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Dollar Flows and Slovakia Vote

Last updated 10/11/2011 4:42 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

• WHAT IS DRIVING THE DOLLAR?
• EUR: SLOVAKIA REJECTS FIRST EFSF VOTE
• GBP: POSEN SPEAKS OF MORE EXPANSION
• CAD: HOUSING STARTS REBOUND
• AUD: BUSINESS CONFIDENCE IMPROVES
• NZD: RUGBY WORLD CUP FAILS TO LIFT SALES
• JPY: STRONG YEN LEADS TO TRADE DEFICIT

EXPECTATIONS FOR UPCOMING FED MEETINGS

WHAT IS DRIVING THE DOLLAR?

There was little consistency in the price action of the U.S. dollar today.   The greenback traded lower against the euro, held steady against the Japanese Yen and strengthened slightly against all of the other major currencies.   Considering the fact that U.S. equities are moving based on the ebbs of tides of Europe, it is no surprise to see the dollar also taking its cue from developments across the Atlantic. Yet the lack of dollar weakness against other currencies suggests that Europe is not the only driver of currency flows.   One of the most important takeaways from recent developments is that central banks are beginning to move with some are acting more quickly than others and this is naturally having an impact on their currencies. The U.S. central bank implemented Operation Twist last month (which we will learn a lot more about when the FOMC minutes are released tomorrow) and is currently divided on whether QE3 is needed.   Based upon last week’s comments from Fed Chairman Ben Bernanke, he seems to support more stimulus but QE3 is a nuclear option filled with complications and therefore not something that the central bank will decide easily.   This is particularly true after Friday’s better than expected non-farm payrolls report, which reduces the pressure on the Fed to act.   Yet the risk of more Quantitative Easing from the Fed is keeping the dollar weak against the Japanese Yen even though both are seen as safe haven currencies.  

The euro is outperforming the dollar because a rate cut by the European Central Bank is still up in the air and if a bailout plan is announced by the end of the month, then ECB President Draghi could realistically postpone his decision on easing to see how the market responds to the plan and anything else that comes out of the G20 Summit.   The British pound on the other hand is underperforming the dollar because of the Bank of England’s recent decision to jump the gun and restart their Quantitative Easing program, which effectively made them more dovish than the Federal Reserve.   The Australian, Canadian and New Zealand dollars are trading more like the euro than the pound or the Yen because the central banks of these countries are still straddling the fence and haven’t quite decided what they will do with monetary policy.   Investors believe that they should lower rates but much of their cautionary comments have been centered on Europe, which means if they no longer feel that the sovereign debt crisis is a risk, these central banks could also forgo a rate cut.

The IBD/TIPP Economic Optimism index was the only piece of U.S. economic data released today and the report showed a slight improvement in sentiment. The FOMC minutes will be released on Wed (we apologize for the confusion) and a number of Federal Reserve officials will be speaking.   We will be on the lookout for any clues about future monetary policy.

EUR: SLOVAKIA REJECTS FIRST EFSF VOTE

Monday, the prospect of a plan to support Greece and European banks sparked a healthy risk rally across the financial markets.   This morning, we have both positive and negative developments for the Eurozone that kept the EUR/USD bid throughout the U.S. trading session. Starting with the good news, the Troika (EU, IMF and   ECB) have completed their review of Greece and expect to release their sixth tranche of aid in early November.   Although the Troika's assessment was grim, when Greece finally receives its next aid payment, a major near term uncertainty will be removed from the market, helping to ease CDS spreads, boost general market sentiment and hopefully the euro.   However even with more bailout funds, the EU/IMF could impose deeper haircuts for Greece on investors.   Back in July, they agreed to a 21 percent haircut but this morning, there are talks of a 40 to 60 percent haircut.   The prospect of incurring such deep loses is weighing on sentiment particularly after EU Juncker said even more losses is possible.   Germany and France also agree that Greece needs to have their debt restructured in a way that could lead to a selective default leading investors to wonder whether this would trigger a CDS event. If it does, expect some major volatility in the financial markets and potential losses by CDS sellers.   If somehow a CDS default event is avoided, there will be plenty of people kicking and screaming but the volatility could be more moderate.   Finally, Slovakia and Malta are the only 2 remaining countries left to approve the prior expansion of the EFSF.   The passage was suppose to be smooth but the Slovakian government complicated the scenario by tying the vote to a confidence vote, causing the euro to give up its gains.   Unfortunately the government lost the confidence vote and now the process will be drawn out further as the Prime Minister attempts to gain support from the opposition for another re-vote.   

