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What a Supercommittee Defeat Means for Currencies

Last updated 11/21/2011 10:07 AM ET (GMT -5) 0 Comments - Add your comment

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Kathy Lien

Director of Currency Research, GFT

The euro and other high yielding currencies have weakened against the U.S. dollar this morning but aside from pessimistic comments from ECB policymaker Stark and the EU's Rehn, there have been no new headlines to explain the move lower in the euro. However fresh headlines are not needed for the euro to weaken because the longer it takes European officials to announce additional support for the region, the more strain it puts on the EUR/USD. If things continue to progress at its current pace with no stopgap measures from European officials, Italian and Spanish bond yields could take another aim at 7 percent. Stark's observation that the risks have increased over the past 2 weeks is spot on - Italian and Spanish bond yields are moving into dangerous territory and even if these countries can afford to pay higher borrowing costs, rating agencies could issue downgrades which would trigger a deadly spiral that hits all corners of the financial market.

What a Supercommittee Defeat Means for Currencies

Unfortunately Europe is not the only part of the world where political gridlock is threatening the economic outlook. On the other side of the Atlantic, barring a miracle, the U.S. debt Supercomittee is expected to announce their failure to come up with a way to cut $1.2 trillion over the next decade. The prospect of the Supercommittee admitting defeat has driven investors back into the safety of the U.S. dollar and U.S. Treasuries. Although this may be counterintuitive to investors, because it reflects greater fiscal troubles in the U.S. and the possibility of a downgrade by more rating agencies, in times of uncertainty, cash is king and when it comes to cash, the U.S. dollar is the world's most liquid currency. The EUR/USD has fallen significantly but the AUD/USD, GBP/USD and NZD/USD have suffered the most because these tend be higher beta currencies. Unless there is a postponement, the lack of urgency and finger pointing means there could be automatic $1.2 trillion across-the-board spending cuts to domestic and defense programs starting January 2013. A year is a long time in the markets which could explain why the reaction to a possible supercommitee impasse is still muted. However there are immediate consequences that can pose significant risks to the U.S. economy. A failure to reach an agreement on spending cuts means that the payroll tax cut and unemployment benefits for millions of people still out of work could expire at the end of this year. If jobless benefits are cut after the holidays, it could have a devastating impact on the economy that causes spending in the U.S. to grind to a complete halt. The payroll tax cut and the expanded unemployment benefits are expected to add 1 to 2 percentage points to GDP next year which means if these programs are not extended, the U.S. could fall back into recession, particularly if Europe's troubles worsen.

The only piece of U.S. economic data released this morning was existing home sales and according to the report, sales increased 1.4 percent in the month of October. Although the details of the report show that homeowners have been forced to lower their prices, the rise in sales signals new life in the housing market. However before geting too excited, pending home sales have been weak which suggests that the rebound in existing home sales may not last. Also, 29 percent of sales were all cash transactions and the inventory of homes on the market have dropped to its lowest level since October 2005. This means many owners have removed their listings, opting instead to wait until the market improves.

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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.