broader measure also rose to its highest level since December 2010. Earlier this week, Ben Bernanke made it clear that the “Federal Reserve stands ready to provide liquidity in the U.S. through a broad-based lending program.”  Even with today’s NFP report, the U.S. labor market is weak and needs more help from the central bank. This week’s decision by the Bank of England to increase asset purchases could make the Fed’s decision to launch QE3 all that easier because the Fed would not be slapped with the stigma of being the first major central bank to revert back to Quantitative Easing. There is an old saying that everything comes in threes and despite today’s rebound in non-farm payrolls, a third round of QE is inevitable, although it may not be as large as the last. 

Next Friday’s retail sales report should go a long way in helping the Fed decide when to introduce its next round of stimulus. If consumer spending is as weak as the prior month when there was zero retail sales growth, then November is still a realistic timing for QE3. If it is strong then perhaps Bernanke can hold off until December. The minutes from the most recent FOMC meeting will also be released on Tuesday and the recap of the meeting will give investors greater insight into the tools that the Fed is discussing and how much support each has within the central bank.

EUR: HIT BY FITCH DOWNGRADES

The reversal in the euro today served as a harsh reminder to investors that the region’s core troubles have not gone away. Having initially rallied as high as 1.3525 on the heels of the stronger U.S. non-farm payrolls report, the euro came crashing down after Fitch downgraded Italy and Spain’s sovereign debt ratings. The smallest of the major bond rating agencies usually trails behind its peers in making changes but this time they jumped the gun and cut their rating of Spain’s long term bonds by two notches from Aa+ to Aa-. This puts their rating one notch below Standard & Poor’s, signaling the possibility of a catch-up move by the other rating agencies. Fitch attributed their decision to “the intensification of the euro area crisis and secondly, risks to the fiscal consolidation effort arising from the budgetary performance of some regions and downward revision of Spain’s medium-term growth prospects.” The downgrade of Spain is a very big deal because it was unexpected whereas S&P and Moody’s both downgraded Italy in recent weeks. The third and fourth largest countries in the Eurozone pose major risks for the region and the downgrade by Fitch of Spain’s rating will only send bond yields and credit default swap spreads even higher, raising the need for the European Union to devise a larger bailout plan. The market is looking for a centralized effort to support both sovereign and financial institutions but policymakers remain torn on how to stave the bloc off of a financial meltdown. The market would be watching closely on whether French President Nicolas Sarkozy and German Chancellor Angela Merkel could forge a joint position on the next steps in the continent's debt crisis ahead of the EU summit. Unfortunately based upon Merkel’s comments this morning, she does not appear to be very willing to compromise. Merkel doesn’t see an immediate need for bank recapitalization or the need to discuss Greece at the Oct 17 to 18 EU Summit. German industrial production was the only piece of Eurozone economic data on the calendar this morning and the data showed production activity declining 1.0 percent which was less than expected but worse than the previous month. The latest CFTC data of speculative positioning showed short EUR/USD positions rising slightly the week ending October 4 ^th . Short positions remain at the highest level since June 2010. Looking ahead, we have German Trade Balance and Investor Confidence report on Monday, German CPI and ECB monthly report on Thursday, followed by Eurozone CPI on Friday.

GBP: BUSY WEEK AHEAD

The British pound rose strongly today against both the U.S. dollar and the euro amid optimism the Bank of England’s decision to reactivate its bond-purchase program will help revive the U.K.’s faltering economy. Policy makers decided to boost the quantitative easing program by 75 billion pounds ($115 billion) yesterday and central bank Governor Mervyn King said he was “confident” the measures would work. Ten-year gilts fell for a third day in response, pushing yields higher. King’s refuses to wait for European governments to signal determination to protect the U.K. from a crisis that threatens to tip Britain’s largest trading partner into recession. It also shows concern that failure to insulate bank funding markets risks recreating conditions that led to the collapse of Lehman Brothers three years ago. The news of resumed asset purchases outweighed the decision of Moody’s Investor Services cut the senior debt and deposit rating of 12 British lenders. Among those cut were Royal Bank of Scotland and Lloyds Banking Group. Moody’s supported the cut by saying the government would be less likely to provide support in the event of failure. The Bank of England, the Financial Services Authority, and the Treasury have all provided guidance that banks that fail in the future should not expect a taxpayer-funded bailout. On a good note, U.K. factory output prices rose more than forecast in September, led by petroleum products and electrical equipment, as firms sought to protect profit margins. Prices charged at factory doors increased 0.3 percent from August. Input prices rose 1.7 percent as crude oil costs climbed. Manufacturers may find it difficult to increase prices as the economic horizon darkens and Europe’s debt crisis intensifies. Significant economic data released next week includes manufacturing and industrial production, the claimant count change and jobs numbers, consumer confidence, and the trade balance. Manufacturing production is expected to be flat while industrial production is expected to decline by 0.2 percent. Jobs numbers might change slightly as 23.9K people are expected to file for unemployment and the unemployment rate should hold at 7.9 percent.  Also, the U.K. is expected to run about the same 8.8 billion pound trade deficit. Should all the data coming out next week show no material improvement, it will reinforce that the Bank of England made the right choice to resume asset purchases to stimulate end demand.

