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EUR: Path of Least Resistance is Still Lower

Last updated 11/17/2011 4:56 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: PATH OF LEAST RESISTANCE STILL LOWER
• USD: BETTER DATA HAS NOT REDUCED PRESSURE ON FED
• GBP: SUPPORTED BY STRONG RETAIL SALES
• CAD: STRONG FOREIGN DEMAND, WAITING FOR CPI DATA
• AUD: FALLS BELOW PARITY TO 1 MONTH LOW
• NZD: COULD RBNZ ABANDON RATE HIKE PLANS?
• JPY: BENEFITS FROM SAFE HAVE FLOWS

EXPECTATIONS FOR UPCOMING FED MEETINGS

EUR: PATH OF LEAST RESISTANCE STILL LOWER

@import url(/css/cuteeditor.css); The euro may have ended the North American session unchanged against the U.S. dollar but the path of least resistance in the currency pair is still lower.   Since Italian bond yields spiked above 7 percent, investors around the world have been wondering if there is a way out of this mess.  The answer is yes but it won’t be quick or easy.  There are 3 main options being floated around by policymakers and economists – issue Eurobonds, get the ECB to print money to monetize debt and put a cap on Italian bond yields.  The first two are beyond the current constraints of the EU Treaty and ECB mandate, leaving only the third as a more realistic option.  However, unlike other central banks that can effectively cap yields by printing money to buy more bonds, the money in the ECB’s pocketbooks are limited.  Also, with 17 countries needing to approve most decisions, we don’t expect any major announcements to be made before the Eurozone Finance Ministers meeting scheduled for the week after Thanksgiving.  In fact, we may even have to wait until the December 9 ^th EU Leaders meeting for any major offer of support.  What this means is that between now and then, the euro could suffer further losses as investors wonder if and when European officials will step with more support.  As we mentioned in yesterday’s note, the greatest risk for the euro right now is a downgrade by rating agencies.  If European yields continue to rise, Standard & Poor’s, Fitch or Moody’s could slash the credit rating of countries like Italy, Spain, Belgium, Austria and possibly even France. This morning's Spanish and French bond auctions were an important test of investor confidence and the results show that even though investors are comfortable holding French bonds, they need to be compensated significantly to be willing to own Spanish debt. The yield paid on Spanish 10 year bonds was 6.97 percent, which is dangerously close to the 7 percent mark, significantly higher than the 5.43 percent paid last month and a record for Spanish bonds since the introduction of the euro. France on the other hand only paid 2.8 percent to sell bonds, up marginally from the 2.3 percent paid in October. With the spread between Italian and Spanish bonds narrowing rapidly, bond vigilantes are beginning their attack on Spain, and if yields continue to rise, it won't be long before the third and fourth largest economies in the Eurozone go knocking on the doors of Germany and France. The rapid rise in Spanish bond yields means that a downgrade of Spain's credit rating is one of the greatest risks for the euro right now. All 3 of the main rating agencies rate Spain one to two notches higher than Italy and if anyone of them decide to slash the country's debt rating, the euro could slip back towards its October lows. With no clear plan of action from European authorities, the relief rally looks tenuous at best. According to German Chancellor Merkel, a Treaty Change is their best option right now. She will be pressing for a change at the December 9th EU leaders summit and the goal would be to allow for the issuance of euro bonds. Merkel doesn't want the ECB to step in to solve the region's fiscal problems but the issuance of eurobonds or unsterilized bond purchases by the central bank (quasi quantitative easing) are among the very few choices Europe as right now to stabilize the bond market and stem the slide in the euro. The EFSF also needs to be given more firepower but as we have seen with the most recent increase, political roadblocks make this option a major challenge

USD: BETTER DATA HAS NOT REDUCED PRESSURE ON FED

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Even though European currencies consolidated today, a quick look at the performance of U.S. equities and the strength of the dollar against the commodity currencies tell us that investors remain nervous about the outlook for the global economy.  The rise in the price of U.S. Treasuries further confirms that investors continue to seek safety in the greenback and the Japanese Yen.   The concern of Federal Reserve officials also doesn’t help because if central bankers are worried, investors should be as well.  According to Fed President Dudley, who is a voting member of the FOMC, the economy is facing several obstacles and next year could feel very much like the second half of 2011 which is stagnant growth with a bent towards weakness.   He also pointed out that there is a vigorous debate going on within the Fed over the need for more stimulus and one of the ways to boost the economy would be to increase bond purchases.  As one of the most dovish members of the central bank, Dudley’s call for stimulus is not surprising and most likely, it is a view shared by many officials within the central bank.   Earlier this morning, Fed President Bullard appeared on CNBC and he sounded far less dovish than some of its counterparts (Dudley included) but as a non-voting member of the central bank, his opposition to tying policy to the jobless rate and his view that the recession risk has passed will only have a limited impact on Fed policy.  Since the last central bank meeting, there have been more signs of improvement than deterioration in economic data but the uncertainty and tensions in Europe have increased and for this reason, we believe the central bank has grown more and not less willing to change monetary policy.  This morning’s U.S. economic reports were better than expected with building permits rising 10.9 percent in the month of October and housing starts falling only 0.3 percent. As a leading indicator of housing market activity, it is very encouraging to see permits increase by the largest amount since December because it means that the confidence of builders have improved enough for them to apply for new projects. Starts were expected to drop by 7.3 percent but after a downward revision to the September numbers, the decline was more nominal. The labor market also continued to improve with jobless claims rising by the smallest amount in 7 months. This is great news for the labor market because eventually the decline in firings should translate into more hiring.  Meanwhile the Philly Fed index declined from 8.7 to 3.6 which is disappointing but with the details of the report showing more optimism about manufacturing activity six months forward as well as an increase in employment, the report only had a nominal impact on the greenback.  Fed Presidents Dudley and Fisher will be speaking again tomorrow and as a voting member of the FOMC, Fisher’s comments will be important to watch. 

