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EUR: EU Summit Fact vs. Fiction

Last updated 10/26/2011 5:16 PM ET (GMT -5) 1 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• EUR: EU SUMMIT FACT VS. FICTION
• USD: MORE GOOD DATA EXPECTED
• GBP: MANUFACTURING ACTIVITY WEAKENS
• NZD: RBNZ TALKS RATE HIKES
• CAD: OIL DROPS 2 PERCENT
• AUD: WEAKER CPI FUELS RATE CUT TALKS
• JPY: MORE STIMULUS FROM THE BOJ?

EXPECTATIONS FOR UPCOMING FED MEETINGS

EUR: EU SUMMIT FACT VS. FICTION

It is getting darker by the minute in Europe and it is still not clear whether the EU has reached a deal on the debt talks. A press conference was suppose to be held at the end of the NY trading session but that time has come to pass with nothing more than rumors about what the EU may or may not include in their rescue plan. Here are the facts – the German Parliament has approved the idea of leveraging the EFSF and the EU has agreed in principal to guarantee bank liabilities. The EU will also require a higher capital ratio of 9 percent with banks first being required to find private sources of capital to finance the increase before extending their hands out for government assistance. Aside from that, every other headline that has hit the market is mere speculation. The EU is having a very tough time agreeing on the haircut for Greek debt so Sarkozy and Merkel will be meeting with bankers tonight to try to break the deadlock.

The lack of details out of the EU Summit should be bearish for the euro but after falling to a low of 1.3799 during the North American trading session, the currency pair has recovered and is trading unchanged for the day. Although it can be argued that investors are blindly optimistic when it comes to the Euro and the EU’s ability to end the sovereign debt crisis, the market’s strong demand for euros cannot be ignored. The latest headlines suggest that the EFSF could be leveraged 4 times to more than EUR1.75 trillion and that the Greek haircut could be closer to 50 percent. If true, this would be positive for the euro because the firepower of the EFSF would be increased to more than the magic number of 1.5 trillion. The smaller haircut would also mean fewer losses for banks. Even if Greece finds themselves unable to come up with the remaining 50 percent and a default occurs anyway, in the short term, smaller losses will be positive for risk appetite. Although European officials are working late into the night, there is still a reasonable chance that the “can will be kicked down the road” and a decision is postponed until November. If that proves to be the case and is made official by European policymakers, the euro could experience the same sell-off that we saw earlier this morning and it will feel like déjà vu all over again as optimism is replaced by skepticism which is then replaced by renewed optimism. The Europeans know that they have to come up with a deal for Greece and a plan to prevent contagion sooner rather than later and as we have seen today, the hope for a plan is enough to maintain the gains in the euro. 

USD: MORE GOOD DATA EXPECTED

Despite the rally in equities, the U.S. dollar traded higher against all of the major currencies thanks in part to better than expected economic data. New home sales jumped 5.7 percent in September, to a 5 month high.  Although sellers had to reduce prices to move inventory, there are at least some signs of demand recovering.  Durable goods orders also fell -0.8 percent which was less than economists had anticipated.  Excluding transportation, orders rose 1.7 percent, which was the strongest gain in 6 months.  Third quarter GDP numbers will be released on Thursday and there is good chance that the data will show a nice acceleration in growth. When it comes to GDP, consumer spending and trade are the two main contributors. Retail sales rose an average or 0.6 percent between the months of July and September versus average growth of 0.13 percent in the second quarter. The same degree of improvement was seen in trade activity. In Q2, the deficit reached a high of -$51.57B and the latest report shows that the deficit has shrunk to -$45.608B. Given these dynamics, it is no wonder that economists expect growth to double.  However stronger GDP growth may not change the market’s belief that QE3 is inevitable. Federal Reserve officials have taken most of the improvements in the U.S. economy with a grain of salt and it is likely that they will feel the same about the Q3 GDP numbers particularly since it is more backwards looking than other pieces of U.S. data. In addition to the GDP numbers, jobless claims and pending home sales are also scheduled for release with claims expected to remain at the 400k while pending home sales are set to rebound. Despite the importance of tomorrow’s economic reports, the dollar will continue to trade based upon the market’s appetite for high yielding currencies. If investors remain optimistic about the outlook for the Eurozone and the end to the region’s sovereign debt crisis, the dollar will come under pressure. If nervousness returns, the greenback will once again benefit from safe haven flows. 

GBP: MANUFACTURING ACTIVITY WEAKENS

The British pound traded lower against both the U.S. dollar and the euro after reports that sentiment has deteriorated sharply among UK manufacturers. The Confederation of British Industry’s industrial orders expectations printed at minus 18 in October versus an expected drop of minus 7. The gauge read minus 9 in September. Manufacturing orders and output are expected to fall over the next quarter, following modest rises in domestic demand and production over the past three months. The deterioration in sentiment was the sharpest since April 2009.  Dovish comments from Monetary Policy Committee members Dale and Miles also weighed on the currency. Dale predicts a sharp decline in inflation in 2012 and said “we are feeling very nervous” about the domestic economy. Miles added that the U.K. faces a difficult economic environment and collectively their comments reinforce the BoE’s recent decision to increase stimulus. The U.K. economic calendar is relatively light this week with only the CBI realized sales and GfK consumer confidence reports on the calendar tomorrow. They both are forecast to be unchanged from last month at minus 15 and minus 30, respectively. While both readings remain weak, a surprise to the upside could lend some support to sterling.

