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FX: Why Trading Will Remain Interesting

Last updated 10/28/2011 5:19 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: WHY TRADING WILL REMAIN INTERESTING
• EUR: WHAT TO EXPECT FROM ECB AND G20
• GBP: SHRUGS OFF PULLBACK IN CONFIDENCE
• AUD: WILL THE RBA CUT RATES THIS WEEK?
• CAD: OIL AND GOLD DOWN
• NZD: HITS FRESH ONE MONTH HIGH
• JPY: IMPACT OF THAILAND FLOODS ON JAPAN

EXPECTATIONS FOR UPCOMING FED MEETINGS

FX: WHY TRADING WILL REMAIN INTERESTING

It has been a very exciting week in the financial markets and one that has been filled with volatility. Europe’s rescue plan helped to resolve some near term uncertainties but even as currencies and equities consolidated today, don’t expect volatility to recede anytime soon.  Next week will be another busy one in the foreign exchange market. In addition to 3 central bank rate decisions, employment reports from a few countries including the U.S., the leaders of the 20 largest economies will be convening in France and investors hope they will consider taking additional steps to stabilize the global economy and prevent recessionary conditions from returning.  All 3 of the central banks meeting next week could potentially change monetary policy. QE3 is still on the table for the Federal Reserve while some economists believe that the European Central Bank and the Reserve Bank of Australia could lower interest rates. More easing is not a done deal in any of these cases and because of that, there could be quite a bit of volatility in the USD, EUR and AUD in the coming week. Economic data has not been horrid and the debt deal in Europe helped to restore some stability in the financial market.

In the U.S. in particular, there have been as many improvements as deterioration in U.S. data. This morning’s personal income and spending reports came in weaker than expected but consumer confidence was revised higher. In the month of October, consumer spending and the labor market improved, which should offer relief to policymakers. Yet according to recent comments from Federal Reserve officials, they are disappointed by the results of Operation Twist and are warming to the idea of more stimulus. The most powerful way to increase stimulus would be to add to their asset purchase program but a more subtle way would be to increase transparency by tying interest rates to the inflation or unemployment rate. There is a good possibility that Federal Reserve officials would opt for the more moderate change to monetary policy to leave QE3 as their last ditch measure to save the economy. At this point, the economy has not deteriorated enough since the introduction of Operation Twist for policymakers to unanimously vote YES to more QE. Non-farm payrolls in particular rebounded in September and the Fed will want to see if this pickup in job growth has been sustained before pulling the trigger on QE3. In other words, why would they use their final bullet if it is not absolutely necessary? Aside from the NFP report and the FOMC meeting, Chicago PMI, Manufacturing and Service sector ISM will also be released. For the past few weeks, the dollar has traded primary on risk and the optimism sparked by the EU debt deal has driven the greenback sharply lower. There are enough U.S. event risks to bring the focus back to the U.S. economy but at the end of the day the key will be how U.S. monetary policy compares with the rest of the world. If the ECB cuts interest rates and the Fed delays QE3, the dollar should rise against the euro but if the RBA commits to steady policy and the U.S. still talks of doing more, the dollar will weaken against the Aussie. We do not expect the Federal Reserve to bite the bullet and announce another round of asset purchases on Wednesday but if for some reason they do, it would be bad for the dollar and will likely drive USD/JPY to fresh record lows.

EUR: WHAT TO EXPECT FROM ECB AND G20

Concerns that the European rescue plan has not brought end to all troubles relating to the Eurozone have prevented the euro from extending its gains against the U.S. dollar. Much of the details of the plan still need to be ironed out at the Ecofin meeting and ISDA needs to decide officially whether the 50 percent haircut on Greece will trigger a credit event. It is widely believed that it will not, but rating agency Fitch believes that the haircut is the equivalent of a default. At stake are $3.7 billion worth of credit default swaps that would need to be paid out If a credit event were to occur. Italy’s latest bond auction was also disappointing with the yield demanded by investors topping 6 percent, far surpassing the 5.86 percent paid for a similar auction last month and the highest interest rate since the launch of the euro.  The bid to cover ratio which is a measure of demand also came out weaker than expected. The auction is a test of confidence in Prime Minister Berlusconi’s austerity program as well as the first test of investor confidence since the rescue plan has been announced. Italy is the next ticking time bomb and so far, it seems that investors are not convinced that the rescue plan for Europe has pulled Italy out of the woods.  Next week’s ECB and G20 meetings could have broad sweeping ramifications for the euro. Investors will be looking to see if Mario Draghi, the new ECB President will lower interest rates to support the Eurozone economy in the face of more demanding austerity programs. Draghi has stayed out of the limelight in the last month of Trichet’s term but next week he will be chairing the ECB meeting for the first time ever and explaining their decision and outlook at their press conference. We know that Draghi supports continued purchases of sovereign bonds of countries such as Italy and Spain and recent economic data has shown slower growth in the region’s two largest countries. Austerity measures by Eurozone nations will most likely lead to slower growth but now that the EU has announced its rescue plan, is a rate cut still necessary? Could the ECB hold off easing for another month to see if the economy improves or worsens? The Eurozone desperately needed a rescue plan but it does not desperately need a rate cut – lower rates will help but could be more potent at different point in time. If the ECB follows through with a rate cut, the euro will give up a large part of its gains but if they forgo easing, the euro could resume its rise. From the G20, investors will be looking to see if they can get greater commitment by other G20 nations to buy European debt. China will be courted from all angles but they have denied that purchases of EFSF bonds will be on the agenda. If no additional support is provided by the G20, investors could be disappointed enough to punish the euro. German retail sales and unemployment numbers are also scheduled for release next week but will be easily overshadowed by the ECB and FOMC meetings.

