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EUR: Early Gains Cut Short by Downgrade

Last updated 11/28/2011 7:11 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: EARLY GAINS CUT SHORT BY DOWNGRADE
• MORE CHEER FOR USD/JPY?
• GBP: BOE OFFICIALS ARGUE FOR MORE QE
• AUD: STRONG RELIEF RALY IN COMMODITY CURRENCIES
• CAD: CURRENT ACCOUNT DEFICIT ON TAP
• NZD: BUSINESS CONFIDENCE IMPROVES
• JPY: YEN CROSSES SOAR, PRESSURE ON BOJ DECREASES

EXPECTATIONS FOR UPCOMING FED MEETINGS

EUR: EARLY GAINS CUT SHORT BY DOWNGRADE

Early gains and optimism in the euro faded quickly as investors realized that there is very little substance to the speculation that progress is being made on the Eurozone debt crisis. With Eurogroup and Eurozone finance ministers meeting this week and the ECB and EU leaders meeting next week, we are not surprised to see investors hoping for some type of deal. Unfortunately given the track record of European officials, we could easily be setting up for another disappointment because when it comes to Europe, everything is taking longer than necessary. In the meantime, borrowing costs in Europe remain extremely high, triggering the concern of rating agencies. We have warned repeatedly in recent weeks that the greatest near term risk for the euro are downgrades. The rally in the EUR/USD this morning was killed by rating agency Egan-Jones’ decision to cut the sovereign debt rating of Italy to BB from BB+. Egan-Jones is an independent rating agency that is much smaller than the 3 larger firms (S&P, Moody’s and Fitch) but extremely well respected in the market. They rate Italy six notches below Moody’s and S&P which probably more accurately reflects the likelihood of default by Italy. Although none of the 3 major rating agencies have Italy on review for a downgrade, they all have a negative outlook on the country’s rating and we strongly believe that more downgrades of Eurozone ratings are expected in the coming weeks. Last week, rating agencies took the axe to Portugal, Hungary and Belgium and more could follow this week. Some of the speculation has centered around an IMF loan for Italy and bonds backed by AAA countries. Both rumors have since been denied but at some point the Europeans need to announce a big bazooka for the region which could be in the form of a Treaty change, Eurobonds, more firepower for the EFSF or any other more creative option but the reality of the matter is that getting 17 nations to agree on anything is a big challenge and one that is compounded by the fact these deals will most likely require greater financial commitment from European nations at a time when they need to get their own fiscal houses in order. Eurozone confidence indicators are scheduled for release tomorrow. Consumer confidence in Germany improved in December which suggests that sentiment in the EZ was not hit as hard as most people expect by the debt crisis. 

MORE CHEER FOR USD/JPY?

The United States may be the world’s largest and most powerful economy but it has been a long time since U.S. developments dictated the direction of currencies and equities. Today was one of those days where goods news from the U.S. completely overshadowed all of the troubles in Europe. Whether this improvement in sentiment will last remains to be seen but for the time being, U.S. investors are relieved that consumers did not retreat into their shells on Black Friday, which is one of the most important shopping days of the year. In fact, sales this Friday were the highest ever and as of 3pm NY Time according to the IBM Benchmark alert, Cyber Monday sales were up 15 percent compared to last year.  The hope is that this strength will carry through to the rest of the holiday season but given the high level of unemployment we are truly skeptical. It is not that we want to cast a cloud on today’s good news because the results have been surprisingly strong but it is no secret that Americans are living above their means and if retailers want to continue luring consumers into their stores, they will need to discount sharply, which would inevitably affect their bottom lines.  Fitch expressed their concerns today by lowering the outlook for the U.S. credit rating from neutral to negative.  Although their reservations have more to do with the fiscal mess in the U.S., Congress’ inability to identify $1.2 trillion in deficit reduction measures is preventing U.S. fiscal finances from returning to healthier levels. The dollar barely reacted because Fitch kept the U.S. credit rating at AAA, while S&P stripped the U.S. of its perfect rating months ago. Meanwhile new home sales was the only piece of U.S. economic data released today and sales rose 1.3 percent in October which was more than economists had expected. Unfortunately if we include the downward revision to September’s report, growth in new home sales was much weaker. The average price of a home sold also fell for the fourth straight month because the only way home owners and builders are moving inventory is by lowering their prices. This trend will most likely to be reflected in tomorrow’s S&P Case Shiller House Price index.  Consumer confidence numbers are also scheduled for release and given the rise in sentiment according to the University of Michigan and Friday’s strong retail sales, there is a reasonable chance that the Conference Board will also report an increase in sentiment which would bode well for USD/JPY. 

