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FX: Fitch Warning, Time for ECB to Print Money?

Last updated 11/16/2011 4:26 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: TIME FOR THE ECB TO PRINT MONEY?
• USD: RISE IN OIL IS BAD NEWS, MORE DATA AHEAD
• GBP: WEAKER DATA AHEAD?
• CAD: OIL ABOVE $100
• AUD: SENTIMENT DETERIORATES
• NZD: HIT BY RISK AVERSION
• JPY: CUTS ECONOMIC ASSESSMENT, WARNS OF MORE STIMULUS

EXPECTATIONS FOR UPCOMING FED MEETINGS

EUR: TIME FOR THE ECB TO PRINT MONEY?

The euro ended the North American trading session lower against the U.S. dollar as stocks tanked on the back of rating agency Fitch’s warning that the Eurozone crisis could threaten the credit outlook for U.S. banks.   If Europe crumbles it will take the world down with it and based upon recent comments from central bank officials, they are just as worried about the fallout from Europe’s debt crisis as rating agencies and investors.   The warning from Fitch should catch no one by surprise because even though U.S. banks do not hold large amounts of Italian, Spanish, Austrian, Belgium and Greek debt, they have written a significant amount of insurance on a large number of these loans and should a credit event occur (either partially or completely), the losses and consequences for the banks would be severe.   For most of the North American trading session, the EUR/USD held steady but with the risk of slower growth, more fiscal trouble and greater uncertainty in the region, any rallies that we saw in the pair was caused by nothing more than short covering.   The EUR/USD has been taking its cue from Italian bond yields which came off their highs – unfortunately when BTPs open for trading tomorrow morning, yields could spike higher once again on the back of the Fitch announcement.   The European Central Bank has been buying European bonds aggressively and without their support, 10 year Italian bond yields could have pushed to a new record high above 7 percent, taking French and Spanish bond yields up with it.   The ECB obviously wants to prevent the situation from worsening because aside from the volatility that it would create in the equity, bond and currency markets, it also makes debt servicing costs too arduous for these countries to hand, putting them at risk of a downgrade.   Another reason for the euro’s stability is speculation of easier monetary policy in China.   Although this would help to support growth domestically and externally, the only reason why China would loosen policy is because they have also become worried about the outlook for the global economy. Buying bonds have kept a lid on yields in Europe but the sheer number of investors willing to take on the ECB means has made the impact of their purchases will be short-lived.   The ECB is spending billions of dollars and yet we could easily turn on our quote screens tomorrow and see the EUR/USD at a fresh 5 week low.   In our morning note, we talked about how the European Central Bank refuses to be the lender of last resort and yet they have been acting like the buyer of last resort.   The main difference between what they have been doing and what the market desperately wants them to do is sterilization.   Currently, the ECB buys European government bonds and sterilizes their purchases by issuing seven day deposits equal to the amount of bonds purchased. In this way, they do not need to print euros and they can prevent inflation from rising.   However the impact of their bond purchases has been limited and if they were to disappear from the market completely, Italian bond yields could spike to 8 or 9 percent, forcing the country to ask for aid and prompting downgrades by rating agencies.   In order to cap yields permanently, the ECB needs to create money and the selloff in the euro suggests that some traders are making this bet.   Meanwhile it is also worth mentioning that Mario Monti has been officially sworn in as Prime Minister of Italy and the interim Greek government led by Papademous has won a crucial vote of confidence that will allow them to start putting their fiscal houses in order.   Of course this means more budget cuts which does not bode well for growth but that’s what investors are asking for which is why we expect more pain than gains in the euro over the next few months.   