GBP: SHRUGS OFF PULLBACK IN CONFIDENCE

The British pound strengthened against both the U.S dollar and the euro despite U. K. consumer confidence falling to a 2 ½ -year low. The GfK consumer confidence report fell 2 points to negative 32 in October, the weakest reading since February 2009. Britons became more pessimistic about spending, adding to signs the economy may slip back into recession. The climate for durable purchases has worsened, suggesting the government can’t rely on people spending their way out of the double-dip recession that looms on the horizon. Confidence has been undermined this year by inflation that is almost double wage growth and the largest government budget squeeze since World War II. End demand remains severely depressed as this index shows and is exacerbated by retail sales falling for five consecutive months. Consumers are feeling the pinch, but British executives are not. Prime Minister David Cameron said executives must justify their pay as a report showed that directors of the largest British companies saw their earning jump by 49 percent in the last financial year. Cameron is concerned about this report, particularly at a time when household budgets are very tight. U.K. stocks retreated from three-month highs as concerns about the sustainability of the recovery persist. Next week’s economic calendar is heavy with releases including the nationwide house price index, manufacturing, construction, and services PMI, preliminary GDP figures, and mortgage approvals. The purchasing managers’ reports deserve particular attention as they will show whether businesses are being hit as hard as consumers.

AUD: WILL THE RBA CUT RATES THIS WEEK?

The Australian, New Zealand and Canadian dollars ended the day virtually unchanged against the greenback. The commodity countries did not release any new economic data today, but they have busy calendars in the week ahead. Specifically, the Reserve Bank of Australia will announce its interest rate decision on Tuesday. Some economists expect the central bank will cut interest rates on concerns about the sluggishness of the U.S. recovery but recent comments by deputy governor Ric Battellino have been more optimistic on the Australian economy implying rate cuts are not a done deal. Battellino noted that up to recently, Australia has been relatively unscathed by the slow pace of the U.S. recovery and the global financial crisis. However, a rate cut is not yet a certainty as there have been some signs of life in those parts of the economy that had been causing the greatest concern, such as retail sales, housing loans, and jobs. But the issue will be whether the economy could grow a bit faster without threatening the inflation target. Commodities across the board declined as traders lock in profits from yesterday’s price surge and the euphoria of the European debt crisis deal wanes.  Oil, copper, and gold all declined from the previous rallies as there is no evidence to support the solution to the Eurozone crisis. Canada’s dollar pulled back from its highest level in more than a month, as demand for riskier assets dampened. On the docket next week for Canada is GDP, employment numbers, building permits, and the Ivey PMI. The unemployment rate is forecast to tick up to 7.2 percent from 7.1 percent as businesses put hiring plans on hold. New Zealand also has a heavy economic calendar next week with building consents, the labor cost index, and employment numbers all scheduled for release. Jobs are expected to grow at a modest 0.6 percent for the quarter as business activity picks up.

JPY: IMPACT OF THAILAND FLOODS ON JAPAN

The Japanese yen strengthened against all of the major currencies today. Yen’s appreciation was supported by a pullback in risk appetite as investors grew cautious over the details in the European debt plan. Meanwhile, the Japanese factory output declined 4 percent in September. The production fell for the first time in six months with manufacturers making fewer cars, chip-related machines and cell phones. According to Ministry of Economy, Trade and Industry (METI), “industrial production appears to be flat.” As Japan’s recovery from March earthquake tapers off, contracting global demand and yen’s strength are adding pressure to exporters. Furthermore, Japanese corporations were also hit hard by the floods in Thailand, causing more disruptions. All nine car manufacturers have been forced to shut down production at their factories in Thailand. While METI said that manufacturers expect output to increase in October, the figures could be revised down amid uncertainty about global growth and supply-chain hiccups. Furthermore, the household spending dipped 1.9 percent in September while unemployment rate dropped to 4.1 percent from 4.3 percent in August. The employment survey was the first one since the nuclear disaster to include the tsunami-devastated prefectures. Despite the improvement in the data, some economists cautioned that the dip in the unemployment rate was more because people stopped looking for work. Thus, more signs of weakness in the Japanese economy could emerge. Looking forward, the CEO of the ESFS, Klaus Regling, will visit Tokyo this weekend. There has been speculation in which Japan could aid Europe by investing in ESFS. As some market participants pointed out, this move could help fight yen’s appreciation. Nonetheless, if Japan made this exotic move, supporting Europe could boost market’s appetite for riskier asset, thus taking the pressure off of the yen. Next week, the releases we expect from Japan are PMI and Housing Starts on Monday. Furthermore, the G20 meetings will commence on Thursday.

EUR/USD: Currency in Play for Next 24 Hours

EUR/USD will be our currency pair in play for Monday. The economic release from Europe is German retail sales at 3:00AM ET/ 7:00 GMT. From the U.S., we expect Chicago Purchasing Manger index at 9:45AM ET/ 13:45 GMT.

Despite its decline today, EUR/USD is currently trading in an uptrend which we determined using the Bollinger Bands. The nearest resistance is at yesterday’s high and the 61.8% Fibonacci level – 1.4254. We drew our Fibonacci retracement from the high in May to the swing low in October. If the pair rallied further, the psychologically significant 1.44 handle could provide major resistance. On the flip side, the first level of support is at 1.4073 (100-day SMA). The pair’s fall could see further support at 1.3899 (10-day SMA).

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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.