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USD: Bernanke Preps Market For Policy Change

Last updated 11/10/2011 4:31 PM ET (GMT -5) 1 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• USD: BERNANKE PREPS MARKET FOR POLICY CHANGE
• EUR: VICTIM OF THE HEADLINES
• GBP: BOE LEAVES MONETARY POLICY UNCHANGED
• CAD: TRADE BALANCE RETURNS TO SURPLUS
• AUD: EMPLOYMENT DATA IN LINE
• NZD: SHARP DETERIORATION IN CONSUMER SENTIMENT
• JPY: MACHINERY ORDERS SHOW MORE WEAKNESS

EXPECTATIONS FOR UPCOMING FED MEETINGS

USD: BERNANKE PREPS MARKET FOR POLICY CHANGE

Today has been a day of recovery in the financial markets. Currencies and equities rebounded while bond yields in Italy retreated, providing some relief to a market that could have easily gone into panic mode if Italian bond yields continued to rise. Thankfully Italy was able to attract enough buyers for today’s bond auction, showing that investors have not abandoned the country completely. The yield that they demand to hold Italian debt was almost two times more than last month, but what is important is they are still willing to bear the risk given the right compensation. Better than expected economic data out of the U.S. also contributed to the improvement in risk appetite but what we found key about today’s developments were the comments from Bernanke. The Fed Chairman appears to be laying the groundwork for changes to monetary policy. We have been hearing a pretty consistent message from Federal Reserve officials which is that they are warming to the idea of an inflation or unemployment target.  With the unemployment rate remaining at a “painfully high” level, the Fed is “focusing intently on supporting job growth” according to Bernanke. He then went on to say that the central bank has the latitude to set an inflation target, a notion that seems to be gaining support within the central bank by the day. Everyone agrees that the U.S. will not escape the turmoil in Europe and the volatility that it creates in the financial markets only adds further strain to the U.S. economy. At this point, there is an extremely good chance that the central bank will introduce an inflation and/or unemployment target in the coming month.

Meanwhile jobless claims rose 390k while the trade balance narrowed to -$43.1 billion.   As long as jobless claims are less than 400k, the labor market is moving in the right direction and returning to its pre-crisis levels.   Unfortunately claims have had a weak correlation with payrolls and for this reason, the Federal Reserve will take the improvement in jobless claims with a grain of salt because fewer firings has not equated to more hiring.   The smaller deficit on the other hand was a breath of fresh air because the rise from -$46.0 billion to -$43.1 billion was caused by a surge in exports, which reached record levels.   Based upon these economic reports, the pressure on the Fed to ease has declined but the crisis in Europe poses a far greater risk on the U.S. economy and for this reason, the central bank is still ready to ease and not tighten monetary policy.   Import prices also fell 0.6 percent, giving the central bank a bit more flexibility to increase stimulus, if needed.   The U.S. bond market is closed for Veteran’s Day tomorrow but the equity and currency markets are open.   The only piece of U.S. economic data on the calendar tomorrow is the University of Michigan Consumer Sentiment survey - confidence is expected to improve slightly in the month of November.

EUR: VICTIM OF THE HEADLINES

It is extremely difficult for central bankers let alone investors to get their hands around the European debt crisis and the challenge is made no easier by the confusion caused from rumors and erroneous announcements. During the early European trading session, the EUR/USD received a lift from a decent Italian bond auction (considering the circumstances) and talk of a noontime announcement by the ECB.  Unfortunately noontime has come and past with not a peep from the central bank. The most powerful way for the central bank to respond to the crisis would be to print money but they are forbidden to do so by the European Treaty. Other options for Europe include an inter-meeting ECB rate cut or more firepower for the IMF but these two options may not be aggressive enough to put an end to the crisis. With the need to elicit support from 17 separate countries, any decision that the Eurozone makes will not be easy. In fact, there has been so much internal strife not between Eurozone nations and members of the central bank that policymakers are deserting. ECB member Bini Smaghi became the latest central bank official to announce his resignation. He will be stepping down from the ECB’s executive board at the end of the year (well before his term ends in 2013) and his departure will be a major loss for the central bank. Having compared default to the death penalty, Bini Smaghi was one of the central bank’s strongest advocates for preventing Greece from default. He is the fourth member of the ECB board to leave this year but his resignation could be political as much as personal because he has been under pressure to step down since Mario Draghi became the head of the ECB to pave the way for a Frenchman to return to the central bank. The EUR/USD was also sent on an intraday rollercoaster ride by Standard & Poor’s who sent out an erroneous message suggesting that France could lose its AAA rating. They corrected this error approximately 2 hours later but that did not stop French bond yields from soaring.  If France were to lose its AAA rating, it would affect the flawless rating of the European Financial Stability Facility which could in turn reduce the lending capacity of the fund. It not unrealistic for France to be downgraded if the EFSF is increased further, requiring more commitment from France to insure against losses of the Eurozone nations. Moody’s is already in the process of assessing its “stable” outlook on the country’s debt with an announcement set to be made as early as December. Meanwhile former ECB Vice President Papademos has been appointed the new leader of the Greek coalition government. This is good news because he comes with deep financial market experience and could help the country approve and implement the budget measures outlined in the EU debt deal quickly. Although there are no major Eurozone economic reports on the calendar tomorrow, it is the macro and not micro stories that matter to the euro.

