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EUR: Collapses as Sovereign Yields Soar

Last updated 11/23/2011 6:04 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: COLLAPSES AS SOVEREIGN YIELDS SOAR
• USD: POST THANKSGIVING DAY BREAKOUT?
• GBP: BOE RULES OUT POLICY FINE TUNING
• CAD: SHARP PULLBACK IN OIL
• AUD: LEADING INDICATORS REBOUND
• NZD: TRADE DEFICIT NARROWED
• JPY: SAFE HAVEN FLOWS DRIVE YEN HIGHER

EXPECTATIONS FOR UPCOMING FED MEETINGS

EUR: COLLAPSES AS SOVEREIGN YIELDS SOAR

It may not be a very happy holiday for traders who have been in the office today witnessing the bloodbath in currencies and equities.  The EUR/USD plunged more than 1 percent to trade at its lowest levels in 6 weeks.  The 10 year German bond auction was a disaster that drove yields in Germany as well as other countries in Europe sharply higher.  We would be surprised if the Europeans are not in full fledged panic mode and French President Sarkozy’s comment that Europe’s liquidity run has begun confirms that the trouble is making everyone inside and outside of Europe, nervous.  Even the rating agencies are worried – Fitch said this morning that France can’t absorb more shocks without undermining its AAA rating. We have warned often that one of the most immediate consequences of rising borrowing costs would be sovereign downgrades.    The crisis in Europe is hitting very close to home this morning for the Germans who sold only EUR 3.644 billion of the EUR 6 billion in 10 year bunds on auction today for an average yield of 1.98 percent. German bunds are typically considered the safest investment in Europe and possibly even one of the safest investments in the world but the failed bund auction proves that Germany has a lot to lose as well if the crisis in the region is allowed to worsen. They have been extremely reluctant about dipping their hands back into their pocketbooks but today's auction serves as a reality check for the Germans who cannot turn their backs on the rest of Europe for much longer.  Eurobonds are not possible without the support of the Germans and neither is the clever scheme of the ECB lending to weaker nations through the IMF.  Now that the Germans have felt the pain, perhaps they will be more willing to commit more funds and support to a European rescue.  The turmoil in the market today even triggered speculation of another rate cut by the ECB which we think is inevitable.  At this rate, unless there is a major recovery over the next week, Super Mario will cut interest rates again in December.   The bund auction erased any goodwill creating by the IMF's offer of liquidity yesterday and was the straw that broke the euro's back . Investors are wary of holding any European assets and if the Germans want to reverse this vicious cycle, they need to dump more money into the EFSF. The continued contraction in Eurozone service and manufacturing activity indicates that the region's economy is weak and if borrowing costs continue to rise at their current pace, Europe could be headed for recession. Time is running out for the Germans to act - Italian bond yields are trading dangerously close to 7 percent while French, German and Italian yields up across the board.  German business confidence numbers are scheduled for release tomorrow and based on the recent uncertainty in the market - we expect nothing but a steep drop is sentiment.

USD: POST THANKSGIVING DAY BREAKOUT?

For the currency market, the Thanksgiving Day holiday usually means low liquidity and thin trading volumes. It’s a time for traders to relax, regroup and spend time with family.  Most people end up taking both the Thursday and Friday off, but for those of us that are still looking to trade on Friday, it is important to know that historically, the Friday after Thanksgiving can be a volatile one. 

The table below shows that for the EUR/USD, GBP/USD and USD/JPY (the three most actively traded currencies), the trading range on Thanksgiving Day is usually very narrow.  Between 2005 and 2007, the range between the high and low in the EUR/USD was no more than 55 pips.  When the financial crisis hit in 2008, trading ranges expanded and have remained wide since then.   However one pattern that has been fairly consistent is the risk of larger move on the Friday after Thanksgiving. 

In 2003, the daily trading range of the EUR/USD and GBP/USD tripled on Friday but in 2004 and 2005 for example, the trading range only expanded slightly. In 2006 and 2007, we saw a breakout once against in both currencies but in 2008, only the EUR/USD saw an expanded range.  The GBP/USD, which already had a big move on Thursday, maintained its volatility on Friday.  In 2009, the EUR/USD and GBP/USD had a big move on both days and in 2010, the EUR/USD had a decent sized move on Thanksgiving Day with a much larger moved experienced in both the EUR/USD and GBP/USD the day after.  So based upon how these currencies traded over the past 7 years, the Friday after Thanksgiving is rarely a boring one.  Even though there are no major economic reports on calendar, thin volatility could lead to a breakout or expanded trading range.   Interestingly enough USD/JPY typically does not move much on either day and that may be due to the fact that most of the volatility is contained within European trading hours. 

One additional wrinkle that we want to add to this analysis is that the markets have been unusually volatile with the big moves triggered in Europe. Since the Europeans do not celebrate Thanksgiving, this does not rule some bizarre trading activity on Turkey Day. 