CAD: VERY STRONG JOB GROWTH

Despite extensive gains during the early half of the NY trading session, the commodity currencies retreated quickly after Fitch downgraded Spain and the moves were so strong that the Canadian dollar turned negative against the greenback. Canada’s economy added the most jobs in eight months in September, led by hiring at schools, bringing the nation’s jobless rate to its lowest level since 2008.   Employment rose 60,900 after a decline of 5,500 in August, causing the unemployment rate to fall to 7.1 percent. The rise marks a recovery for the country’s labor market after the economy added a net 1,600 workers in the previous two months. The report was definitely better than expected, but not necessarily a game changer as some parts of Canada’s economy remain weak. The Canadian government is deciding to link the performance pay of senior government workers to its effort to cut spending as it seeks to eliminate its budget deficit. The plan to eliminate the deficit by the fiscal year that begins April 2014 depends on the ability to find C$4 billion ($3.9 billion) annually in spending cuts. Economic data coming from Canada next week includes housing starts, trade balance, and manufacturing sales. The Australian and New Zealand dollars rose for a fourth day after the European Central Bank yesterday reintroduced yearlong loans for banks and the Bank of England boosted its asset-purchase program. These commodity currencies are benefitting from less fear emanating out of Europe. No new economic data came from Australia today, but the docket is packed full for next week. Releases include job advertisements, home loans, employment numbers, inflation expectations, consumer sentiment, and business confidence. New Zealand authorities are working to contain an oil slick heading toward shore from a container ship that is caught on a reef near the North Island port of Tauranga. The authorities do expect oil to come ashore and are deploying specialty vessels to help contain the slick. They have also conducted aerial and on-water assessments, and are spreading chemicals to help disperse the fuel. Next week, New Zealand will release the REINZ house price index and business manufacturing index.

JPY: BOJ WORRIED ABOUT ECONOMIC HEADWINDS

It was a mixed day for the Japanese Yen, which held steady against the greenback, traded lower against the Aussie and pound and higher against the euro and Canadian dollar. The Bank of Japan held its overnight rate at level close to 0 percent and maintained the asset purchase facility at 50 trillion yen. Moreover, the central bank sounded the alarm over the headwinds facing the global economy. "As supply constraints have mostly been resolved, demand-side factors, particularly overseas economic performance, have gained more significance. The uncertain outlook for the global economy and instability in financial markets are underscoring the downside risks for Japan’s economy,” said Masaaki Shirakawa, the Bank of Japan governor. These comments reflect the country’s reliance on its export industry to sustain the growth while the persistent strength of the yen cripples the economy. Nonetheless, BoJ maintains that the Japanese economy would resume a moderate recovery in H2 as rebuilding efforts progress in disaster-stricken areas. Meanwhile, the Japanese government approved the third emergency funding for jump-starting the reconstruction in northeastern Japan. But this 12 trillion yen budget and tax-increase bill could once again cause more political gridlock in the Japanese parliament. Once implemented, the recovery in Japan could gain another boost with the added fiscal stimulus. Looking forward, we have BoJ monthly economic report and machinery orders data on Tuesday and Tertiary Industry Activity on Wednesday next week.

EUR/USD: Currency in Play for Next 24 Hours

EUR/USD will be our currency pair in play for Monday. While there is no data from the U.S., we expect German Trade Balance report at 2:00 AM ET/ 6:00 GMT, followed by Sentix Investor Confidence index at 4:30AM ET/ 8:30 GMT. Furthermore, French President Nicolas Sarkozy and German Chancellor Angela Merkel will be meeting on Sunday to bridge the differences on how to support European banks.

Despite the collapse in euro, the currency pair lingers in the range trading zone, which we determined using the Bollinger Bands. The nearest support is at the recent low of 1.3145. If that level is broken, the psychologically significant 1.30 handle could provide more significant support. On the upside, should the EUR/USD rise, it will find resistance at 1.3569, the 23.6% Fibonacci level. The Fibonacci retracement was drawn from the swing high in May to the swing low in October. Should EUR/USD edge even higher, the pair could find further resistance at 1.3718 (upper first standard dev. Bollinger Band).

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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.