GBP: BOE LEAVES MONETARY POLICY UNCHANGED

As expected, the Bank of England left monetary policy unchanged this morning which leaves interest rates at 0.5 percent and the asset purchase target at GBP 275 billion. Having just raised their asset purchase program last month, the chance of the Bank of England taking additional action today was slim. However with that in mind, the central bank may still need to ease monetary policy if the European crisis is not resolved anytime soon and if borrowing costs in Italy continue to rise. The latest economic reports suggest that the economy may have contracted last quarter and unless demand picks up this quarter, the central bank may choose to give everyone an early holiday present by raising stimulus even further in December. Typically, we won’t know how close central bank officials are to changing monetary policy until the minutes from the Bank of England meeting are released 2 weeks later but next Wednesday we have the Quarterly Inflation Report. This report plays a big role in the central bank’s monetary policy decisions. Aside from providing greater insight into their outlook for the economy and monetary policy, the central bank could also officially lower its growth projections which would be bearish for the pound. The European Commission cut its 2011 growth forecasts for the U.K. from 1.1 to 0.7 percent today. They warned that the ongoing strains in the banking center and the risks posed by the Eurozone sovereign debt crisis could push U.K. growth into negative territory in “at least one of the next few quarters.”   We expect the central bank to share the EC’s grim assessment of their economy which would reinforce their belief that even though inflation is above 5 percent right now, it will fall sharply in the coming months.

CAD: TRADE BALANCE RETURNS TO SURPLUS

Despite the rebound in equities, it has been a mixed day for the commodity currencies. The Canadian dollar strengthened following reports that the country’s trade deficit returned to surplus for the first time in 8 months. Thanks to a 4.2 percent rise in exports and a 0.3 percent decline in imports, Canada reported a trade surplus of C$1.246 billion in September versus a deficit of C$0.49 billion the previous month. Although the Canadian dollar benefitted significantly from the stronger economic report that refutes other weakness that we have seen in the Canadian economy, it is worth mentioning that the main factor behind the increase was prices as the cost of energy products rose 8.0 percent. Volumes still increased by 0.3 percent which is a small bump up but nonetheless a move in the right direction. Australian economic data was in line with expectations with 10k more people finding new work in the month of October. This drove the unemployment rate down from an upwardly revised 5.3 to 5.2 percent and kept the Australian dollar from further losses. The only reason why Australian businesses added fewer jobs in October compared to September was because part time jobs declined. If we look at full time jobs alone, they actually increased by 20.0k compared to a total employment change of 10.1k. This is good news for the Reserve Bank of Australia but was apparently not enough to stop them from lowering interest rates earlier this month. Part of the reason for the decision to ease was inflation and according to the latest consumer inflation expectations report, prices are expected to rise by only 2.5 percent compared to a prior reading of 3.1 percent. In New Zealand, consumer confidence tumbled significantly in the month of November which explains the underperformance of the New Zealand dollar, the only commodity currency that extended its losses today. The fear is that if confidence has weakened, the RBNZ may have grown more reluctant to normalize monetary policy.

JPY: MACHINERY ORDERS SHOW MORE WEAKNESS

In a mixed trading day, the Japanese yen lost ground to the euro, Canadian dollar, and Swiss franc while strengthening against the rest of the majors. The previous promise made by the Japanese administration stopped short of a SNB-like move in pegging the yen to the dollar. While the Prime Minister Yoshihiko Noda’s government was able to fend off speculators, the looming European debt concern has sustained yen’s appreciation. According to a report by a credit research firm, Japan’s publicly traded companies lost a total of 301 billion yen ($3.9 billion) due to the currency’s advance. As exporters suffered sliming margins and losses, the increasing outflows of investments showed the hollowing out of industries. Furthermore, Akio Toyoda, the president of Toyota warned of a potential collapse of the automobile industry. A key gauge of Japan’s corporate capital spending declined more than expected in September. The core machinery orders fell by 8.2 percent, reflecting the grave concerns that the Japanese manufacturers have. In a further sign of unease about the economic outlook, the consumer confidence index remained unchanged in October, with the pace of improvement moderating. Meanwhile, the lower house of parliament approved a 12.1 trillion yen reconstruction package to rebuild from the March disaster, on top of two packages worth a total of 6 trillion yen already pledged. Although the global demands have been on the decline, the rebuilding effort could expand domestic demands once kicked in. Looking forward, the Tertiary Industry Activity data is expected to fall due to the uncertainty in the global market and yen’s strength.

GBP/USD: Currency in Play for Next 24 Hours

GBP/USD will be our currency pair in play for the next 24 hours with the U.K. Producer Price Index scheduled for release at 4:30AM ET / 9:30 GMT. From the U.S., we expect U. of Michigan Confidence Index at 9:55AM ET / 14:55 GMT.

Despite the volatility in GBP/USD today, the pair has managed to stay within the range-trading zone which we determined using the Bollinger Bands. The nearest resistance level is at 1.5946, the convergence of 20-day SMA and 50% Fibonacci level. We drew our Fibonacci retracement from the swing high in August to the low in October. Further up, the 200-day SMA could contain the pair’s rally at 1.6137. On the downside, the psychologically significant 1.58 handle and the 50-day SMA could provide support. A break below that level, we could see GBP/USD targeting the second std. dev. Bollinger Band at 1.5702.

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Comments (1)

Darkdoji

November 11, 2011 at 05:23 AM ET

Whatever happened to the ecofin ministers meeting on the EFSF? A ticking time bomb don't you think? It seems to me fund managers soaking up Italian bonds at this time are being plain greedy thinking about the yields (and their bonuses) and not the consequences for their stake holders. Would you put your money in Italy at this time? I would not,

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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.