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How Much Further Can EUR Rise?

Last updated 10/27/2011 3:55 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

• HOW MUCH FURTHER CAN EUR RISE?
• USD: SLIPS AS SAFE HAVEN FLOWS EASE
• GBP: SIGNS OF RECOVERY IN SPENDING?
• AUD: STRONGEST GAINS THIS YEAR
• CAD: OIL AND GOLD PRICES RISE
• NZD: EXTENDS GAINS ON RISK APPETITE AND RBNZ HAWKISH
• JPY: BOOSTS ASSET PURCHASES, NO SIGN OF INTERVENTION

EXPECTATIONS FOR UPCOMING FED MEETINGS

HOW MUCH FURTHER CAN EUR RISE?

The euro took out all of its near term resistance levels to rise to a high of 1.4247against the U.S. dollar on the heels of the EU’s debt deal.  The fact that the discussions on bank recapitalization/Greek haircut and EFSF leverage have not been delayed any further was received with strong enthusiasm.  The 300 point rally in the EUR/USD is one of the strongest one day moves that we have seen in the currency pair this year, leading traders to wonder how much further can the euro rise.  From a technical perspective, the rally in the EUR/USD stopped just short of the 61.8 percent retracement of the sell-off that lasted from May to October but beyond that, the next area of resistance is not until 1.45. Given the strength of today’s rally, the momentum in the market and fundamental significance of today’s European announcement, there is a good chance that the EUR/USD will continue to rise until there is some piece of bad news that kills the rally.   Investors around the world are cheering the fact that the Europeans have sucked it up and did what was necessary to mitigate a deeper crisis in the region.   Their sheer relief that the process hasn't been drawn out even further (aside from the fact that some technicalities need to be ironed out at the November Eurozone Finance Ministers meeting) has provided a nice boost to risk appetite.  With that in mind, here are 5 reasons why the euro has performed so strongly this morning and why a continued rally is possible:

1. The EU Rescue Package provides near term stability for the financial sector, lifting risk appetite and the euro

2. Greek Haircut of 50% reduces the losses that banks need to absorb, which is positive for stocks and risk

3. European Banks will need to repatriate funds to meet new capital requirements, which could mean more demand for euros

4. ISDA confirmed that the PSI will not trigger a credit event on Greek debt, which is positive for risk

5. Traders were short euros going into the EU Summit and now that a deal has been reached, it has triggered a wave of short covering

W e have been optimistic that the Europeans would come up with something, knowing that the consequences of not doing so would be too severe and now that the announcement has been made, the euro, Australian dollar and other high yielding currencies have strengthened significantly. We expect the rally in the Euro to continue for the time being but traders need to be aware that as soon as a piece of bad news hits, the currency could give up its gains quickly because the rescue plan does not resolve all of the region's troubles. Greater financial commitments mean greater austerity which can result in slower growth.  However in the meantime, the momentum  is on the side of euro bulls.

USD: SLIPS AS SAFE HAVEN FLOWS EASE

The EU debt deal driven improvement in risk appetite drove the U.S. dollar lower against all of the major currencies.   Safe haven flows eased out of the greenback back into risky currencies such as the Australian, New Zealand and Canadian dollars.  U.S. stocks also rose strongly as the smaller haircut on Greek debt means smaller losses for European banks.  Also by not triggering a credit event, sellers of credit default swaps won’t have to rush to raise funds to meet default payment agreements.  If that occurred, it would have probably wrecked additional havoc on the financial markets and offset the positive implications of the EU debt deal.  This morning’s better than expected U.S. economic reports had little positive impact on the U.S. dollar.  According to the latest GDP numbers, the U.S. economy grew by 2.5 percent in the third quarter which was in line with expectations while jobless claims dropped to 402k from 404k. The third quarter was a good period in the U.S. economy but the GDP report is one of the more backwards looking pieces of U.S. data on the calendar and based upon recent comments from central bank officials, the improvements are not expected to be sustained.     The low level of jobless claims is encouraging but layoffs have had a poor correlation with hiring.  At bare minimum however, it does indicate that job growth deteriorated significantly this month. Pending home sales on the other hand fell 4.6 percent which was much worse than economists had anticipated.  Until there is a broader economic recovery, it will be difficult for the housing market to recover fully.  Personal income, spending and the final University of Michigan consumer sentiment numbers will be released on Friday.  The pickup in retail sales points to the possibility of stronger spending numbers.  Although encouraging, tomorrow’s reports are not significant enough to sway the central bank’s decision to ease monetary policy even if they are very strong or weak.

GBP: SIGNS OF RECOVERY IN SPENDING?