GBP: POSEN SPEAKS OF MORE EXPANSION

Signs of weakness in the U.K. economy drove the British pound lower against the U.S. dollar and euro.   Industrial production rose 0.2 percent in August, which was stronger than expected, but manufacturing production fell 0.3 percent.   The disconnect was accounted for by an increase in non-manufacturing activity such as oil and gas extraction, which is encouraging, but does not allow us to overlook the weakness in manufacturing and the implications that it could have for U.K. GDP. According to the National Institute of Economic & Social Research (NIESR)’s GDP estimate, the U.K. economy grew by 0.5 percent in the third quarter, a stronger read than the prior month’s report but still well below the country’s pre-recession peak.   As such, the U.K. economy remains weak which explains why the British Chamber of Commerce’s Director General said the economy is showing signs of stagnation.   However not all news was bad news – the British Retail Consortium saw a slight increase in spending last month.   The BRC sales index rose 0.3 percent after falling 0.6 percent in August. Although spending was much stronger than the market’s -0.9 percent forecast, any sterling positive impact was offset by the BRC’s Director General’s comment that on an inflation adjusted basis, sales were lower.   At the end of the day, the U.K. economy is still very weak and we expect tomorrow’s employment report to provide further validation for the central bank’s recent decision to increase monetary stimulus.   Although we do not believe that another round of stimulus will follow, BoE member Posen left the door open by saying that the QE program will be reviewed every month and can be expanded again. According to the PMI numbers, employment in the manufacturing continued to fall while labor levels in the service sector remained virtually unchanged.   If the U.K. employment report shows an increase in jobless claims, the British pound slip further against the U.S. dollar and euro.  @import url(/css/cuteeditor.css);

CAD: HOUSING STARTS REBOUND

The Canadian, Australian and New Zealand dollars may have ended the North American trading session slightly lower against the greenback but the fact that they are well off earlier lows and closing near their highs is a testament to the market’s overall appetite for risk.   Economic data from the commodity producing countries were also better than expected, giving investors hope that the global economy is starting to regain its momentum.   Canadian housing starts rose 7.3 percent to 205.9k in the month of September thanks largely to a rise in multi-unit projects.   Central banks around the world have kept interest rates at a very low level for the past few years and low rates have helped to support borrowing in an environment where borrowing qualifications and terms have become more stringent.   The uptick in housing starts last month reflects the fruits of their efforts.     Business confidence in Australia also improved materially last month.   The National Bank of Australia’s Business Confidence index rose from -9 to -2 while the business conditions index rose to +2 from -3 in August.   As an export dependent country, many corporations hoped that the decline in the Australian dollar would help to boost economic activity but unfortunately the AUD/USD has rebounded quite a bit since then and is trading within a whisker of parity. Even though the New Zealand dollar also held steady, their latest economic report did not show any improvements.   The Rugby World Cup failed to substantially boost spending with credit card receipts rising a mere 0.4 percent which was far below the market’s 1.1 percent forecast.   Australian consumer confidence and housing market numbers are scheduled for release this evening.   The deterioration in the labor market in August and the volatility in the financial markets poses a risk to sentiment.  

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JPY: STRONG YEN LEADS TO TRADE DEFICIT

With equities consolidating after Monday’s strong rise investors have piled back into the safety of the Japanese Yen.   The Yen held steady against the U.S. dollar but traded higher against all of the other major currencies (with the exception of the euro). Last night’s Japanese economic reports showed the country’s Y123.3B trade surplus turning into a -$694.7B deficit in the month of August.   Higher commodity prices, weak growth and a rapidly rising currency took a toll on exports while boosting import demand. Although the current account balance remained in surplus, the balance shrank for the sixth consecutive month, illustrating the challenges of a slow economy and a strong currency.   The Ministry of Finance and the Bank of Japan have refrained from intervening in the Japanese Yen in recent weeks but based upon recent comments from policymakers, we could possibly see another round of intervention in the near term.   It appears that the Finance Minister wants to first convince his global counterparts to support Japan’s intervention efforts at the November G20 meeting before asking the BoJ to sell the Yen.   Yet Japan’s ruling party chief continued to call on the central bank to sell the yen to counter the currency’s extreme strength but Finance Minister Azumi wants to discuss the Yen’s rise with the G20 to see how they can help stabilize the Yen. According to their monthly report, the Bank of Japan expects overseas growth to remain firm and for Japanese output to rise in the fourth quarter, albeit at a slightly slower pace of growth than the third quarter.   Meanwhile confidence in Japan remains mixed. The government’s consumer confidence index increased, showing an improvement in sentiment but the Eco Watchers survey of taxi drivers, waiters and other blue collar workers declined.   After such a heavy dose of economic data, it will be a quieter night for Japan with only machine orders scheduled for release.  @import url(/css/cuteeditor.css);

GBP/USD: Currency in Play for Next 24 Hours

Our currency pair in play for the next 24 hours is the GBP/USD. U.K employment numbers are scheduled for release at 4:30 AM ET or 8:30 GMT followed by the U.S. FOMC Minutes at 2:00 PM ET or 14:00 GMT.

After hitting a low of 1.5265 earlier this month, the GBP/USD has finally stabilized and recovered some of its recent losses.   The currency pair is now trading in the range trading zone which we define using Bollinger Bands.   Should the GBP/USD extend its gains, near term resistance will be at 1.5782, the 38.2 percent Fibonacci retracement of the August to October sell-off.   Above that, the 50-day SMA and psychological 1.60 level will serve as more significant resistance.   If the GBP/USD trickles lower and resumes its slide, the first level of support will be at the first standard deviation Bollinger band 1.5455 and below that the October low of 1.5265.

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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.