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Forex Positioning, G20 And Week Ahead

Last updated 10/14/2011 4:51 PM ET (GMT -5) 1 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• FOREX POSITIONING, G20 AND WEEK AHEAD
• EUR: DON’T EXPECT MUCH TO LEAK OUT OF G20
• GBP: BOE MINUTES WILL BE THE KEY
• CAD: STRONG RISE IN OIL PRICES
• AUD: COOLER CHINESE INFLATION BOOSTS RISK
• NZD: CONSUMER CONFIDENCE WEAKENS
• JPY: ECONOMIC DATA IMPROVES

EXPECTATIONS FOR UPCOMING FED MEETINGS

FOREX POSITIONING, G20 AND WEEK AHEAD

It has been a great week in the financial markets with U.S. stocks rising to a one month high after falling to a one year low in early October.  As a function of the improvement in risk appetite, investors have moved their money out of the safety of U.S. dollars and recycled them back into higher yielding currencies. Over the past week, the greenback declined against every major currency, falling more than 5 percent against the Australian dollar and approximately 4 percent against the euro, Swiss Franc and New Zealand dollar.

Recent data from the CFTC has showed long dollar, short euro positions rising to their highest levels in nearly a year but the recent recovery in the EUR/USD has slashed short positions by 10 percent. As of last Tuesday, investors still remain aggressively short dollars but with the greenback extending its slide through the end of the week, we suspect that speculators are now at least thirty percent less short dollars going into the new trading week. This implies that there will be less short covering in the EUR/USD and other high yielding currency pairs in the coming week and more bandwidth for traders to renew their short positions. In other words, unless there is overwhelmingly positive developments over the next week, the upside in the EUR/USD could be limited because there will be fewer traders buying euros to cover their short positions.

For the past few weeks, the market has been focused on the Eurozone but if nothing comes out of this weekend’s G20 meeting, the lack of euro area event risks next week could mean that investors may finally shift their attention back to the U.S. economy.   This is good timing because it will be a very busy week for U.S. economic data with a number of manufacturing, inflation and housing market reports scheduled for release along with the Treasury’s report on foreign demand for U.S. dollars and the Fed’s Beige Book. These pieces of economic data will help to clarify the overall outlook for the U.S. economy and if there is enough consistency in economic data, it may even help the central bank solidify its monetary policy plans, although the Fed will still need to see another month of non-farm payrolls and retail sales before finalizing their decisions. In our opinion, the most important pieces of U.S. economic data next week are the inflation and Treasury International Capital Flow reports. If price pressures increase, the case for more stimulus weakens significantly. The TIC data on the other hand will reflect the market’s appetite for U.S. dollars after the first ever downgrade of the U.S.’ long term credit rating by Standard & Poor’s.

To the relief of the Federal Reserve, retail sales rose strongly in the month of September. Consumer spending increased 1.1 percent with sales ex autos rising 0.6 percent.  Despite the decline in equities and the volatility in the financial markets, the rebound in job growth and the need to fill backpacks have led to the strongest increase in consumer spending in 7 months. Demand was particularly healthy for clothing, furniture, motor vehicles, and other department store items. Consumers also spent more money eating out and filling their gas tanks last month. The increase in spending will contribute positively to Q3 GDP. Compared to the second quarter, spending in the third quarter was far more robust which implies much stronger GDP growth between July and September.  However the outlook for the U.S. economy is far from rosy with the University of Michigan Consumer Confidence index falling from 59.4 to 57.5 in the month of October. The G20 Finance Ministers meeting is underway and will continue into the weekend. More will be discussed in the euro portion of our commentary, but in general, we do not anticipate any major announcements as this meeting is aimed at preparing recommendations for the Cannes Summit of G20 leaders in November.

EUR: DON’T EXPECT MUCH TO LEAK OUT OF G20

The rally in the euro over the past week has been nothing short of impressive. After falling to a low of 1.3150 the previous week, the EUR/USD is now trading more than 700 pips higher. What baffles us the most about the rally is that there are few reasons to justify the move other than hope and optimism.  Outside of approving the EUR440 billion EFSF expansion announced back in July, European policymakers have yet to verify that a major rescue plan for the Eurozone is in the works. Nonetheless most investors believe that a deal is in the works and have expressed their optimism by selling dollars and buying euros. As we mentioned earlier, the G20 Finance Ministers meeting is underway and there is widespread belief that the finance ministers are expected to support the IMF’s plan for a larger European bailout fund. There has been quite a bit of buildup going into the Cannes Leaders Summit in November. Finance Ministers are holding a meeting this weekend where they will most likely discuss ways to deal with the sovereign debt crisis. A meeting of European Union leaders will then follow on October 23 ^rd where further details will probably be ironed out. Then finally, the leaders of the world’s most powerful countries will convene in early November and hopefully announce a deal for Europe that is both coordinated and aggressive. Although deep discussions will be had this weekend, based on the denials of European policymakers, we do not expect much to be leaked out to the public. It appears that policymakers are taking a page from the 1980s Latin American debt crisis where a deal was desperately needed but denied by policymakers until a surprise announcement was made to end the crisis. Hopefully that is indeed what European policymakers are going for because if nothing is in the works, the euro will be in big trouble.  Meanwhile investors completely shrugged off Standard & Poor’s decision to downgrade Spanish debt because S&P was the second rating agency to make this announcement. Next week however, Spanish and French bond auctions will be focus as we wait to see if investors have really been spooked by recent downgrades. There continues o be a lot of debate about how significant of a write off Greek banks will need to take and unfortunately this speculation is not expected to dissipate anytime soon. Like the U.S., there will be quite a bit of European economic reports on the calendar next week including the German ZEW survey, the IFO report and German producer prices.

