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FX: A Spooky Day in the Market

Last updated 10/31/2011 5:27 PM ET (GMT -5) 1 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• FX: SPOOKY DAY IN THE MARKETS
• EUR: NOTHING IS EVER EASY WITH GREECE
• GBP: GDP TO TAKE ON PMI
• AUD TRADERS NOT POSITIONED FOR A RATE CUT
• CAD: GDP GROWTH BEATS EXPECTATIONS
• NZD: REPORTS WEAKER HOUSING NUMBERS
• JPY: THIS WONT BE THE ONLY INTERVENTION

EXPECTATIONS FOR UPCOMING FED MEETINGS

FX: SPOOKY DAY IN THE MARKETS

It has been a spooky day in the financial markets. Aside from the Bank of Japan’s intervention induced rally in the Japanese Yen crosses, all of the major currency pairs traded lower as trouble in the financial sector and new political risks in the Eurozone sends equities tumbling and risk appetite contracting. This week is a big week in the financial markets with 3 central banks holding monetary policy announcements. Each one has been monitoring the situation in Europe closely for the market’s response to last the EU debt deal. Unfortunately the EURUSD has erased all the gains that it enjoyed after the rescue plan was announced which is a sign that investors are not convinced Europe’s troubles are behind us. They are absolutely right because the Greek Prime Minister has called a referendum on the EU loan agreement, which would be only the second time ever that a referendum has been announced in modern day Greek history (the first being on the issue of monarchy). More on this is discussed in the euro section of our commentary but the most important impact of the referendum is the uncertainty that it creates for the Eurozone. Should the Greeks reject the EU loan agreement, European policymakers will be driven back to square one - not a good position to be.

If the gains and overall enthusiasm for the EU debt deal had been sustained, policymakers would feel far more comfortable with postponing their decisions to increase monetary stimulus. Unfortunately the reversals in the market and the increase in uncertainty and in turn volatility have now raised the odds of a rate cut by the Reserve Bank of Australia and the European Central Bank.   The same is true for the Federal Reserve who may have grown more willing to pull the trigger on additional stimulus. Whether policymakers decide to do so this week or not remain to be seen but there is no way that they could be happy with the market’s reaction to the EU’s rescue plan so even if rates are not lowered, central bankers will most likely express further concern about the global economic outlook, paving the way for easier monetary policy in December.

The rapid fire demise of MF Global is yet another example of how leveraged bets can go wrong. The financial institution was forced to file for Chapter 11 today after investors grew increasingly concerned about their $6.3 billion portfolio of Italian, Spanish, Belgian, Portuguese and Irish debt. Demands by regulators, credit downgrades and margin calls led to the collapse of a company whose bets that Europe would not let Italy or Spain default is probably right in the long run. Thankfully MF Global is much smaller than Lehman Brothers and trading only constituted a fraction of its overall business. They were mainly a broker and trade clearinghouse and had this not been the case, the impact on the markets would have been far more damaging. With that in mind however, we suspect that there are plenty of other MF Globals out there in the form of traders, hedge funds and large investors who may have leveraged too much on a European debt deal. If more trouble surfaces, it will take a big bite out of the recent recoveries and if policymakers want to be proactive, they could opt for an insurance cut. 

EUR: NOTHING IS EVER EASY WITH GREECE

It is no secret that Greece has been the source of most of the Eurozone’s troubles. Having amassed a large amount of debt driving borrowing costs to levels that they can no longer service, investors around the world have been forced to agree to take a massive haircut on their bond holdings just to bring stability the region. European leaders have spent many sleepless hours figuring out how to convince bond holders to voluntary accept losses and to prevent contagion. All Greece needed to do was sit in the corner and nod their head silently, accepting the terms that they so desperately needed to avoid default. Unfortunately the Greeks have not accepted the help quietly and have instead wrecked additional havoc on the market by announcing a referendum on the debt deal. This is only the second time in modern day history that Greece has held a referendum – the first was back in 1974 when the government wanted to abolish the monarchy. This time, the referendum is on the debt deal and Greek citizens will be asked to vote yes or no to the loan agreement.  With a recent poll released by a Greek newspaper citing 59 percent of respondents being against the new EU deal, the referendum could lead to a no vote that would be disastrous for the Eurozone. Considering that the finance minister wants to hold the referendum after the October agreement has been finalized with EU Partners, the vote will most likely be held in November or December, prolonging the uncertainty in the region. If the government succeeds in winning the referendum, it would be very positive for the euro, but it is very far from a done deal and the decision to hold the vote is an extremely risky one that could have dire consequences for the region. The Greeks just like to stir up trouble and they will probably face increased criticism from their European counterparts who have worked hard to strike a deal. Unfortunately in the near term, this could add pressure on the European Central Bank to cut interest rates or at least telegraph plans to do so this week. For this reason, we could see further losses in the euro. 

