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FX: The Consequences of Misplaced Optimism

Last updated 10/17/2011 9:59 AM ET (GMT -5) 0 Comments - Add your comment

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Kathy Lien

Director of Currency Research, GFT

This may be a busy week for U.S. economic data but this morning's reports had very little impact on the U.S. dollar. The G20 came up with nothing this weekend and investors are beginning to realize that their recent optimism could be misplaced. Over the past few weeks, there has been a general belief that behind closed doors, European officials are working on a Grand Master Plan to save the euro. However European officials have gone to lengths to temper the market's expectations, dashing hope that a deal will be reached before the G20 leaders Summit in November. German Finance Minister Schaueble and Chancellor Angela Merkel said that the EU Summit would not present a definitive solution to the Eurozone debt crisis. Although U.K. Finance Minister Osborne expects "something quite impressive" from the Oct 23 EU Summit, if Germany refuses to agree on bank recapitalization, an expansion of the EFSF or a new package for Greece, the meeting will be another bust. At this point, it is not even clear if EU policymakers will be able to agree on releasing the next tranche of aid to Greece before the end of the month. These recent comments illustrate how much of a challenge it is to come up with a plan that all 17 Eurozone nations find agreeable. Given the amount of time and effort that it took to have the July EFSF expansion approved, doubling or tripling the size of the EFSF, will be an even steeper uphill battle. Investors are finally beginning to realize that there is no fast and easy solution to the Eurozone's sovereign debt crisis and we will be lucky if an agreement can reached before the end of the year. With this in mind however, there is still a small chance that the conflicting comments from European officials represent a smart strategy of managing market expectations. If they dropped hints that a deal is in the works, there would be more short covering in the euro and the currency's reaction to the announcement would be far more tempered. Instead, they would make a much bigger splash if they disagreed for weeks, keeping the general market short euros, then suddenly announcing a big comprehensive plan that would squeeze the currency pair sharply higher. 

Meanwhile the reaction to this morning's U.S. economic reports show that investors are no longer fazed by weaker U.S. economic data. The Empire State Manufacturing index rose from -8.82 to -8.48 in the month of October. Economists had anticipated a more significant rebound but demand did not recover as much as they had expected. However given that the contribution of NY manufacturing activity to national manufacturing output is small compared to the Philadelphia and Chicago regions, we need to see similar deterioration in Philadelphia or Chicago for investors to adjust their QE3 expectations. Industrial production activity rose 0.2 percent last month, which was in line with expectations but still weak after the downward revision to last month's report. Courtesy of the comments from German officials today, expect currencies and equities to trade heavy for most of the U.S. session.

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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.