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EUR: Cheering Berlusconi Resignation

Last updated 11/8/2011 5:08 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

• EUR: CHEERING BERLUSCONI RESIGNATION
• USD: FED COMMENTS AND CHINESE DATA DUMP
• GBP: STILL MORE WEAKNESS THAN STRENGTH
• CAD: BOOSTED BY BETTER ECONOMIC DATA AND HIGHER OIL PRICES
• AUD: TRADE SURPLUS NARROWS
• NZD: CREDIT CARD SPENDING NUMBERS ON TAP
• JPY: INTERVENTION WATCH

EXPECTATIONS FOR UPCOMING FED MEETINGS

EUR: CHEERING BERLUSCONI RESIGNATION

Backed into a corner after losing Parliamentary majority in today’s key vote, Italian Prime Minister Berlusconi has offered to resign after the Parliament passes its austerity measures. Even though Berlusconi’s resignation offer is conditional, which means he is trying to hang onto his seat for a while longer, the rally in currencies and equities show that investors are just happy about the increasingly realistic prospect of getting rid of the longest serving Prime Minister in the country’s post war history. We have said that a resignation by Berlusconi would be positive for the euro because it paves the way for temporary technocratic government whose main goal will be to push through reforms. The definition of a technocratic government is one that is led by technical experts and not politicians who do not need to worry about political popularity. The only wrinkle is that as of this second, Berlusconi remains in office and it is not clear exactly when the reform package will arrive in the Senate. In the past Berlusconi has said this would occur by mid November but so far, the additional measures that Italy promised to deliver on have not been presented to Parliament. After the vote occurs, Berlusconi is expected to formally announce his resignation (instead of just offering to do so), paving the way for the President to either form a new government or hold early elections. In reality, this will probably occur within the next 2 to 3 weeks. Until he announces his formal resignation, Berlusconi could still find a way to stay in power and for this reason we are only hesitantly bullish euros. Greece was suppose to pick a new leader today but talks have hit a hurdle with politicians balking at the Eurogroup’s demand that the new coalition government provide a written commitment signed by both parties to honor the terms of the EU debt deal made in late October including the 50 percent haircut on Greek bonds. Mr. Samaras, the leader of the main opposition party said “I won’t allow anyone to question the statements I have made” and it is this counterproductive pride that is hampering progress in most of Europe. 

In the meantime, euro traders need to continue to keep an eye on Italian 10 year bond yields which ended the day at 6.715 percent.   We are getting dangerously close to 7 percent level in Italian bonds, which is level that starts to make bond servicing costs in exorbitantly expensive. If Italy’s 10 year bond yields hits 7 percent, they could be forced to ask for support in the same manner as Greece. The 7 percent level is a psychologically hobbling number that will require Italy to pay billions more in interest – something they may not be able to afford without external support. The rumors of a margin hike on Italian Treasury Bonds (BTPs) have also returned which if true would be extremely bad for Italy because investors could just end up dumping the bonds rather than put up more margin. Logically, the euro should respond negatively but when margins were increased on Irish bonds back in May, the euro rose.  With Berlusconi’s offer to resign, we don’t anticipate any significantly bearish news for the euro over the next 24 hours. For this reason, the relief rally in the EUR/USD could gain traction. 

USD: FED COMMENTS AND CHINESE DATA DUMP

The improvement in risk appetite drove the U.S. dollar lower against all of the major currencies. There were only a few pieces of U.S. data released this morning and they were not particularly market moving. According to the latest reports, economic optimism and small business confidence has increased slightly. With the labor market printing slightly better numbers and equities recovering in the month of October, we are not particularly surprised by the improvement in sentiment. Although encouraging, it is important to remember that the U.S. economy is still deep in the woods and for this reason the market and Federal Reserve officials have overlooked these stronger reports. A number of Federal Reserve officials gave speeches today and their comments are particularly important because they are voting members of the Federal Open Market Committee. Philadelphia Fed President Plosser was the first to speak and he supported the idea of an inflation objective which would reduce uncertainty and enhance credibility. He believed that the Fed should set 2 percent as their long term inflation objective and one of the ways to achieve this target (if needed), could be QE3. Plosser does not believe that further easing is necessary at this point but he is also the most hawkish member of the FOMC, having voted against recent policy moves. Therefore his support for an inflation target may not be a view shared by his colleagues at the Federal Reserve. Minneapolis Fed President Kocherlakota also supported the notion of increased transparency. He said the Fed should adopt a public contingency plan that would provide guidance on how they would react to different scenarios. This includes using other tools to lower interest rates such as securities purchases and extending their interest rate pledge.  The main takeaway from Plosser and Kocherlakota is that policymakers agree much more on measures to increase transparency than to increase stimulus. 

