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THE STORIES IN THE CURRENCY MARKET

• CONTINUED DEMAND FOR SAFETY DRIVES DOLLAR HIGHER
• EUR: GREATEST NEAR TERM RISK
• GBP: WATCH OUT FOR DOWNWARD REVISIONS TO GROWTH
• AUD: LIFTED BY RBA MINUTES
• CAD: OIL PRICES ON THE RISE
• NZD: PPI ON TAP
• JPY: BOJ TO LEAVES RATES UNCHANGED

EXPECTATIONS FOR UPCOMING FED MEETINGS

CURRENT US INTEREST RATE: 0.25%
	12/13 Meeting	01/25 Meeting
NO CHANGE	66.0%	63.4%
CUT TO 0BP	34.0%	35.3%
HIKE TO 50BP	0.0%	1.3%

CONTINUED DEMAND FOR SAFETY DRIVES DOLLAR HIGHER

Safe haven flows continue to trickle into the U.S. dollar which traded higher against all of the major currencies with exception of the Japanese Yen.   The strength of the Yen confirms that even though U.S. stocks ended the North American trading session virtually unchanged, investors are still very nervous about the outlook for Europe.   Ten year Italian bond yields are back above 7 percent and as if that was not enough of a problem, French, Spanish, Belgium and Austrian 10 year bond yields all rose to its highest levels since the introduction of the euro.   Not only does this reflect a crisis of confidence and skepticism about incoming Prime Minister Mario Monti’s ability to contain the crisis, but it also increases borrowing costs across the region.   Despite the abundance of U.S. economic data on the calendar this week, Europe remains the number one focus and the main driver of currency flows.   In this type of market environment, the only thing that matters to the U.S. dollar is risk on or risk off.   The U.S. has its own fiscal troubles and growth has been anemic at best but investors have become accustomed to the sluggish pace of recovery and they are fairly certain that there will be little acceleration in growth over the next few months.   However when it comes to Europe, no one knows exactly how bad things will get and in the euro portion of our commentary, we discuss the most pressing risk for euro.   In times of heightened uncertainty, cash is king and as the main reserve currency, being in cash means being in dollars, where liquidity is the highest.   The rise in U.S. Treasury prices and the decline in U.S. yields confirm that investors are seeking safety in the greenback.  

Wednesday’s Treasury International Capital flow report should show strong demand for U.S. dollars because in the month of September, the greenback rose 13 percent against the Franc, 9 percent against the New Zealand dollar and more than 5 percent against the euro and Australian dollar.   The greenback has recovered significantly since then but that does not draw away from the fact that lower ECB growth forecasts and the resignation of ECB member Stark drove investors into the arms of the U.S. dollar that month.    Aside from the TIC report, consumer prices and industrial production numbers are also scheduled for release.   Although the rise in the Empire State manufacturing survey points to stronger production, consumer price growth is expected to be flat due to lower gas prices.   This morning’s U.S. economic reports were better than expected, but the impact on the dollar was nominal because the upside surprises did not convince anyone that the Federal Reserve will abandon its plans to change monetary policy next month. Retail sales rose 0.5 percent in October, compared a forecast for 0.3 percent growth. Consumption of items excluding autos and gas rose 0.7 percent, more than 3 times the market's forecast. However the problem is that spending grew at a slower pace in September compared to October. This can be partially blamed on lower gas prices but with the unemployment rate at 9 percent, the lack of job growth and the overall weakness of the U.S. economy is the main reason why consumers are not spending. Unfortunately the depressing conditions in the economy will not improve anytime soon which means the outlook for consumption remains grim. With producer prices falling, the Federal Reserve still has room to ease. Based on this morning's comments from Federal Reserve officials, the idea of more stimulus is gaining traction within the central bank. For example, Fed President Evans, who is a voting member of the FOMC, called for "increasing amounts of policy accommodation" because inflation has been relatively tame and unemployment is too high. Although he admits that his view is unusual for the Fed, he feels that the central bank should be acting as if there's a very big problem. Evans supports the notion of an inflation target and believes that it should be between 2 and 3 percent – he is one of the most dovish members of the FOMC. Fed President Bullard on the other hand is not as pessimistic as Evans but he too believes that more can be done. Options include large scale asset purchases and reopening liquidity facilities if Europe's troubles worsen. He also supports the idea of changing the central bank's communication tools but he believes that tying policy to the unemployment rate could be a disaster. Bullard's views are important and in line with some other comments from U.S. policymakers, but he is not a voting member of the FOMC this year which means that he can only provide recommendations to the monetary policy committee.