USD: RISE IN OIL IS BAD NEWS, MORE DATA AHEAD

The U.S. dollar ended the North American trading session higher than most of the major currencies and the strength of the greenback confirms that the market is still in risk off mode.   It has been another day filled with U.S. economic reports but once again, the data only had a nominal impact on the greenback because small changes in the U.S. economy matters little in a world focused on the uncertainties in Europe and the rise in oil prices. The price of crude rose above $100 a barrel to a 5 month following news that the direction of oil flow in the Seaway pipeline will be reversed.  Higher oil prices do not help the global growth story even if recent inflation indicators have shown price pressures easing.   It will put more pressure on growth and raise the risk of recession in many parts of the world.   In the U.S, consumer prices fell 0.1 percent, pushing down the annualized pace of price growth to 3.5 from 3.9 percent. Not only was this weaker than economists had anticipated, but it is also the softest CPI reading in 6 months. Excluding food and energy costs, prices increased 0.1 percent showing that much of the decline in overall inflationary pressures was caused by lower gas prices.   Meanwhile the latest industrial production report provides further evidence that the manufacturing sector could be leading the recovery.   Manufacturing activity rose 0.7 percent in October, a pace of growth that was much stronger than the previous month.    More importantly however, the Treasury reported big demand for dollar denominated assets in September.   Foreign investors bought $84.5 billion Treasury notes and bills, up from $60.1 billion in August.   Demand for long term assets also increased by $68.6 billion from $58.0 billion – there was a good mix between official and private demand with China, Japan and U.K. increasing their holdings.   The Treasury’s report confirms that demand for safety drove the greenback higher in September and even though the dollar has given up part of its gains since then, we expect demand to remain robust.   Housing starts, building permits, jobless claims and the Philadelphia Fed survey are scheduled for release tomorrow.   A pullback is expected in housing starts but building permits should rebound.   Based upon the Empire State and industrial production numbers, manufacturing activity is on the rise and we expect to see similar strength in the Philly Fed report.  @import url(/css/cuteeditor.css);

GBP: WEAKER DATA AHEAD?

The British pound weakened against both the U.S. dollar and the euro.  U.K. unemployment jumped in the third quarter as the number of young people looking for work climbed above 1 million for the first time in at least 19 years.  Unemployment rose by 129,000 this quarter to 2.62 million, the most since 1994 while the jobless rate climbed to a 15-year high of 8.3 percent.  Only a monthly basis, the report was slightly better with only a 5.3k increase in claimants compared to a forecast of 21.0k.   Nonetheless, the figures add pressure on Prime Minister David Cameron to do more to boost an economy at risk of sliding back into recession as Europe’s escalating debt crisis devastates financial markets.  The Bank of England cut its growth and inflation forecasts significantly today, saying output is likely to remain flat until the middle of 2012.  BOE Governor Mervyn King said Britain faces a “markedly weaker” outlook for economic growth and persistent danger from Europe’s debt crisis, as policy makers signaled they may need to expand stimulus further.  Growth over the next few quarters is likely to be weaker and may be “broadly flat” in the first half of 2012, King told reporters as he presented the Quarterly Inflation Report.  He also noted there is no meaningful way to quantify the worst case scenarios associated with the Eurozone.  The Bank of England is in the second month of a program of bond purchases aimed at shielding the U.K. economy from the fallout from the euro region’s sovereign debt crisis. Policy makers said today that failure by European officials to resolve the turmoil could lead to “significant adverse effects” on the global economy.  Later tonight, nationwide consumer confidence will be released from the U.K. followed by retail sales on Thursday.  Confidence is expected to tick up slight to 46 from 45 in September while consumer spending is expected to decline.   The British Retail Consortium which conducts a similar survey as the Office of National Statistics, found spending contracting significantly in October.   As a result, the door is wide open for additional stimulus.

