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THE STORIES IN THE CURRENCY MARKET

• EUR: WHAT IS THE MAGIC NUMBER FOR ITALY?
• USD: BREAK BETWEEN STOCKS AND CURRENCIES
• GBP: HOUSE PRICES RISE BUT NO REAL SURPRISE
• AUD: GOOD BUT NOT GREAT DATA
• NZD: OIL AND GOLD PRICES RISE
• CAD: HOUSING STARTS DUE TUES
• JPY: RESERVES EXPECTED TO RISE POST INTERVENTION

EXPECTATIONS FOR UPCOMING FED MEETINGS

CURRENT US INTEREST RATE: 0.25%
	12/13 Meeting	01/25 Meeting
NO CHANGE	60.0%	58.0%
CUT TO 0BP	40.0%	40.7%
HIKE TO 50BP	0.0%	1.3%

EUR: WHAT IS THE MAGIC NUMBER FOR ITALY?

Tomorrow could be D-Day for Berlusconi.   The Parliament will be holding a vote on state financing that could be followed by a confidence vote on the nation’s austerity measures.   If Berlusconi loses this vote, he will be under serious pressure to resign.   If he wins the vote, which is unlikely, then Italy could remain stuck with a leader that has so far proven ineffective in steering his country out of financial crisis. Berlusconi has been a larger part of the problem than the solution and for this reason his resignation could be cheered by traders in the currency and bond markets even if it introduces a bit of uncertainty about the nation’s next leader.   Fresh blood is desperately needed at this time and many investors believe that anyone could do a better job than Berlusconi.   Unfortunately the Italian Prime Minister will not step down without a fight and this political battle is one of main reasons why investors are demanding a premium for holding Italian bonds.   These days, it is extremely important for currency traders to watch bond yields.   Italian yields have hit a record high above 6.5 percent and there is a lot of talk in the market that 7 percent is the magic number.   If Italy’s 10 year bond yields hits 7 percent, the speculation of Italy becoming the next Greece would escalate significantly.   The 7 percent level is a psychologically hobbling number that will require Italy to pay billions more in interest – which they may not be able to afford without external support.

Greek, Irish and Portuguese yields are all above that level and we know what state those countries are in right now.   If Berlusconi wins the no confidence vote, yields will probably rise quickly towards 7 percent, which could be negative for the euro.   Typically higher yields are positive for the currency but in the case of Italy, higher yields could quicken their demise.  

 

The price action in the foreign exchange market today is a good example of what is in store for the rest of the week.   With no major U.S. economic reports on the calendar, headlines out of Europe has and will continue to be the number one driver of risk appetite.   This morning, reports that the European Investment Bank could lend support to the banking sector helped the euro recover its losses against the U.S. dollar but the gains were fleeting as investors quickly shifted their focus back to Italy.   This schizophrenic price action shows just how little commitment there is to euro short AND long positions. Last week, short EUR/USD positions were cut significantly according to the CFTC and the resignation of Greek Prime Minister Papandreou will move the country forward in its path to receiving additional monetary support from its European neighbors.   Although Italian-German yield spreads have widened to record levels and the possibility of forced resignation of Italian Prime Minister Berlusconi is at its highest level ever, investors have not given up on buying euros because they know that Europe will not let Italy fail.   There is no question that Italy is a much larger problem than Greece but this is a crisis of confidence and it won’t take much to turn the euro around even though the odds still currently favor more losses and gains. Recent economic data in the Eurozone including this morning’s German industrial production report show more deterioration in the Eurozone economy.   The same is expected for tomorrow’s trade and current account numbers.

 

The strength of EUR/CHF is also worth noting.   The euro may have weakened against most currencies but it rose strongly against the Franc on talk that the Swiss National Bank could raise its EUR/CHF peg to 1.30. 

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USD: BREAK BETWEEN STOCKS AND CURRENCIES

U.S. stocks reversed sharply in the last 2 hours of the New York Trading session, recovering all of its earlier losses to end the day deep in positive territory.   Currencies, which normally have a strong correlation with equities failed to participate in the rally, making the move suspect if not for the rally in bonds and commodities.   Aside from currencies, investors in all other asset classes appeared more optimistic but this could be one of the rare cases where currency traders have a better grasp of the risks in the market than bond, commodity and equity traders. combined   There was very little to explain the rise in stocks.   Yes, the European crisis will probably be “under control” within 2 years according to ECB’s Stark because if it isn’t, we are in for some serious trouble.   In fact, the crisis needs to be on its way to recovery by the first half of 2012 if not sooner if policymakers want to prevent a 15 percent drop in asset values around the world.   The world won’t come to an end because of the problems in the Eurozone and it won’t be long before we know whether Italy turns into Greece.   In the meantime, there could still be more pain than gain.   The U.S. economic calendar is extremely quiet this week aside from a few speeches by Federal Reserve officials but there is a data dump on Wednesday from China that will take the focus off Europe temporarily and put it onto global growth.   Weaker inflation and industrial production numbers could slow the revaluation of the Yuan and monetary tightening as well as raise concerns about China’s appetite for commodities.   With this in mind, we expect today’s break in the correlation between stocks and currencies to be short-lived because the price action of both equities and forex is determined by risk appetite and tomorrow we will learn whether Berlusconi loses majority support in tomorrow’s Parliamentary vote, which could lead to his resignation.   