GBP: BOE OFFICIALS ARGUE FOR MORE QE

Like many of the other major currencies, the British pound rebounded against the U.S. dollar today. However its gains were limited by weaker economic data and calls for more Quantitative Easing from U.K. policymakers. Compared to the other major currencies, sterling underperformed, causing the value of EUR/GBP to rise. The big disappointment was in the retail sector – according to the Confederation of British Industry who conducts a survey or retailers, spending fell for the sixth month in a row and by the fastest pace in more than 2 years. The CBI index dropped to -19 from -11, to the lowest level since March 2009. Spending on food, beverages and clothing suffered across the board with retailers predicting even weaker sales to come. Last night, Lloyds of London also reported weaker business activity which is in line with the deterioration in consumer spending and explains why Bank of England policymaker Fisher said more stimulus may be needed. Last month, he voted to increase stimulus by GBP 75 billion and made it clear this weekend that he will support doing more in the coming months. The central bank is widely expected to increase Quantitative Easing by at least GBP50 billion before March because the current program of bond purchases is set to expire in February. How quickly they act will depend on how the European crisis plays out. Fisher was not the only U.K. policymaker to speak today although he was the most direct about his voting plans. In a written statement, Bank of England Governor Mervyn King expressed his concerns about the outlook for the U.K. economy. More specifically, he talked about the threat that the euro crisis has on the U.K. recovery and how spare capacity and weak earnings will weigh on inflation. King expects growth to be considerably weaker than 3 months ago and for broadly flat growth over the next six months with a significant risk of inflation target undershooting. These are not the words of a optimistic central banker and it is clear that King leans towards easier monetary policy. The same appears to be true for MPC member Weale who sees little growth in the current quarter and the first half of 2012 and argues that there is a “strong case” for further asset purchases. Given these unambiguously pessimistic comments, the BoE could increase stimulus as quickly as next month

AUD: STRONG RELIEF RALY IN COMMODITY CURRENCIES

Having suffered the most when risk appetite contracted, the Australian, New Zealand and Canadian dollars benefitted the most from today’s risk rally. The rise in commodity prices also helped to lift the comm. dollars but the real catalysts were the strong U.S. Black Friday sales and the hope for progress on the EU’s debt crisis. Australia, New Zealand and Canada are small heavily export dependent economies that are extremely sensitive to global growth. For the past month, these currencies have weakened significantly on the fear that a recession in the Eurozone and volatility in the financial markets would wreck havoc on global demand. The Reserve Bank of Australia responded with an interest rate cut in November, as a precaution. If the markets stabilize, additional easing may not be necessary. New Zealand was the only commodity producing country with any economic reports over the last 24 hours and surprisingly enough, business activity and confidence improved in the month of November. New Zealand businesses grew more optimistic about investment, livestock, capacity utilization and commercial construction. However it is worth noting that they grew less optimistic about employment, exports and residential construction.  Canadian current account numbers will be released tomorrow and given stronger trade and foreign investment into Canada in the third quarter, current account activity is expected to have improved which could accelerate the gains in the loonie. 

JPY: YEN CROSSES SOAR, PRESSURE ON BOJ DECREASES

The turn in risk appetite and the rally in U.S. equities helped to ease safe haven flows out of the Japanese Yen. Yen crosses traded sharply higher today with AUD/JPY and NZD/JPY leading the gains. A week ago, Japanese officials were pulling their hairs out in frustration about the yen, which rose back to its pre-intervention levels. Over the past 2 trading days however, USD/JPY has recovered strongly to the relief of policymakers. According to Bank of Japan Governor Shirakawa, the central bank is watching the recent Yen rises carefully but their goals seems to be aimed at getting the G7 and the G20 to understand their FX stance because they know that unilateral intervention is not nearly as effective as coordinated intervention. Also, they realize that they have very little control over the Yen until the situation in Europe stabilizes.  For the time being, Shirakawa expects the Japanese economy to continue to slow but then resume a moderate recovery in 2012. Small business confidence was the only piece of Japanese data released overnight and unsurprisingly, the uncertainty in the global economy, the volatility in the financial markets and the floods in Thailand caused sentiment to deteriorate. The confidence index slipped to 45.8 from 46.4 in November – a reading below 50 suggests that pessimists outnumber optimists. Tonight, Japan will release its jobless rate, overall household spending and retail trade numbers. A bit of improvement is expected in most of the releases but in general tell a story of a weak economy. 

EUR/USD: Currency in Play for Next 24 Hours

Our currency pair in play for the next 24 hours is the EUR/USD. Eurozone consumer confidence indicators will be released at 5:00 AM ET or 10:00 GMT. U.S. consumer confidence and house price index will be released at 10:00 AM ET or 15:00 GMT.

The EURUSD is currently in a downtrend which we define using Bollinger Bands. Support is at the October low of 1.3150. If this level is broken, the next place of support would be the psychologically significant 1.30 level. Resistance on the other hand is at the first standard deviation Bollinger band and if that level is cleared, the next area of support will be 1.36.

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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.