GBP: SUPPORTED BY STRONG RETAIL SALES

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The British pound strengthened against the euro and U.S. dollar but the gains were modest at best.  The resilience of the British pound stems primarily from this morning’s better than expected retail sales report.  Consumer spending rose 0.6 percent in the month of October.  Originally, economists and investors had expected spending to decline due to weaker consumer confidence, tensions in the financial markets and higher unemployment.   However according to the Office of National Statistics widespread discounting by retailers attracted consumers to the stores.  Pre-Christmas Sales and price-matching promotions by supermarket chains drove food sales up 0.6 percent.  Demand for computers, telecoms, sporting goods and toys also rose strongly which is a relief for the Bank of England who could really use some good news at this time.   Unfortunately it remains to be seen whether this strong appetite for spending will last. Consumer sentiment dropped to a record low in the month of October according to Nationwide.  It may be difficult for consumers to keep up their spending habits if they feel so pessimistic about the outlook for the U.K. economy.  Bank of England Governor King shares their frustration and concerns about the danger posed by Europe’s debt crisis.  No U.K. economic reports are scheduled for release tomorrow, which means that the pound should return to taking its cue from the market’s risk appetite. 

CAD: STRONG FOREIGN DEMAND, WAITING FOR CPI DATA

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The selloff in U.S. stocks and the decline in commodity prices drove the Canadian, Australian and New Zealand dollars lower.  The NZD/USD fell the most, extending a sell-off that has gone on for the past four trading days and its underperformance can be traced back to the recent deterioration in economic data.  Not only has service sector activity slowed and consumer confidence deteriorated, but producer prices also eased in the third quarter.  Back in October, when the Reserve Bank of New Zealand last met, they talked about raising interest rates and we are certain that given the recent deterioration in economic data, their commitment to raising rates have waned.  The prospect of dovish comments from the RBNZ could drive the NZD/USD even lower.  From Australia average weekly wages was the only report on the calendar and despite the slowdown in wage growth, the annualized pace of average weekly wages accelerated to 5.3 from 4.4 percent.  Nonetheless risk aversion drove the Australian dollar back below parity for the first time in more than a month.  Of the three commodity currencies, the Canadian dollar dropped the least.  Foreign demand for Canadian dollar denominated assets rose 7.35B in the month of September, which was much stronger than forecast.  Considering that the loonie weakened significantly that month (USD/CAD rose from 0.98 to 1.05), the strong demand for the CAD implies that some investors sought safety in the Canadian currency.  Compared to some other countries around the world, Canada is not immune but more insulated from Europe and for this reason the sell-off in the CAD has been more moderate. Canadian consumer prices are scheduled for release tomorrow and inflationary pressures may have risen based upon the increase in the price component of IVEY PMI. 

JPY: BENEFITS FROM SAFE HAVE FLOWS

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The Japanese yen edged higher against most of the major currencies. As the Japanese officials kept the market on alert for further intervention, investors remain wary of trading back into the yen. Since the latest intervention by the Japanese officials on October 31 ^st , some market participants have speculated that the Bank of Japan was targeting a specific USD/JPY level. With the extended appreciation in yen, the damaging effects have been trickling down to the Japanese exporters. BoJ heeded a subdued pace of recovery in the country’s exports and industrial production. The slowing global economy, the persistent strength of yen and the recent flooding in Thailand could pose more downside risks to the country’s manufacturing sectors. “Japan’s economy activity has continued picking up, but at a more moderate pace mainly due to effects of a slowdown in overseas economies,” the BoJ said in its November report. This downward revision was the first time in five months since BoJ lowered its outlook in the wake of the March earthquake and tsunami. The rebound in demand could be led by “emerging and commodity-exporting economies.” In addition, the gradual increase in reconstruction-related demand could lend more support to the domestic economy. With no economic release on the docket, the trading in yen could hinge on the risk appetite and the news flow coming out of Europe.

USD/CAD: Currency in Play for Next 24 Hours

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USD/CAD is our currency pair in play for the next 24 hours.   Canadian CPI numbers are scheduled for release at 7:00 AM ET  / 12:00 GMT which will followed by leading indicators at 8:30 AM ET   / 13:30 GMT.  U.S. leading indicators will be released at 10:00 AM / 15:00 GMT.

USD/CAD is currently in an uptrend, which we determine using Bollinger Bands.  Resistance is at the second standard deviation Bollinger Band of 1.0337. Support on the other hand is at 1.0075, a level the currency pair’s weakness has stalled at on a number of occasions. 

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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.