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FX: EUR RUMORS CONTINUE, RISK BOOSTED BY BETTER US DATA

Last updated 10/18/2011 5:23 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: EUR RUMORS CONTINUE, RISK BOOSTED BY BETTER US DATA
• EUR: INVESTORS STILL REACHING FOR ANY HOPE OF A BAILOUT PLAN
• GBP: CPI HITS RECORD HIGH, BOE MINUTES IN FOCUS
• AUD: RBA MINUTES SHOW HURDLES TO RATE CUTS
• CAD: CONSUMER SENNTIMENT DETERIORATES
• NZD: OIL UP, GOLD DOWN
• JPY: BOJ VOICES CONCERN ABOUT EXTERNAL ENVIRONMENT

EXPECTATIONS FOR UPCOMING FED MEETINGS

FX: EUR RUMORS CONTINUE, RISK BOOSTED BY BETTER US DATA

Risk appetite stabilized today on the heels of better than expected earnings from Bank of America and stronger economic data from the U.S. Sluggish growth across the globe did not dampen corporate America as much as some economists had feared and with Apple reporting earnings after the bell there was a sense of hopefulness in the markets.  Unfortunately Apple missed analyst expectations which could weigh on risk for the next 24 hours. Yet the optimism today was limited to the commodity currencies because the main risks are centered in Europe, leaving investors hesitant about going long euros and pounds. In fact speculators still hold large amounts of short euro positions and their decision to retain or reduce those positions will hinge upon the outcome of the October 23 ^rd EU Summit. With only a few days to go before the EU Finance Ministers and Leaders meeting over the weekend, there is very little chance that the Germans will shift their tone and start hinting of a big announcement.  As a result, we do not expect any major gains in the EUR/USD before the Summit. The rest of the high yielding currencies on the other hand are still benefitting from the improvement in risk because they are less sensitive to the troubles in the Eurozone and more sensitive to the trend of global growth. Last night’s economic reports show that China is setting up for a soft landing with stronger domestic demand offsetting weaker Q3 GDP growth. To the relief of investors, recent economic reports from the two economic centers of the world have not been as weak as the market may have feared.

There are a number of U.S. economic reports scheduled for release on Wednesday, but none of these reports are expected to have as much of an impact on risk appetite as the ongoing problems in Europe. Consumer prices for example could be pushed higher by the increase in wholesale prices while housing market numbers will probably show a rebound in starts and a pullback in permits. The Beige Book report will most likely reflect concern about the outlook for the U.S. economy but also acknowledgement of the recent improvements in economic data. However there won’t be enough here to help the Fed make a decision on monetary policy.  The only thing that the Fed is looking to do is to increase transparency about its forecasts and policy plans.  To some this means the possibility of an inflation target but establishing an inflation target similar to the ECB or the BoE represents a major change in FOMC policy and not one that policymakers will adopt easily. 

Meanwhile the latest Treasury International Capital flow report shows that even though the U.S. government may have lost its AAA rating, the dollar has not lost its luster. According to the TIC data, foreign demand for U.S. dollars rose $89.6B in August, with purchases of long term assets rising by $57.9B. Despite the overall weakness in the U.S. economy, the prospect of more stimulus from the Federal Reserve and the downgrade by S&P, the uncertainty in the global economy drove investors into the arms of safe haven currencies. In August, the dollar fell to a record low against the Japanese Yen and Swiss Franc, prompting aggressive action by the Bank of Japan and the Swiss National Bank to stem their currency's rise. Both the BoJ and the SNB came into the markets in August to buy dollars with hedge funds and other speculators piggybacking on the move. The largest purchases came from the U.K., Switzerland, Caribbean and Japan. Normally there is barely any change in Swiss demand for dollars but in August, Swiss investors purchased $39.1B worth of dollar denominated investments. The Japanese also came into the market in size ($21.8B) but considering that central bank purchases only accounted for 33 percent of the flow and the $32.5B investments made by hedge funds in the Caribbean, there is no question that speculators joined in on the move. For the U.S. government, this was the best case scenario because the greatest risk of a downgrade is a massive exodus out of U.S. Treasuries. Even though China was a net seller of U.S. Treasuries which was probably their way of opposing the U.S.' fiscal policies, other central banks were far more worried about the negative impact of their rising currencies than the credit worthiness of U.S. Treasuries. At the end of the day, we know that the downgrade did not cause a massive collapse in the market and for the time being Treasuries are still viewed as one of the safest investments in the world.