GBP: BOE MINUTES WILL BE THE KEY

The British pound also extended its gains against the U.S. dollar but resumed its slide against the euro. The rally in the GBP/USD has been fueled entirely by risk appetite because if the pound was trading on economic fundamentals and monetary policy outlook alone, it would be much lower. In fact, sterling has weakened over the past week against every major currency except for the U.S. dollar and Japanese Yen. The Bank of England took a big step last week in expanding its asset purchase program and even though economic reports released since then have been mostly positive, the fact that they jumped the gun and increased stimulus when everyone else is still on the fence is very negative for the British pound. In response, the pound has fallen more than 4 percent against the Australian dollar and more than 2 percent against the Swiss Franc, and euro since the announcement. Yet what the positive economic reports imply is that the Bank of England will not need to increase asset purchases again unless there is a new shock to the financial markets. Inflation and retail sales numbers are scheduled for release in the coming week and we believe that both economic reports will surprise to the upside. Normally, one would expect the BoE to only increase stimulus if consumer price growth declined but desperate situations call for desperate measures and if the BoE’s decision was based on CPI alone, they would be tightening not easing because CPI growth is well above their target. With producer price growth increasing in the month of September, there is a reasonable chance that CPI rose as well. The increase in the BRC retail sales report also points to stronger consumer spending. The problem however will be in the minutes from the Bank of England’s latest monetary policy meeting. If the minutes show widespread concern amongst policymakers, it will sap any optimism caused by positive economic reports.  Alternatively the pound could benefit from any major opposition to the increase in stimulus.

CAD: STRONG RISE IN OIL PRICES

The Australian, Canadian and New Zealand dollars continued to extend their gains against the greenback thanks to the improvement in risk appetite and the rise in commodity prices. The Australian dollar has been the true star performer, rising nearly 8 percent against the U.S. dollar since falling to a low of 0.9420 on October 4 ^th . No major economic reports were released from Australia but New Zealand reported a decline in consumer confidence while Canada reported a sharp rise in manufacturing sales. Yet these economic reports are considered second tier which means their impact on the commodity currencies is minimal. Instead, the commodity currencies soared on the heels of lower inflationary pressures in China. Consumer prices slowed to 6.1 from 6.2 percent while PPI growth cooled to 6.5 from 7.3 percent. According to our colleague Boris Schlossberg, “unless the rate of change in price levels begins to accelerate, market analysts expect that the PBOC will not tighten monetary policy any further leaving both the Reserve requirement Ratio and the interest rate on hold.” Australia and New Zealand rely heavily on Chinese demand and diminishing prospects of tighter monetary policy is positive for China as well as commodity producing countries.  The minutes from the Reserve Bank of Australia meeting will be released next week along with Canadian consumer prices. Investors will also need to keep an eye on Chinese GDP, industrial production and retail sales because like the inflation reports, these numbers should have a big impact on the commodity currencies and risk appetite in general.

JPY: ECONOMIC DATA IMPROVES

The Japanese yen has weakened against all of the major currencies today as the Ministry of Finance signals that a new plan to fight against yen strength is in the works. The yen has been one of the best performing currencies since the global economy started to show signs of stress despite numerous attempts by the BoJ to intervene, safe-haven appeal kept the yen strong. The government has come under increasing pressure from major Japanese companies and business associations to step up their efforts in taming the appreciation. According to Japanese government officials, a new round of measures against a persistently strong yen could be unveiled as early as next week. The new proposal could include additional funding to encourage Japanese firms’ expansion overseas amid the strong yen. The 100-billion-dollar package, introduced in August, enabled Japanese banks and corporations to get funding when acquiring foreign companies and securing raw materials. The DPJ policy official Tsutomu Okubo said the ruling party is considering boosting the fund by 25 percent. Furthermore, DPJ party leaders including the policy chief Seiji Maehara showed strong support in this program as a way to contain yen’s rally. Since additional funding would need to be approved in the next budget, the market would be able see whether words could actually translate into action in parliament’s meeting next week. Investors could be watching the development closely as there is no significant economic data on the docket for Japan.

USD/JPY: Currency in Play for Next 24 Hours

USD/JPY will be our currency pair in play for Monday. From Japan, we expect the release of final Industrial Production at 00:30 AM ET/ 4:30 GMT on Monday. From the U.S., we expect the Empire Manufacturing Index at 8:30 AM ET/ 12:30 GMT, followed by Industrial Production at 9:15 AM ET/ 13:15 GMT. Furthermore, finance ministers and central bankers from G20 will be meeting in France over the weekend.

With a strong boost from Japanese Ministry of Finance today, USD/JPY is currently trading in an uptrend which we determined using the Bollinger Bands. The nearest resistance level is at 77.48, the high of Oct. 12 ^th . Further up, the 100-day SMA could tame the pair’s rise at 78.29. On the downside, the 50-day SMA and upper first std. dev. Bollinger Band could provide support at 76.85. Beyond that, USD/JPY could find significant support at 75.94, the postwar record low.

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Comments (1)

moonie

October 16, 2011 at 06:51 PM ET

Very insightful. Great column.

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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.