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EUR: GREATEST NEAR TERM RISK

With French, Italian and Spanish bond yields spiking higher, the euro is once again under pressure.   The currency pair tested 1.35 for the second time in the past four trading days as investors worry about what comes next for the Eurozone.   Both Greece and Italy have installed new leadership and it should only be a matter of time before Greece passes its austerity measures, paving the way for the release of its next aid payment.   Unfortunately Italy and not Greece is the target of attack by investors.   No one expects Italy and Greece to implement their austerity measures tomorrow but the patience of investors is wearing thin quickly and without external support from the European Union or the European Central Bank, borrowing costs in Italy could rise even further.   The greatest near term risk for the euro and the straw that could break the euro’s back is a downgrade.   Italy, France, Belgium, Hungary and Austria are all at risk for a downgrade, but a downgrade of Italy and France would have the most significant impact on the euro.   With Italian 10 year bond yields back above 7 percent, credit default swap spreads are at levels typically in line with countries rated Ba2 or Ba3, instead of its current rating of A2.   Moody’s has already warned that the rating could be reduced to “significantly lower” levels if Italy is shut out of the bond markets.   Both Moody’s and S&P have Italy on negative watch while Fitch rates the country one notch higher.   France is also at risk of being downgraded but that would most likely happen if its EFSF commitments are increased or Italy is forced to ask for aid from its European neighbors. We suspect that European officials are once again calling each frantically to figure out a way to stabilize the financial markets.     If Italian bond yields remain above 7 percent going into the next European Central Bank meeting, another rate cut could be on its way.   In the past, the EUR/USD has had a very strong correlation with the S&P 500 but in recent weeks, the two instruments have decoupled with the euro taking its cue almost exclusively from Italian bonds.   With yields in the Eurozone imploding, we are now on downgrade watch.   The recent tensions have spooked everyone from investors to central banks and so it is no surprise to see investor confidence in Germany fall to its lowest level in 3 years. The German ZEW survey fell to -55.2 from -48.3 while the Eurozone ZEW survey slipped to -59.1 from -51.2 in the month of November. These are the lowest levels that we have seen since the global financial crisis and indicate that investors care little about the stronger GDP growth reported in the third quarter.   The Eurozone economy may have outperformed other countries in the past but it could realistically fall back into recession in the coming year.   For the time being, ECB officials still refuse to be the lender of last resort according to ECB member Mersch who joins a long list of policymakers sharing the same views.   As a result, the path of least resistance for the euro remains lower.   

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GBP: WATCH OUT FOR DOWNWARD REVISIONS TO GROWTH

The British pound weakened against the U.S. dollar but strengthened against the euro on the heels of dovish comments from policymakers and the prospect of sharp downward revisions to GDP.   Bank of England Governor Mervyn King said that uncertainty about the global economy has increased and that inflation undershoot is more likely.   Also, King noted spare capacity in the U.K. economy may lead to faster inflation slowing.   Chancellor Osborne has said the threat to the U.K. from the Eurozone crisis is “very serious.”   He also noted that monetary policy plays a key role in support the U.K. economy and that the extent of the CPI drop is uncertain at this point.   Inflation is a big focus because it remains at excessively high levels, forcing policymakers to justify monetary easing every opportunity they can. Data today showed inflation last month easing more than expected on a headline basis.   CPI rose 0.1 percent in October, pushing the annualized pace of consumer price growth down to 5.0 from 5.2 percent.   Core price growth on the other hand increased which is problematic for the central bank if they want to ease monetary policy even further.   With the economy under pressure from the government’s budget squeeze and Europe’s sovereign debt turmoil, King will face questions at a press conference tomorrow on the central bank’s use of quantitative easing to prevent another recession.   King will be presenting the Bank of England’s Inflation Report including new economic projections.   Growth forecasts are expected to be revised down significantly. Meanwhile the house price index decreased 1.4 percent over the year and decreased by 0.7 percent over the month in September.   Tomorrow is a busy day for economic releases with labor market numbers scheduled for release along with the central bank’s Quarterly Inflation Report.   