EUR: INVESTORS STILL REACHING FOR ANY HOPE OF A BAILOUT PLAN

The rumor-mill was in full swing today causing widespread volatility in the euro. The theme remains the same which is that investors are hoping for a big announcement at the EU Summit but French and German officials continue to throw cold water on the speculation by denying that they have reached an agreement to increase the Eurozone’s rescue fund to EUR2 trillion. German Chancellor Merkel has been working hard at managing the market’s expectations, saying that the EU will not solve the crisis in one summit.  Although they could possibly lay out a plan for Greece, the chance of a detailed plan being unveiled over the weekend remains slim. Therefore we have been regularly surprised by the strong reaction to unsubstantiated rumors because European officials have consistently refuted any reports of progress. Eventually the Europeans will reach an agreement and offer a rescue plan that will hopefully cover the financing needs of Spain, Italy, France and Belgium but until the announcement is made, there is very little reason to jump into long euro positions. If the Europeans announce a plan that satisfies investors, the euro will enjoy a rally that will last for days and possibly even weeks to come. In the meantime, it is important to heed Moody’s warning on France. This morning, the rating agency said the country’s “debt metrics are the lowest of any AAA rated country,” signaling the possibility of a downgrade. As the second largest country in the Eurozone, a downgrade of France would be far more significant than any of the other downgrades made to Eurozone nations combined. Considering that France accounts for a fifth of all EFSF guarantees, a sovereign downgrade could put the EFSF’s AAA rating at risk as well.  Greece also remains at the brink of default – Prime Minister Papandreou said this morning that the government is struggling to prevent a default. However with this in mind, if the five point plan presented by EC President Barroso gains traction, it could lend support to the euro. The continued troubles in the Eurozone have not been lost by investors as confidence drops to a 3 year low. The ZEW survey fell from 43.6 to 38.4 in October with investors growing more pessimistic about current and future economic conditions.  

GBP: CPI HITS RECORD HIGH, BOE MINUTES IN FOCUS

Of all the major currencies, the British pound performed the worst today despite hotter inflation numbers. Consumer prices rose 0.6 percent to an annualized pace of 5.2 percent. This matched the strongest pace of inflation growth ever in the U.K. and raises the question about whether the Monetary Policy Committee made the right decision to increase asset purchases earlier this month. By boosting Quantitative Easing at a time when inflation is at a record high puts the U.K. economy at risk of a deeper contraction in the future if the central bank is forced to manage inflation expectations at the expense of growth. The only saving grace is that MPC officials have telegraphed the rise in inflation and have made it clear that they believe price pressures will fall rapidly next year as one off factors such as increases to utility prices and the higher VAT tax are normalized. In the meantime all eyes will be on tomorrow’s BoE minutes. The central bank surprised the markets this month by boosting asset purchases sooner than most people had anticipated and it will be interesting to see how many members of the monetary policy committee supported the move. 