GBP: GDP TO TAKE ON PMI

Of all the major currencies, the British pound held up the best against the U.S. dollar but the big action was in the EUR/GBP. Sterling rose nearly 2 percent against the euro, enjoying one of its strongest rallies this year. The currency’s outperformance against its European counterpart reflects the world’s existing concerns about investing in Eurozone assets. The U.K. may have its own problems but fiscal austerity by the Cameron Administration and monetary stimulus from the Bank of England makes U.K. policymakers appear far more aggressive in tackling both debt and growth issues than countries within the Eurozone which has helped the pound attract safe haven seekers.  The official end of October was also supposed to bring solid demand for U.S. dollars as fund managers rebalance their positions. Unfortunately month end rebalancing came and went with little impact on any currency outside of the GBP/USD. There is little to explain the unusual strength of the pound outside of month end flows because the latest economic reports were mixed. Consumer credit grew at a faster pace last month but mortgage approvals and net lending slowed. The outlook for the housing market has also worsened according to property researcher Hometrack. Third quarter GDP numbers are scheduled for release tomorrow along with manufacturing PMI and house prices. There was a sharp deterioration in the CBI index which points to weaker manufacturing activity but slightly better retail sales and trade numbers means that growth in the third quarter is expected to have accelerated compared to the second quarter. Considering that the PMI numbers are more current, a big disappointment in manufacturing activity could overshadow slightly stronger GDP growth. 

AUD TRADERS NOT POSITIONED FOR A RATE CUT

The Reserve Bank of Australia has a monetary policy announcement this evening and the majority of economists expect the central bank to cut interest rates for the first time in 12 months. The call for a rate cut is largely based on softer inflationary pressures experienced in the third quarter. Although the country is no longer experiencing the double digit annual growth enjoyed before the financial crisis, aside from inflation, there are few reasons for the RBA to move on rates. The global equity markets have recovered strongly since their last meeting on October 4 ^th and the same recovery has been seen in commodity prices. The labor market also enjoyed stronger job growth with the unemployment rate dropping for the first time since March. As a result, consumer confidence has increased which will hopefully translate into more spending. Recent comments from RBA officials suggest that they are positive on the outlook for China and believe that Chinese demand will continue to fuel Australian growth.  Yet speculation about a rate cut was sparked by the October RBA minutes which included a line that said “ Members believed that an improved inflation outlook, if confirmed by further data, would increase the scope for monetary policy to provide some support to demand, should that prove necessary.” The key is “confirmed by further data” which we don’t see much evidence of which could explain why the pullback in the A$ has been shallow. Even though economists expect a rate cut, investors are not positioned for one as long Aussie, short US dollar positions grew in the week ending on October 25 ^th . This means that if the RBA were to lower rates, the AUD/USD could slip below 1.05. Of the 3 commodity currencies, the NZD/USD fell the most on the heels of weaker housing market data. The Canadian dollar was supported by better than expected growth and inflation figures. Industrial product and raw material prices rose in September while the economy expanded by 0.3 percent in August, which was weaker than the upwardly revised growth experienced in July but stronger than the market’s forecast. Aside from the RBA decision, manufacturing PMI will also be released from Australia this evening.

JPY: THIS WONT BE THE ONLY INTERVENTION

The Bank of Japan finally intervened in the Japanese Yen, sending it sharply lower against all of the major currencies. For the past 2 weeks, the Yen tested the government’s patience by rising to record highs on a near daily basis and today’s action shows that policymakers throwing in the towel and saying, that’s enough! In the early Asian trading session, the BoJ stepped into the market to sell Yen and buy U.S. dollars, triggering a move that took the pair from a record low of 75.575 to a high above 79 in a matter of minutes. Since then, the pair pulled back 150 pips from its post intervention high and the question now becomes whether this round of intervention by the BoJ will work. It is no secret that unilateral intervention by a central bank is rarely effective and in the case of the Japanese, two out of the last 3 rounds of intervention lasted for no longer than 24 hours before the Yen began to rise again. The only time intervention was effective was in March, when the G7 sold Yen in sympathy for the Japanese following the Earthquake. This time around, there is very little reason for the G7 or G20 to back Japan's move. Central banks around the world are looking to ease their own monetary policies and intervening in the Yen would be counterproductive. The only way intervention would work is if the Bank of Japan comes in repeatedly, spooking speculators from taking any short USD/JPY positions. Further intervention is certainly possible because the Japanese have a great deal of money to spend. Back in September, the Japanese increased their war chest for intervention by Y15 trillion to Y46 trillion ($600B), the largest ever and the MoF vowed to do all that it takes to engineer a satisfactory movement in the Yen. For intervention to be truly effective however, the U.S. needs to back off their plans to ease monetary policy because the main source of USD/JPY weakness has been the prospect of further stimulus from the Federal Reserve. The path of least resistance for USD/JPY is still lower but if the pair slips back down to 76, expect the central bank to be in the markets once again.  Meanwhile the latest economic reports were mixed with manufacturing activity rebounding. The housing market on the other hand remains very weak with starts falling an annualized 10.8 percent last month. 

GBP/USD: Currency in Play for Next 24 Hours

GBP/USD is our currency pair in play for the next 24 hours with manufacturing PMI and GDP numbers scheduled for release at 4:30 AM ET or 8:30 GMT. U.S. Manufacturing ISM and Construction Spending will be released at 10:00 AM ET or 14:00 GMT. 

After quite a bit of intraday volatility, the GBP/USD has recovered a large part of its earlier losses to end the day only slightly lower. The currency is still trading comfortably in an uptrend according to our Double Bollinger Bands. However 1.6140 is a significant resistance for the pair. Not only has it been unable to rise above that level for the past 3 trading days, but the rally has been capped by the 200-day SMA and the 61.8 percent retracement of the May to October sell-off. Support on the other hand will be at 1.60, which is a psychologically significant level as well as the 50 percent retracement of the same move and the 100-day SMA.

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Comments (1)

Marc

October 31, 2011 at 09:42 PM ET

GBPUSD is our currency in play ...... GMT0830 -> GMT0930

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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.