The U.S. economic calendar remains devoid of any major reports over the next 24 hours, leaving the market to focus on China. Tonight we have a Chinese data dump with inflation numbers due for release followed by industrial production and retail sales. Inflationary pressures in China are expected to ease with commodity prices falling which would be positive for risk appetite because it reduces the chance of additional tightening. However should CPI or PPI surprise to upside, it would have a negative impact on risk. The same is true for industrial production and retail sales – stronger numbers would help the commodity currencies extend their rally while weaker numbers will shave off recent gains. Chinese data is almost just as important as U.S. data these days and with no major U.S. economic reports on the calendar this week and global growth at a standstill, these reports could set the tone for trading for the next 24 hours. 

GBP: STILL MORE WEAKNESS THAN STRENGTH

The British pound continued to edge higher against the U.S. dollar and is quickly closing in on its two month high. The latest U.K. economic reports were mixed with industrial production activity stagnating in the month of September. Manufacturing production increased at a slightly faster pace but the 0.2 percent rise will hardly make a difference on GDP. According to National Institute of Economic and Social Research, the U.K. economy is expected to have grown by 0.5 percent in October, which is the same pace of growth predicted for the prior month.  Last week, the Institute predicted a 50 percent chance of the economy falling into recession but BoE Markets Director Fisher was less optimistic when he said that a contraction could occur in the current quarter. Retail sales dropped 0.6 percent in the month of October according to the British Retail Consortium. This report tends to have a fairly good correlation with the official retail sales index and for this reason, we believe that the weak economy may have been put a greater drag on consumer spending last month. The RICS house price balance slipped to -24 percent which implies that prices are falling but when taking into account the index of sales which climbed to its highest level since April 2010, the house price report wasn’t nearly as bad. Looking ahead, U.K. trade numbers are scheduled for release tomorrow morning. With manufacturing PMI falling to a 28 month low and the new orders subcomponent dropping to its lowest level since March, we have good reasons to believe that trade activity deteriorated. The Bank of England has a monetary policy meeting this week and even though we believe interest rates and the asset purchase program will remain unchanged, the sentiment in the central bank probably worsened as the European crisis and weak economic data hangs over the economy. 

CAD: BOOSTED BY BETTER ECONOMIC DATA AND HIGHER OIL PRICES

The Australian, New Zealand and Canadian dollars tacked on minor gains versus the greenback on the heels of better than expected economic data. In Canada, housing starts rose 207.6k in the month of October, which was more than economists had forecasted and less than the previous month but only after the upward revision. Although the housing market remains soft, this is a piece of good news that has gone over well with Canadian dollar investors, particularly on a day when oil prices have risen 1.5 percent. The country’s housing price index is scheduled for release tomorrow and house prices are expected to rise modestly. In Australia, business confidence was mixed and the trade surplus narrowed due to weaker imports and exports. The trade surplus fell 13 percent to A$2.56 billion as exports dropped 2.5 percent and imports fell by 1.3 percent. Weaker global, lowered oil prices and a strong currency weighed heavily on economic activity in the month of September which can explain why the Reserve Bank of Australia decided to lower interest rates at their last monetary policy meeting. Although Australian businesses grew slightly more optimistic on the prospect of an interest rate cut (the survey was taken before the rate cut), they grew more concerned about current economic activity. New Zealand credit card numbers are scheduled for release this evening followed by Australian consumer confidence. Though important, these numbers will probably take a backseat to the Chinese data dump. Weaker Chinese economic reports would erase the gains in the commodity currencies while stronger numbers would extend the rallies.

JPY: INTERVENTION WATCH

The Japanese Yen may have strengthened against all of the major currencies over the past 24 hours, but to the small relief of Japanese officials, it ended the North American session off its highs. The big story for the Yen is the fact that USD/JPY has broken its 5 day low. If USD/JPY breaks below 77.50, we could see the Bank of Japan come back into the markets to buy dollars and sell yen. The Japanese government has committed to doing all that it takes to stop the Yen from strengthening and for the past week, they have been successful. However, the jitteriness in the market has driven investors back into the arms of the low yielding Yen, which has traded higher against all of the major currencies. Fighting Yen strength has always been an uphill battle for the Japanese government but this time their firepower is a lot higher with their intervention war chest is at its largest level ever and they are ready to spend it. No major Japanese economic reports were released last night but the country’s current account and trade balances are due this evening followed by the Eco Watchers report. The country’s trade surplus is expected to rise significantly which refutes the argument that the strong Yen is placing a major drag on the economy.  The sentiment of waiters and taxi drivers in Japan is expected to improve slightly but for the most part, the Japanese are still more worried than optimistic about the outlook for their economy. 

GBP/USD: Currency in Play for Next 24 Hours

The GBP/USD will be our currency pair in play for the next 24 hours with the trade balance due for release at 4:30AM ET or 8:30 GMT. 

The latest rally in the GBP/USD has reinvigorated the currency pair’s uptrend according to our Double Bollinger Bands strategy. Unfortunately the currency pair ended the North American trading session at its key resistance level of 1.6100, the 61.8% Fibonacci retracement of its sell-off between August and October. If this level is broken, the GBP/USD still needs to contend with its 200-day SMA at 1.6140. Should the pair fail to extend its gains and trickle lower, support will be found at 1.5940, which is the 50% Fibonacci retracement of the same move and the 20-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.