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GBP: HOUSE PRICES RISE BUT NO REAL SURPRISE

The British pound held steady against the U.S. dollar but appreciated against the euro for the third consecutive trading day.   The U.K. is one of the few countries to release any meaningful economic reports this week and the first round of data is an example of what investors should expect, which are mostly mixed reports. House prices increased in the month of October according to Halifax.   The increase in prices has mostly been in London while the rest of the country is in a completely different world.    Lenders have also tightened credit, which means fewer sales are being done and the ones that were completed were by overseas buyers snapping up prime London property. Tonight’s RICS house price balance will probably tell a similar story, particularly since Nationwide had also reported an increase in prices.   Employment confidence on the other hand deteriorated according to Lloyds, which indicates that U.K. businesses have grown wearier of adding employees – a development that is in no way positive for the U.K. economy.   The BRC retail sales report will be releases=d this evening followed by industrial production and the GDP estimate.   The decline in the manufacturing PMI index points to weaker industrial production, particularly since new orders fell to their lowest level since March 2009.   No major upside surprises are expected in this week’s U.K. economic reports but as we have seen today, that may not stop the pound from rising against the U.S. dollar and euro because demand for sterling has less to do with the U.K. economy and more to do with the risks involved with investing in the U.K. versus Europe.  

 

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AUD: GOOD BUT NOT GREAT DATA

The Australian dollar weakened slightly against the greenback while the Canadian and New Zealand dollars edged higher.   Australia was the only country to release economic data overnight and despite the currency’s weakness, the latest data showed improvements in the month of October.   More specifically, AiG’s Performance of Construction Index rose from 30.0 to 34.7, which implies that the building industry contracted at a slower pace in October.   This uptick is in line with a more closely followed and broader survey conducted by the Australian Industry Group, but the difference was that this report showed an expansion in construction activity.   Job advertisements also fell less than expected last month despit fewer ads have been posted for the past 4 months.   Together these numbers suggests that even though the Australian economy has improved, it remains at a greater risk of contraction than acceleration and for that reason, the AUD/USD could also be vulnerable to further losses. The Australian trade balance and business confidence reports are scheduled for release this evening.   Weaker global growth and a strong currency are expected to continue to weigh on trade and business activity.   Meanwhile housing starts in Canada are expected to decline in October which would also be in line with recent deterioration in the Canadian economy.   The Bank of Canada is hard pressed to lower interest rates and we believe there is a reasonable chance for the central bank to choose to do so before the end of the year.   

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JPY: RESERVES EXPECTED TO RISE POST INTERVENTION

The pullback in risk appetite drove the Japanese Yen higher against all of the major currencies. Although the Yen also rose against the U.S. dollar, the currency pair is still hovering near 78.00 with its trading range limited to 25 pips.   There has been a lot of talk that the Japanese have continued to sell the Yen but we won’t see proof until the Ministry of Finance releases its monthly intervention report at the end of the month. In the meantime, we could gather some clues from Japan’s official reserves report which will be released this evening.   Intervention activity tends to boost reserves because Japan accumulates more U.S. dollars when they buy USD/JPY. With that in mind however, considering that net long positions in the Yen have fallen nearly 50 percent according to the latest CFTC Commitment of Traders report, the Japanese government has effectively spooked a large number of Yen traders from shorting USD/JPY. Although the snapshot of positioning was taken shortly after intervention earlier this month, the price action in USD/JPY suggests that Yen traders have probably stayed away from taking any major positions since then.   According to last night’s economic reports, the leading composite index increased in the month of September but the coincident index which measures current account activity fell from a sharply downward revised 90.3 to 88.9, the lowest level in four months.   The mixed reports left the Cabinet’s assessment of the economy unchanged at “halting to fall.”   

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EUR/GBP: Currency in Play for Next 24 Hours

EUR/GBP will be our currency pair in play for the next 24 hours.   German current account and trade numbers will be released at 2:00AM ET or 6:00 GMT.   This will be followed by U.K. industrial production at 4:30 AM ET or 8:30 GMT.

 

After falling sharply at the begging of last week, EUR/GBP is in a downtrend which we define using Bollinger Bands.   Support is at the 7 month low of 0.8530 while resistance is at the first standard deviation Bollinger Band of 0.8616.   

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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.