The improvement in risk appetite lifted the pound against the U.S. dollar but as the optimism stems out of the euro area region, the euro is still the outperformer.  The EU debt deal is great news for U.K. banks.  Not only will a credit event not be triggered according to ISDA but U.K. banks will also avoid recapitalization according to the European Banking Authority because they are much better capitalized than their European counterparts.   The pound also benefitted from the only piece of U.K. data released this morning – which was the Confederation of British Industry’s retail sales report.  According to the CBI, retail sales declined at a slower pace in the month of October.  Analysts had expected the CBI index to hold steady at -15 but instead it rebounded to -11.   The expected sales balance for November also rose to its highest level since June, pointing to the possibility of a stronger holiday shopping season.  However with the index still in negative territory, demand remains weak overall.  Household finances are stretched which explains why Monetary Policy Committee members expect the Bank of England to purchase the full amount of additional assets they committed to earlier this month.  Consumer confidence numbers will be released this evening and sentiment is also expected to remain weak.

AUD: STRONGEST GAINS THIS YEAR

The Australian, Canadian and New Zealand dollars rose sharply against the greenback with the Aussie enjoying its strongest rally year to date.  With no Australian or Canadian economic data on the calendar today, the rally was sparked entirely by Europe’s debt deal which boosted risk appetite across the financial markets.  Many central banks around world and the Australians in particular based their own monetary policy outlooks on the instability in Europe.  Now that euro area policymakers have reached a deal to stabilize the region, one of the main risks in the market has been eliminated, encouraging investors to take on risk again.  The hawkishness of the Reserve Bank of New Zealand along with positive comments from Reserve Bank of Australia officials indicates that the countries down under are not suffering nearly as much as the countries in the Northern Hemisphere.  With high interest rates and a steady economy, the commodity currencies are extremely attractive to investors who are earning next to nothing domestically.  This is even truer for New Zealand dollar denominated investments which could earn higher yield if the RBNZ raises interest rates in the next 3 to 6 months.  Weaker trade activity in the month of September did not stop the RBNZ from saying that rising price pressures could necessitate a rate hike in the near term. The Canadian dollar also rose to a fresh 1 month high against the greenback, shrugging off the Bank of Canada’s recent dovishness.  As risk currencies, the AUD, CAD and NZD tend to be more sensitive to global risk appetite than domestic concerns unless there is a unique shock to those economies because the idea is that what is good for the world will be good for export dependent countries.  No economic data is expected from any of the 3 commodity producing countries over the next 24 hours which means that risk appetite will continue to drive their price action.

JPY: BOOSTS ASSET PURCHASES, NO SIGN OF INTERVENTION

The Japanese Yen weakened against every major currency with the exception of the U.S. dollar.  Risk appetite helped to lift the yen crosses but USD/JPY remains under pressure with Japanese officials disappointing on their attempts to curb Yen strength.  Last night, the Bank of Japan added 5 trillion Yen to their asset purchase program which was less ambitious than the market had hoped for. Some analysts had hoped that the program would be extended to as much as 30 trillion yen but instead, it was increased to only 20 trillion.  On top of that, the Ministry of Finance has yet to ask the Bank of Japan to intervene in the yen despite its persistent strength against the greenback. The market is starting to look at Shirakawa and Azumi as inept and without action, their words will be taken with a grain of salt. The Japanese government can’t just sit aside and do nothing – as their downgraded GDP forecasts show, the strong yen is expected to have a major drag on Japan’s economy which is now only expected to grow by 0.3 percent in 2011/2012 fiscal year compared to a prior forecast of 0.4 percent.  Growth the following year is now expected to be 2.2 versus a prior forecast of 2.9 percent.   The outlook for inflation was also lowered as a direct consequence of the strong currency, slow global growth and decline in equity prices.  We continue to believe that it should only be a matter of time before the Japanese finally replace verbal with physical intervention.  Tonight will be a very busy night in Japan with consumer prices, household spending, industrial production and the jobless rate scheduled for release.  Further deterioration is expected in most of the indicators, increasing the need for intervention by the central bank.

USD/JPY: Currency in Play for Next 24 Hours

USD/JPY will be our currency pair in play for the next 24 hours. The economic releases we expect from Japan are employment data and inflation data at 7:30PM ET / 23:30 GMT, followed by Industrial Production at 7:50PM ET / 23:50 GMT. From the U.S., we expect personal income, personal spending, and PCE Index at 8:30AM ET / 12:30 GMT. Furthermore, we also have the final U of Michigan Confidence Index at 9:55AM ET / 13:55 GMT.

As the Bank of Japan disappointed the market today with less-than-expected stimulus, USD/JPY made another record low and is currently trading in a downtrend which we determined using the Bollinger Bands. The nearest support is at the postwar low of 75.65. Further down, the psychologically significant 75 handle could provide major support. On the upside, 76.51 (10-day SMA) could serve as first level of resistance. The high in October could provide further resistance at 77.5.

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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.