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CAD: OIL ABOVE $100

The Canadian, Australian and New Zealand dollars all weakened against the greenback. Australia’s leading index fell 0.3 percent in September following a revised 0.7 increase in August.  Australians are starting to become more pessimistic about economic growth as the European debt crisis worsens.  The quarterly wage price index printed lower than expected at 0.7 percent versus 0.9 percent.  The September quarter marks the third quarter in a row that the rise through the year for the Public sector was below that of the Private sector.  The Reserve Bank of Australia set an annual fee of 15 basis points for financial firms to access standby funds as the nation moves to adopt global liquidity rules aimed at averting a repeat of the credit crisis.  The secured facilities at the RBA will cover gaps between lenders’ liquid assets and global regulators’ requirements.  RBA Governor Stevens should elaborate on this point later tonight in his speech.  Cotton output in Australia, set to be the world’s third-largest shipper, may surge as much as 25 percent to an all-time high after floods boosted water supplies and spurred record plantings.  Increased production in Australia will add to global supplies, pressuring prices that have tumbled 55 percent from a record in March.  The Canadian dollar dollar received a boost as signs of a U.S. economic recovery buoyed confidence that Canadian exports will benefit from increasing demand in their biggest market.  The loonie also erased its losses as crude oil rallied above $100 a barrel.  Foreign security purchases will be released from Canada tomorrow morning.  Investors may have sought more Canadian investments this month as Canada is more insulated from the European sovereign debt crisis.  The New Zealand dollar also sold off as fears of the spread of the Eurozone crisis loomed.  However, the kiwi may slide further as quarterly input and output PPI numbers are expected to have moderated over the past three months. 

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JPY: CUTS ECONOMIC ASSESSMENT, WARNS OF MORE STIMULUS

The Japanese yen against strengthened against all the major currencies with the exception of the euro.  The Bank of Japan cut its economic assessment as Governor Masaaki Shirakawa called the European debt crisis the biggest danger for the nation’s export-led recovery.  The BOJ left its asset-buying fund unchanged at 20 trillion yen ($260 billion).  A few board members have become more concerned the economy’s outlook has worsened since October, he said.  The BOJ may bolster stimulus again if the yen resumes its gains after climbing to postwar highs against the U.S. dollar.  Given the gap in the board’s views, the BOJ probably sees about a 50 percent chance they will need to provide monetary stimulus in December.  At this meeting, the BOJ held the interest rate between zero and 0.1 percent and left unchanged at 35 trillion yen fixed-rate lending program to encourage banks to extend loans in a unanimous decision.  Japan’s economic activity has continued to pick up, albeit at a more moderate pace.  The central bank downgraded its growth evaluation from last month, noting the economy will experience an adverse effect from the slowdown in overseas economies and the appreciation of the yen as well as from the flooding in Thailand.  Japan is the world’s largest corn importer and made its biggest purchase of European grain in at least a decade, seeking a cheaper alternative to U.S. supply.  Japan, which sourced almost 90 percent of its corn last year from the U.S., the biggest exporter, is seeking different options after a drought hurt the U.S. crop, driving annual prices to an all-time high and curbing global food supplies.  Korean companies are set to maintain record bond sales on demand from Japan.  Overseas investors, led by Japan, increased holdings of Korean bonds by 91 percent in the first 10 months as Europe’s debt crisis and the credit downgrade of the U.S. made Korea’s debt more attractive.  The Bank of Japan will release its monthly economic report tomorrow morning.

GBP/USD: Currency in Play for Next 24 Hours

Our currency pair in play for the next 24 hours is GBP/USD.   Economic data we expect from the U.K. is October retail sales at 4:30 AM ET / 9:30 GMT.   From the United States, we expect October building permits and housing starts as well as jobless numbers at 8:30 AM ET / 13:30 GMT.   Also scheduled for release from the U.S. is the November Phildelphia Fed. Index at 10:30 AM ET / 15:30 GMT.

GBP/USD continued to slide since yesterday and is still trading in a down trend, which we determined with Double Bollinger bands.   Nearest support is at 1.5720, the 50% Fib retracement when drawn from the low on October 6 ^th to the high on October 31 ^st .    Should the pair continue to fall, significant support will be found at 1.5610, where the 61.8% Fib lies.   To the upside, nearest resistance is at 1.5875, where the lower first Bollinger band lies.   Above that, heavy resistance will be found at 1.6010 where the 100-day SMA and 50% Fib, when drawn from the high on May 28 ^th to the low on October 6 ^th , converge.

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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.