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USD: Main Fed Takeaway is Not Giving Up on QE

Last updated 11/2/2011 4:07 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

• USD: MAIN FED TAKEAWAY IS NOT GIVING UP ON QE
• EUR: WHAT TO EXPECT FROM THE ECB
• GBP: CONSTRUCTION PMI RISES TO 5 MONTH HIGH
• NZD: EMPLOYMENT NUMBERS ON TAP
• AUD: SHARP DECLINE IN BUILDING PERMITS
• CAD: SMALL GAINS IN OIL AND GOLD
• JPY: STILL SUFFERING FROM YEN STRENGTH

EXPECTATIONS FOR UPCOMING FED MEETINGS

USD: MAIN FED TAKEAWAY IS NOT GIVING UP ON QE

Rather than increasing transparency, the Federal Reserve left investors more confused than ever following this afternoon’s monetary policy announcement.  The tone of the FOMC statement was slightly more upbeat but the comments from Bernanke and the central bank’s latest GDP forecast reflect continued concerns about the outlook for the U.S. economy. The dollar rallied initially following the release of the FOMC statement and has for the most part held onto its gains. The central bank left rates unchanged and to the surprise of most investors, passed on the opportunity to take additional steps to stimulate the economy. Although very few people expected the Fed to increase asset purchases this month, going into the FOMC rate announcement, there was a general belief that they would at least lay the groundwork for easier monetary policy by signaling a change in their communications strategy. Yet not only did they fail to do so but their statement contained a slightly more optimistic outlook. The central bank felt that economic growth had strengthened somewhat in the third quarter thanks in part to faster growth in household spending. This surprise optimism sent the dollar soaring against higher yielding currencies as it signaled a weaker possibility of QE3.  However if the Fed grew optimistic, then why would they reduce their GDP forecasts for 2011, 2012 and 2013 so significantly? Previously the central bank expected the U.S. economy to expand between 2.7 to 2.9 percent in 2011 and 3.3 to 3.7 percent in 2012. Now they expect this year’s growth to be between 1.6 and 1.7 percent and next year’s growth to be between 2.5 and 2.9 percent.   The Fed also expects the unemployment rate to remain above 8.5 percent until the end of 2012. These pessimistic forecasts leave the door open for more stimulus and Bernanke’s comments confirm that the Federal Reserve has not given up on QE3.

In his post monetary policy meeting press conference, Bernanke reminded everyone that even though they grew more optimistic about the outlook for the third and fourth quarter, their medium term outlook was downgraded. At its current state, the outlook “remains unsatisfactory” and for that reason, the Fed can still provide more stimulus and accommodation. According to Bernanke, they have a range of tools to do more and there is a good chance these tools will be tapped next month. Based upon the dissent within the central bank, the differentiating tone between the FOMC statement and Bernanke’s press conference, the possibility of the Federal Reserve opting for more unconventional measures has increased. QE3 is still on the table but targeting the unemployment and inflation rates still appear to be the central bank’s preferred option. It is worth noting that Charlie Evans voted to ease over leaving monetary policy unchanged. The last time this occurred was during the financial crisis and if the European debt crisis escalates, more members of the Fed could join in his call for easier monetary policy. Based on recent comments from Fed officials, it may not take much to convince other FOMC members to ease again and for this reason USD/JPY has barely budged.

EUR: WHAT TO EXPECT FROM THE ECB

The euro ended the day higher against the U.S. dollar ahead of what will be one of the most closely watched European Central Bank monetary policy meetings this year. Thursday’s European Central Bank announcement will be monumental for 2 reasons.  It will be the first time in 8 years that the meeting will be chaired by someone other than Trichet. It will also be a meeting where the ECB either cuts interest rates or signals plans to do so for the first time in more than 2 years. Over the past month, financial and economic conditions in the Eurozone have taken a turn for the worse – based upon the latest PMI numbers which show contraction in the service and manufacturing sectors, the region’s economy is headed for recession. Rising borrowing costs and fiscal austerity will put additional pressure on growth, making recession not only possible but probable. It will be a baptism of fire for Mario Draghi, the new ECB President who will be inheriting a region deep in crisis. Removing the 50bp of tightening by Trichet earlier this year is not only needed but would be a sign that the new ECB head will be tackling the crisis head on in a decisive and aggressive manner.  If Draghi lowers interest rates at his first ever monetary policy meeting, he will be digging a knife into the heart of the euro even if it the bitter medicine that the region requires.  If rates are held steady but Draghi signals plans to cut in December, the euro could still suffer but the sell-off would not be as sharp. Either way, the ECB monetary policy announcement will most likely be a no-win situation for the euro. One of the main arguments for holding off till December aside from being able to offer investors an early holiday present is the fact that new staff forecasts will be available for that meeting, giving Draghi the evidence he needs to justify a rate cut but with equities and currencies under pressure, he may not be able to wait. Aside from interest rates, Draghi will also be grilled about his willingness to involve the central bank in any secondary bond market purchases. Last month, Draghi appeared willing to intervene in the debt markets by buying the bonds of troubled Eurozone nations, an issue so contentious that it has led to the resignation of some ECB members. Trichet said earlier this week that Draghi’s readiness to buy bonds was misinterpreted and he will be under pressure by reporters to clarify his stance. At the same time, euro traders will continue to keep an eye on sovereign debt developments. There is a good chance the next tranche of aid for Greece will not be released until after the referendum is held which puts the country at risk of missing certain bond payments if the referendum occurs in December.   So far, the euro is receiving some support from rumors of a possible investment into the EFSF by China but the support could wane easily if the ECB is dovish. 