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AUD: LIFTED BY RBA MINUTES

Although the Canadian, Australian, and New Zealand dollars all traded lower against the greenback, the NZD sold off the most while the AUD’s losses were nominal.   The Reserve Bank of Australia released the minutes from its monetary policy meeting on November 1 ^st and the minutes noted that there was a case for keeping interest rates unchanged, yet global economic risks and slowing inflation sealed the argument for a “modest” easing.   The RBA’s first rate cut in 31 months reflects lower forecast growth and inflation over the next two years as Europe’s sovereign-debt crisis dims prospects for the global economy.   Traders see an 84 percent chance RBA Governor Stevens will lower borrowing costs by another quarter of a percentage point in December, down from 100 percent prior to the release of the minutes.   The total number of motor vehicle sales in Australia was up 1.1 percent on the month in October.   Tonight the leading index and wage price index are scheduled for release from Australia.   Bank of Canada Governor Mark Carney said that North American banks may slow domestic lending as they use some of their cash to buy assets from European financial companies dealing with the region’s debt crisis.   He also noted that Canadian banks are so strong they can do both – lend domestically and buy European assets.   He also said the direct impact of any European slowdown on Canada may be “relatively modest” because there are fewer direct trade links than with the United States.   Commodity prices have risen to a seven-week high, but recently experienced a sell-off as Italian yields surged.   Manufacturing sales rose 2.6 percent in September - the third consecutive monthly increase.   The gain in September largely reflected higher sales in the petroleum and coal products and transportation equipment industries.   Also, the number of new motor vehicle sold in September increased 1.5 percent.   Higher sales of trucks more than offset a decline in passenger car sales.   New Zealand’s dollar fell as well today as investors sought safer assets.   There was no new economic data released today, but producers input and output prices for the third quarter are due for release Wednesday evening.

 

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JPY: BOJ TO LEAVES RATES UNCHANGED

The Japanese yen strengthened against all the major currencies today as Italian borrowing costs reviving concern Europe’s debt crisis is spreading, damping investor confidence for riskier assets.   Japanese companies, Thailand’s biggest foreign investors, may spend more to build factories in neighbors including Indonesia and Vietnam after the worst flooding in 70 years disrupted global production.   The recent trend of accelerating investment into Thailand will cool despite the fact that Thailand is such an ideal destination.   The floods have rippled through the supply chains of Japanese auto and electronics makers, as parts shortages affected operations across the globe.   The Bank of Japan will announce its overnight call rate later today and release a monetary policy statement with it.   Expectations are for the central bank to leave the interest rate unchanged at less than 0.10 percent.   There have been two very welcome pieces of news on Japan’s economy the past few days.   First was the announcement over the weekend that Prime Minister Yoshihiko Noda had defeated opposition from Japan’s agricultural lobby and agreed to join the Trans-Pacific Partnership.   This trade accord offers the hope that Japan is serious about becoming more competitive and letting market forces shake things up.   The other piece of good news was the report yesterday that Japan’s economy grew for the first time in four quarters, aided by exports.   So it seems a little counterintuitive that Japan keeps trying to weaken the yen in a vain attempt to aid its exports industries.   Analysts estimate that the Bank of Japan sold about 8 trillion yen ($102 billion) at the end of last month, sending the currency down as much as 4.7 percent before it rose again.   For exporters struggling with the shaky global demand, turbulent markets and factory shutdowns from recent natural disasters, it was welcome, albeit brief, relief.   

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GBP/USD: Currency in Play for Next 24 Hours

Our currency pair in play for the next 24 hours is GBP/USD.   We expect jobless numbers and the unemployment rate for the U.K. for the months of September and October to be released at 4:30 AM ET / 9:30 GMT.   The Bank of England will release its Inflation Report at 5:30 AM ET / 10:30 GMT.   From the United States, we expect the October consumer price index, at 8:30 AM ET / 13:30 GMT.   U.S. long-term and net TIC flows for September are scheduled for release at 9:00 AM ET / 14:00 GMT.   Lastly from the U.S. is Industrial production and capacity utilization for October and the NAHB housing market index for November at 9:15 AM ET / 14:15 GMT and 10:00 AM ET / 15:00 GMT, respectively.

 

GBP/USD has been range-bound over the past few days but is now trading in a down trend, which we determined with Double Bollinger bands.   Nearest support is at 1.5795, where today’s low and the 50-day simple moving average lie.   Should the pair continue to drop, significant support will be found at 1.5720, at the 50% Fib level when drawn from the low on October 6 ^th to the high on October 31 ^st .   Looking up, nearest resistance is at 1.6000, which is psychologically significant, the price of the 100-day SMA, and where the 50% Fib lies when drawn from the high on May 28 ^th to the low on October 6 ^th .   Second resistance is at 1.6080 where the upper first standard deviation Bollinger band can be found.  

 

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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.