GBP: BOE RULES OUT POLICY FINE TUNING

The British pound strengthened against the euro but weakened against the U.S. dollar.  The Bank of England released the minutes today from their monetary policy meeting on November 10 ^th .  Policy makers were unanimous in their decision to maintain the target for asset purchases this month, as some officials said an increase in stimulus may be needed in the future.  While risks from the euro-area debt crisis “had increased,” it said there was “little merit in fine tuning” the program while the current four-month round of purchases were continuing.  The Bank of England said today that failure by   Europe ’s leaders to tackle the debt turmoil “could result in a much weaker external environment.” While its forecasts show inflation falling below its 2 percent target in a year, it noted that price growth remains well above its target and that the projected undershoot is “not very large.”  British gilt yields fell to record lows on the central bank minutes.  Both 10- and 30-year yields dropped to record levels as an increase in stimulus may be needed.  U.K. Chancellor of the Exchequer   George Osborne   may propose a plan to channel low-cost loans to companies through commercial banks to spur economic growth.  The model, based on the European Union’s European Investment Bank, would see the AAA-rated Treasury raise money in bond markets to finance the credit to small and medium-sized firms.  The British Bankers’ Association released October mortgage approvals today; 35.3k mortgages were approved, more than the expected 32.3K and more than September’s 33.5K.  October approvals rose to their highest levels since May of last year. 

CAD: SHARP PULLBACK IN OIL

The Canadian, Australian, and New Zealand dollars all traded lower against the U.S. dollar as investors seek safer assets.  Australia’s leading economic index increased 0.1 percent in September, following a downwardly revised 0.2 contraction in August.  A large gain in money supply more than offset negative contributions from building approvals, stock prices, and rural goods exports.  In the past couple months, economic strengths and weaknesses have been balanced.  Construction work done showed a massive increase of 12.5 percent in the third quarter; expectations were for a 2.1 percent increase.  This followed a downwardly revised contraction of 0.1 percent in the second quarter.  However, residential construction remains weak as it fell 1.6 percent and has fallen for four quarters.  RBA Assistant Governor Debelle delivered a speech about a new Committed Liquidity Facility that forms part of Australia’s implementation of the Basel III liquidity reforms.  In short the new facility was designed to ensure that the banking system in Australia is even more resilient and stable than it has been to date.  Bank of Canada Governor Carney is scheduled to speak today at the Metropolitan Board of Trade in Montreal.  The Canadian dollar slid to a six-week low as investor risk aversion rose following news that Germany failed to get the full amount of bids in a debt auction.  No new economic data was released today from Canada or New Zealand.  The kiwi fell to an eight-month low on concern from the European debt crisis.  New Zealand’s two-year swap rate fell three basis points to 2.635 percent, the least since 1993.  New Zealand's trade balance was narrower than forecast as imports exceeded exports by NZ$282 million.  This was smaller than expected and significantly lower than the previous month. 

JPY: SAFE HAVEN FLOWS DRIVE YEN HIGHER

The Japanese yen strengthened against all the major currencies with the exception of the U.S. dollar as investors sought safer assets.  No new economic data was released from Japan today.  Japanese Prime Minister Yoshihiko Noda said late Tuesday that Japan will provide loans of around 67 billion yen to Iraq to help the resource-rich country accelerate its reconstruction process.  This is an attempt to boost economic ties between Japan and Iraq, which has the world’s third-largest crude oil reserves.  For the purpose of promoting investment in large-scale infrastructure projects in Iraq, the two countries decided to begin negotiations on the establishment of a new financial scheme, which could involve Japanese export credit agencies and require collateral, such as crude oil.  The yen’s recent strength may be unsettling many Japanese companies, especially export firms.  However, Japan’s former Vice Minister for Finance Eisuke Sakakibara told reporters he is not concerned about the currency’s current level of around 77 to the U.S. dollar.  He noted that in terms of the real effect on the exchange rate, this rate is not as high as 79 in 1995.  The yen’s strength will continue as long as Europe’s debt troubles persist and the U.S. economy remains weak.  The two interventions in the currency market by Japanese authorities have been a losing battle as long as fundamental data and investors continue to drive the yen to new highs.  The yen will also continue to rise against the dollar to help cancel out the Japanese current account surplus.  Economic data on the docket tomorrow includes Tokyo and national core consumer prices indexes, as well as the corporate services price index.  Price increases are expected to ease as the global economy is struggling to keep end demand strong.

EUR/GBP: Currency in Play for Next 24 Hours

Our currency pair in play for Thursday is EUR/GBP.  Economic data we expect from Germany is third quarter GDP, exports and imports, and private consumption at 2:00 AM ET / 7:00 GMT.  Also from Germany, we expect IFO business climate, current assessment, and expectations all for the month of November at 4:00 AM ET / 9:00 GMT.  The United Kingdom will release third quarter GDP figures, consumption and spending, exports and imports, and total business investment all at 4:30 AM ET / 9:30 GMT.  EUR/GBP has been sliding over the past month, but recently received a boost and is now trading range bound, which we determined using Double Bollinger bands.  Nearest support is at the 10-day SMA of 0.8570.  Should the pair drop further, significant support will be provided at 0.8485, the November low.  To the upside, nearest resistance is at the upper first standard deviation Bollinger band price of 0.8675.  Should the pair break out from that price, heavy resistance will be encountered at 0.8745, where the 200-day SMA and upper second Bollinger band 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.