GBP: CONSTRUCTION PMI RISES TO 5 MONTH HIGH

The British pound traded higher against the U.S. dollar but lower against the euro. U.K. construction output unexpectedly strengthened in October as new business increased, boosting employment in the sector. The United Kingdom’s construction purchasing managers’ index rose to a five-month high of 53.9 from 50.1 in September. The market was expecting a reading of 50.1. Reports of new contract wins from previously quoted projects and some advance orders for 2012 led to the steepest increase in new business since the spring. However, due to current economic conditions, it may be some time before the sector starts seeing the sustained growth it really needs. Global finance ministers don’t support a proposed European Union tax on financial transactions; U.K. Chancellor of the Exchequer George Osborne told banks in a letter addressing their concerns over the levy.  Osborne said it was clear after a meeting of Group of 20 finance ministers in France last month “that the necessary international consensus does not exist” to implement such a tax globally. The U.K. government has argued that any tax can only be viable if applied worldwide. Osborne also says that the tax would be harmful to jobs and growth. Robert Jenkins, Member of the Financial Policy Committee from the Bank of England gave a speech at the CFA Institute in Paris. He noted that bankers should strive for risk adjusted return targets instead of a high return on equity. If firms did that, he argued, financial institutions would lengthen the period for which they determine success to 10 years or more. 

NZD: EMPLOYMENT NUMBERS ON TAP

The Canadian and Australian dollars strengthened against the U.S. dollar while the New Zealand dollar weakened. Even though Australia cut its interest rate from 4.75 percent to 4.5 percent on Monday, moves in the debt market show expectations that Reserve bank Governor Glenn Stevens will follow the first rate cut in 2 ½ years by lowering borrowing costs next month to spur spending in the Christmas holiday season. The implied yield on December interbank cash rate futures was 4.26 percent, indicating traders expect another rate cut at the RBA’s December 6 ^th meeting. Policy makers across the Asia-Pacific region are lowering interest rates as Europe’s debt crisis dims prospect for the world economy. Australia’s building approvals dove sharply in September coming in at minus 13.6 percent versus a forecast of minus 4.5 percent. They follow a downwardly revised 10.7 percent increase in August. Construction and services may remain slightly soft in the Australian economy in the near term. The Canadian dollar rose from the lowest level in almost two weeks against the greenback as risk appetite improved.  Oil provided further support to the Loonie as it rose for the first time in four days on a better-than-expected ADP report. The New Zealand dollar weakened on renewed Eurozone worries. However, it could receive a boost tomorrow from the unemployment numbers scheduled for release. The employment rate is expected to tick down to 6.4 percent from 6.5 percent last month.

JPY: STILL SUFFERING FROM YEN STRENGTH

The Japanese Yen strengthened against all of the major currencies with the exception of the Canadian dollar. The Japanese government faces almost 40 trillion yen ($512 billion) in losses from intervening in the foreign-exchange markets to halt the yen’s advance, according to estimates by JPMorgan Chase & Co. Finance Ministry data showed Japan’s losses to amount to over 35 trillion yen at the end of 2010. The Bank of Japan is coming to realize that it is difficult to change the trend of the currency market with unilateral intervention. Even if the intervention can stem the currency’s gains temporarily, the yen will eventually appreciate due to fundamental drivers. Japan intervened in the foreign-exchange markets to weaken the yen for the third time this year and Finance Minister Jun Azumi said he will continue to intervene until he’s “satisfied.” Japan is said to have spent a record 8 trillion yen to halt the currency’s gains, according to the BOJ’s projection of deposits held by financial institutions at the central bank. More and more companies are feeling the effects of the strong yen; Sony Corp., Japan’s largest consumer-electronics exporter, forecast its fourth consecutive annual loss and slashed television sales targets after the yen reached a postwar high and floods in Thailand cut production. The company predicted a 90 billion-yen ($1.2 billion) annual loss, compared with its earlier estimates for a 60 billion-yen full-year profit. Other companies such as Toyota and Honda are still trying to rebound from output losses caused by Japan’s March earthquake. The automakers face the strong yen as well and now must contend with possible parts shortages due to flooding in Thailand. Japan’s monetary base increased 17.0 percent in October, versus a 17.3 percent forecast and following a 16.7 percent increase in September. The expanding money supply should hopefully lead to additional spending and investment in the economy – things that Japan desperately need to pull it through the recovery and reconstruction stages. Kyushu Electric Power Co. started a nuclear reactor at one of its nuclear plants, the first unit to come online since the Fukushima crisis eight months ago. The unit will start delivering much-needed electricity to the power grid later today. 

EUR/USD: Currency in Play for Next 24 Hours

Our currency pair in play for the next 24 hours is EUR/USD. The European Central Bank will announce its interest rate decision at 8:45 AM ET / 12:45 GMT. The September factory orders from the U.S. and ISM non-manufacturing composite for the month of October will be released at 10:00 AM ET / 14:00 GMT. 

EUR/USD has recovered some of its losses today but still remains range bound, which we determined with Double Bollinger bands. Nearest support is at 1.3600 where both the lower first Bollinger band and yesterday’s low lie. Should the pair fall below that price, significant support will be found at the second lower Bollinger band price of 1.3400. To the upside, nearest resistance is at today’s high of 1.3828. Should the pair continue upward, heavy resistance will be found at 1.3980 where the upper first Bollinger band lies. 

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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.