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EUR: What Lies Ahead

Last updated 11/18/2011 4:49 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: WHAT LIES AHEAD
• USD: FOMC MINUTES TO PROVIDE CRUCIAL CLUES TO FED POLICY
• GBP: LIFTED BY RISK
• CAD: CONSUMER PRICES RISE MORE THAN EXPECTED
• AUD: OIL DOWN, GOLD UNCHANGED
• NZD: SOLD OFF EVERY DAY THIS WEEK
• JPY: STILL STRUGGLING WITH YEN STRENGTH

EXPECTATIONS FOR UPCOMING FED MEETINGS

EUR: WHAT LIES AHEAD

Another week has passed with very little progress on a solution for the European sovereign debt crisis. Both Italy and Greece have installed new leadership but aside from that, comments from European officials suggest that there has been more contention than cooperation in the Eurozone. Although the euro and other high yielding currencies rebounded today, they have all weakened against the greenback this week, with many touching one month lows in the process. A quick look at European bond yields makes the rally in the euro and equities not much of surprise because throughout the past week, the euro has been taking its cue from yields.  Italian, Spanish and French bond yields have declined, bringing some relief to the market.  Ten year Italian bond yields rose above 7 percent more than once this week but with yields settling on Friday lower than where it was Monday, the risk of spiraling debt costs sinking Italy has decreased. In no way shape or form is Italy out of the woods, but after a week where it appeared that there was no end in sight for the European crisis, reports of a possible deal between the ECB and IMF has reinvigorated hope for a solution even though it was later reported that the model of ECB lending to the IMF is long dead. There are ways out of this crisis and we outlined some of them in our note yesterday. The ECB/IMF model would be clever way to get around the EU Treaty change and allow the ECB to provide money to countries like Italy through the IMF. Unfortunately both the ECB and the Germans, who controls the purse strings, do not support the deal and the ECB has done nothing but oppose having a greater role in the debt crisis. Eurobonds could also be issued or the central bank could monetize its debt but both require a treaty / mandate change. We also mentioned the possibility of a cap on Italian bond yields but with the talk of a cap on bond purchases this morning, a yield cap doesn’t seem to have the support of the central bank. Representatives of more fiscally sound countries have voiced strong opposition to the bond purchase program and a limit basically shoots down the idea of debt monetization.     If the market knows that the ECB has a limit to their bond purchases, they will use that to their advantage and start attacking bonds once the limit is met which would be terrible news for the euro. None of these options are quick and easy and given the structure of the EU/EMU, it will take longer than normal for any agreements to be reached which is why we continue to believe that the path of least resistance is lower for the euro.

The holiday in the U.S. next week means there will be less liquidity in the market which could increase volatility. Europe will be releasing a number of economic reports including the November advance PMI figures and the IFO. Unfortunately given increased tensions in the market and the pressure that austerity measures pose to the Eurozone economy, the odds favor weaker economic reports that could weigh on the euro. The European Commission will also be meeting on Wednesday to discuss a new package of measures aimed at increasing governance in the region. A number of European officials are scheduled to speak next week and their comments along with the movement in European yields will continue be the main driver of the euro. As we inch closer to the EU Leaders Summit in December, expect there to be more speculation about the possible rescue plans for Europe.

USD: FOMC MINUTES TO PROVIDE CRUCIAL CLUES TO FED POLICY

Despite the abundance of U.S. economic data this week, the dollar has traded on one thing and one thing alone which is risk appetite. Having strengthened against all of the major currencies (with the exception of the Japanese Yen), the pullback in the greenback today is in line with the rise in equities and the decline in European bond yields. There has been both good and bad news on the economy this week with the highlights being a slowdown in retail sales growth and weaker inflationary pressures. Consumer spending may have been better than expected but it was still lower than the previous month. Manufacturing activity and leading indicator increased but the problem is that these reports have not been enough to make Federal Reserve officials more optimistic about the U.S. economy expect for maybe Fisher who can’t wait till the day he can call for tighter monetary policy. As one of the most hawkish members of the central bank, he believes that American businesses are “incredibly muscular.”  Dudley on the other hand, who is on the other side of the spectrum repeated yesterday’s comments where he said the economy faces “significant downside risks.” He doesn’t believe that the U.S. will fall into recession but that of course hinges upon how the Eurozone sovereign debt crisis plays out. It will be a shortened trading week next week with very little market moving economic reports on the calendar. Although existing home sales, revisions to Q3 GDP, durable goods, personal income, personal spending and jobless claims are still worth watching for any major surprises, the most important release next week with be the minutes from the most recent FOMC meeting. When the central bank last met, they left investors more confused than ever. The tone of the FOMC statement was slightly more upbeat but the comments from Bernanke and the central bank’s latest GDP forecast reflect continued concerns about the outlook for the U.S. economy. The Fed downgraded their growth and inflation forecasts significantly but passed on the opportunity to take additional steps to stimulate the economy. Although very few people expected the Fed to increase asset purchases going into the FOMC rate announcement, there was a general belief that they would at least lay the groundwork for easier monetary policy by signaling a change in their communications strategy. Yet not only did they fail to do so but their statement contained a slightly more optimistic outlook which is why the FOMC minutes are so important in shedding more light on where the central bank stands on future policy actions. Meanwhile keep an eye on Washington because the balanced-budget amendment, which was a crucial element to raising the debt ceiling in the U.S. was rejected by the House today. This has put a serious snag into the Supercommittee’s efforts to come up with $1.2 trillion in savings over the next 10 years before the deadline of November 23 ^rd .