NZD: RBNZ TALKS RATE HIKES

In the current market environment, the Reserve Bank’s unique perspective on interest rates is extremely positive for the New Zealand dollar.  Although the RBNZ left interest rates unchanged at 2.5 percent, they said that the prospect of rising domestic pressure will require future rate rises. At a time when other central banks are talking about easing monetary policies, the RBNZ’s unambiguous plan to raise rates has sent the NZD/USD soaring. Having lowered interest rates earlier this year to stimulate their economy following an earthquake, the New Zealand government is looking to remove some of that stimulus and like the Australians, they are not as concerned about the problems in the U.S. and Europe. We do not expect the RBNZ to raise rates before the end of the year but their hawkish bias could help keep the currency bid through December. Meanwhile softer inflationary pressures in Australia sparked speculation of a rate cut by the Reserve Bank. Consumer prices grew 0.6 percent in the third quarter, which was in line with expectations but lower than the Q2 CPI growth. On an annualized basis, CPI growth eased to 3.5 from 3.6 percent. Based on inflation, the RBA can ease, but recent comments from central bank officials suggest that a rate is unlikely because unlike other central banks, the RBA is optimistic about the outlook for their economy. More specifically, the RBA’s Battelino sees continued demand for Australian commodities from China. Although there have been signs of slower growth, the RBA still feels that the emerging countries remain robust and they are pleased to see the recent improvements in U.S. data.  After selling off briefly following the release of the Bank of Canada’s monetary policy statement, the loonie recovered strongly as risk appetite improved. The statement contained the same bearish tone as yesterday’s monetary policy announcement. The BoC explained that the reason why they overlooked the recent improvements in Canadian data is because their recovery represents a rebound from a temporary pullback. Overall, sluggish growth in the U.S. and the possibility of a brief recession in the Eurozone has made the BoC very concerned about the outlook for the Canadian economy. 

JPY: MORE STIMULUS FROM THE BOJ?

To the frustration of Japanese policymakers, the Yen climbed to a fresh record high against the U.S. dollar. Yen strength is nothing new – the currency has been testing the upper bounds of its range for the past few trading days prompting repeated threats of intervention from government officials. This evening, with the Bank of Japan scheduled to make a monetary policy announcement, investors around the world will be watching closely to see if the central bank will finally put action behind their words. One option would be to intervene in the Yen. Having recently boosted their intervention fund, the Bank of Japan has plenty of money to spend. The only reason why they have been holding back is because they want to see how the market responds to the EU Summit. Once the volatility settles, they will be tempted to take action. Another way to weaken the Yen and stimulate their economy would be to increase asset purchases. There is a good chance that the Bank of Japan could announce further easing measures that would involve buying long term JGBs. Joint action by the BoJ and the MoF is not unusual – in August the MoF instructed the BoJ to intervene right before the BoJ’s decision to increase stimulus on the very same day. The Japanese government knows that coordinated intervention is the only type that really works but convincing their G7 counterparts to participate in joint intervention in this current market environment will be difficult. For this reason, the next best option could be joint action by the MoF and BoJ. Will this stop to Yen from rising? Probably not because it is the market’s lack of desire to own dollars that has driven USD/JPY lower and not necessarily their desire to hold Yen. As long as U.S. policymakers give investors little reason to buy dollars, USD/JPY will have a tough time rallying. The BoJ has intervened 3 times since September 2010 and 2 out of the 3 times, USD/JPY reversed quickly after. The only time intervention worked was in March but that was coordinated and G7 central banks only agreed to join in the sale of Yen because of Japan’s earthquake. 

EUR/USD: Currency in Play for Next 24 Hours

Our currency pair in play for the next 24 hours will be EUR/USD. Economic data we expect for release from the Eurozone is the October business climate indicator and consumer, economic, industrial, and services confidence numbers at 5:00 AM ET / 9:00 GMT. From the United States, we expect third quarter gross domestic product and jobless numbers for this week at 8:30 AM ET / 12:30 GMT. Also from the U.S. we have September pending home sales at 10:00 AM ET / 14:00 GMT and the Kansas City Fed manufacturing activity index for the month of October at 11:00 AM ET / 15:00 GMT.

EUR/USD has been on the rise over the past few trading sessions and still remains in an uptrend, which we determined using Bollinger bands. Nearest support is at today’s low of 1.3800. This price is psychologically significant and has been a level of contention in the recent past. Should the pair fall through this price, significant support will be found at the 20-day SMA of 1.3650. To the upside, nearest resistance can be found at 1.4090, where the 200- and 100-day SMAs and second upper Bollinger band all converge. Should the pair break out of this level, heavy resistance will be found at 1.4050, the 61.8% Fib. We drew our Fibonacci retracement from the high on May 4 ^th to the low on October 4 ^th .

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Comments (1)

Darkdoji

October 26, 2011 at 06:36 PM ET

Senior frames have come to or are near alignment - the Euro is going down big time. They could not fix it. They doing their level best to make it look like they chipped at it enough to calm the markets. In the days ahead - it will all unravel to justify what the monthly chart pivot pattern has been saying for eons - market unbalances have resolved into strong selling pressure with an initial target for this initial run set to 1.2733 or slightly lower. Fractal pivots never lie (can be slow to reveal - but once revealed, it is the market's firm agenda). Wish I had the money to trade long term instead of suffering these short term fluctuations that must of need play day to day on our way down.

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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.