AUD: RBA MINUTES SHOW HURDLES TO RATE CUTS

The Canadian, Australian, and New Zealand dollars all strengthened against the greenback. The economic calendars have been quiet for the commodity countries except for the Reserve Bank of Australia releasing the minutes from the monetary policy meeting it held on October 4 ^th . The Australian dollar took a slight dip on the release of the dovish minutes but recovered quickly once investors realized that there are a number of hurdles before the RBA would realistically cut interest rates.  There was good reason to expect “solid” economic growth in the medium term, but growth over the short term was not likely to be as strong as earlier expected. The weaker growth outlook implied a softer outlook for the labor market, which the RBA acknowledged had already weakened. As a result, the inflation outlook may be more consistent with the two or three percent inflation target range. Wheat stockpiles in Australia, set to be the world’s second-biggest shipper, may climb near to a record by September as competition for rail capacity with coal-mining companies creates transportation bottlenecks. The Canadian dollar rose against the greenback following stronger than expected U.S. data. However, the European debt crisis dented consumer confidence as Canadians’ optimism in their economic prospects fell to its lowest in two years. There is a huge psychological impact of continuing negative news of political gridlock in the U.S. and economic uncertainty in Europe. These forces have caused fear in Canada’s consumers and have contributed to further erosion of confidence.  The Canadian government unveiled legislation today to end the Canadian Wheat Board’s monopoly on marketing wheat and barley in the country’s biggest grain-growing region. Additionally, copper fell the most in two weeks as slowing China growth signals weak demand. New Zealand’s reconstruction of the earthquake-devastated city of Christchurch will boost growth and inflation pressure, RBA Governor Alan Bollard said, signaling interest rates will probably need to increase. The rebuild is likely to cost NZ$20 billion ($15.9 billion), equivalent to 10 percent of New Zealand’s GDP. Salvage teams suspended the removal of oil from a stranded container ship off the northeastern coast of New Zealand because of rough seas and strong winds. The ship remains “in a precarious state” and more oil could wash up on beaches. 

JPY: BOJ VOICES CONCERN ABOUT EXTERNAL ENVIRONMENT

It was a mixed day for the Japanese Yen which traded higher against the British pound but weakened against the Canadian and Australian dollars. The Bank of Japan released its financial systems report and initiative on the macroprudential front report today. In the reports, the central bank voiced concern of increasing future uncertainty over the external environment, especially the sovereign debt crisis in Europe. The BOJ also noted that financial conditions of firms and households in Japan have generally continued to ease amid the low interest environment. Furthermore, risks at financial institution remained restrained and Japan’s financial system has maintained its robustness. Japan’s financial system as a whole has been maintaining stability since the natural disasters in March. However, in order to ensure long-lasting stability, three major challenges need to be addressed: financial institutions should enhance the effectiveness of risk management; financial institutions should further strengthen their capital bases and; financial institutions should construct stable profit bases. Coming up with material solutions to these challenges will help prevent Japan’s economy from stalling. In the BOJ’s report for initiatives on the macroprudential front, the central bank seems well prepared to handle any adverse conditions that could materialize in the future. The Bank of Japan has implemented a number of advanced initiatives and policy responses designed to ensure the stability of the entire financial system. Emphasis has been placed on the following possible concerns: the interconnectedness among financial institutions, financial markets, and other components of the financial system; and a feedback loop between the real economy and the financial system. Japanese nationwide department store sales fell 2.4 percent in September, following a 2.9 percent decline in August. Consumers are still not shopping as sentiment remains depressed. Japanese stocks fell amid the 10-month low in volume as concerns in Europe persisted. On the docket is all industries activity for the month of August. The market is expecting a decline of 0.2 percent after activity increased 0.4 percent in July. A positive surprise could prove businesses have recovered from the March natural disasters and conditions are continuing to improve. 

GBP/USD: Currency in Play for Next 24 Hours

Our currency pair in play for the next 24 hours will be GBP/USD. The Bank of England will release its monetary policy meeting minutes tomorrow at 4:30 AM ET / 8:30 GMT. We then expect from the U.S. the consumer price index, housing starts and building permits all for the month of September at 8:30 AM ET / 12:30 GMT.  Finally, the Federal Reserve will release its Beige Book at 2:00 PM ET / 18:00 GMT.

GBP/USD has been quite volatile over the past month and is now trading range bound, which we determined using Bollinger bands. Nearest support is at the 20-day simple moving average price of 1.5580. This price has also been a level of prior contention over the past month. Should the pair fall through that level, more significant support should be found at 1.5458 where the lower first standard deviation Bollinger band lies. To the upside, nearest resistance will be found at 1.5850, where the second upper Bollinger band and the 38.2% Fib converge. We drew our Fibonacci retracement from the high on April 28 ^th to the low on October 6 ^th . Should the pair break out from that level, heavier resistance will be encountered at the 50-SMA of 1.5920.

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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.