GBP: LIFTED BY RISK

The British pound strengthened against the U.S. dollar as gains in U.S. equities reduced demand for the U.S. currency. On the other hand, the pound weakened against the euro amid speculation European leaders are stepping up efforts to combat the region’s sovereign debt crisis. Ten-year gilts gave up a third consecutive weekly advance as investors had more appetite for risk. There was no new economic data out from Britain today, but the pound refused to break higher despite positive UK retail sales data. There was a much-needed boost for Britain’s ailing economy with the release of October’s retail sales figures yesterday morning. The British shop sales numbers showed a monthly increase of 0.6 percent, a sign that the economy is recovering and consumer are starting to regain confidence. However, the Bank of England still sees a “very strong case” for adding more stimulus to the U.K. economy unless the outlook improves. If things do evolve as the BOE’s forecasts suggest, quantitative easing may be ramped up again in February of 2012. The pound’s safe-haven appeal has been offset lately by two opposing forces – weak economic growth and the fact that the BOE is talking about more quantitative easing. Key economic reports scheduled for release from the U.K. next week include public sector net borrowing, monetary policy meeting minutes from November 10 ^th ’s meeting, revised GDP and industrial order expectations. Gross domestic product is forecast to have expanded by 0.5 percent in the third quarter, following 0.2 percent growth in the second quarter.

CAD: CONSUMER PRICES RISE MORE THAN EXPECTED

The Canadian and Australian dollar strengthened against the greenback while the New Zealand dollar extended its losses. Canada’s annual inflation rate slowed for the first time in three months in October as energy-price gains faded while food costs increased. The consumer price index rose 2.9 percent in October from a year earlier, compared with a 3.2 percent pace in September. The annual core inflation rate slowed to 2.1 percent from September’s 2.2 percent. The Canadian dollar rallied off the news as prices rose more than forecast. The Bank of Canada renewed its target for 2 percent inflation for the next five years. Canada’s composite leading index rose 0.2 percent in October, after a gain of 0.1 percent in September. Household spending remained the strongest factor, while manufacturing remained the weakest. No new economic data was released from Australia or New Zealand but next week Australia will release its leading index and report of construction work done. Construction is expected to have risen 2.1 percent from 0.7 percent last month. Also next week, New Zealand will release its inflation expectations and trade balance. Inflationary pressures may ease further as producer prices have declined significantly during this quarter. The trade deficit is expected to contract as demand from overseas buyers has picked up recently.

JPY: STILL STRUGGLING WITH YEN STRENGTH

The Japanese yen weakened against all of the major currencies with the exception of New Zealand and U.S. dollar.  Japan reported better than expected growth for 3Q earlier this week as manufacturers pulled themselves out of the slump following the quake in March. While prices remained deflated, the outlook for 4Q remained dim. The growth in the U.S., one of Japan’s major trading partners, has been sluggish. Meanwhile, the trade deficit is expected to widen to 0.2 trillion yen as the Ministry of Finance publishes its report next Tuesday. Japanese manufacturers have been under pressure stemming from natural disaster and global uncertainty. The export industry was not able to pick up momentum since the trade deficit first reported in April. BoJ has grown increasingly concerned as the hollowing-out effect of the Japanese industry could spread amid yen’s appreciation. With no resolution on the European debt crisis, BoJ would be kept restless on yen’s further strengthening as risk-averse investors seek safety in the country’s currency.  Inflation and trade numbers are scheduled from Japan next week.

USD/JPY: Currency in Play for Next 24 Hours

Our currency pair in play for Monday is USD/JPY. The September Coincident and Leading index is scheduled for release from Japan at 12:00 AM ET / 5:00 GMT. Japanese convenient store sales for October will be released at 2:00 AM ET / 7:00 GMT. The Chicago Fed’s national activity index for the month of October is scheduled for release at 8:30 AM ET / 13:30 GMT. Also from the U.S. is existing home sales for the month of October due at 10:00 AM ET / 15:00 GMT.

USD/JPY has been steadily declining since the last BOJ intervention and is now trading range-bound, which we determined using our Double Bollinger bands. Nearest support is 76.40, where the lower first Bollinger band lies. Should the pair continue to slide, significant support can be found at 75.56, where the lower second Bollinger band and the recent low before BOJ intervention lies. To the upside, nearest resistance is at 77.22, where the 20-day SMA lies. Heavy resistance should be encountered at 78.05, where the upper first Bollinger band lies.

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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.