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THE STORIES IN THE CURRENCY MARKET

• CENTRAL BANKS TO THE EZ RESCUE
• USD: SOLID DATA ADD FUEL TO RISK RALLY
• GBP: CONSUMER CONFIDENCE REMAINS WEAK
• CAD: QUARTERLY GDP GROWTH ACCELERATES
• AUD: RETAIL SALES AND PMI ON TAP
• NZD: LIFTED BY RISK RALLY
• JPY: CONTRACTION IN MANUFACTURING

EXPECTATIONS FOR UPCOMING FED MEETINGS

CURRENT US INTEREST RATE: 0.25%
	12/13 Meeting	01/25 Meeting
NO CHANGE	64.0%	58.9%
CUT TO 0BP	36.0%	38.2%
HIKE TO 50BP	0.0%	2.9%

CENTRAL BANKS TO THE EZ RESCUE

Thanks to the coordinated action by the world’s largest central banks, it has been a great day in the financial markets.   U.S. equities are up more than 3 percent, bond yields in Europe have declined and 10 year Italian yields are back below 7 percent.   In the currency market, investors took their money out of the safety of the U.S. dollars and U.S. Treasuries (which is why prices have fallen today) and recycled them back into higher yielding currencies.   The Australian and New Zealand dollars are the day’s best performers, but the euro and other European currencies also enjoyed a nice rally.   Over the past few months, European officials have struggled to stabilize the financial markets and increase consumer confidence – they had 2 opportunities to do so this week but have fallen short again. Rather than sitting on the sidelines waiting for European leaders to put their politics aside seven major central banks decided to take matters into their own hands today.   The People’s Bank of China was the first to announce a 50bp cut in their reserve requirement ratio.   Their decision was aimed at freeing up capital for banks to lend, which would effectively increase liquidity and hopefully stabilize the economy.   The PBoC’s action was aimed at their local economy whereas the actions of the Federal Reserve, European Central Bank, Bank of England, Bank of Japan, Swiss National Bank and the Bank of Canada were aimed at supporting the financial market in general.   By cutting the rate on dollar swaps, central banks effectively reduced the cost banks in foreign countries must pay to borrow dollars.   These foreign banks get their loans from their own central banks who borrow from the Fed which explains why the Fed took the lead in increasing the availability of dollars in the market.   Although investors have interpreted today’s action to be overwhelmingly positive for risk, we can’t help but wonder if central banks took this action because they felt that financial conditions are much worse than they want us to believe which is why more liquidity is needed immediately.

 

However with the Dow Jones Industrial Average up nearly 500 points today, one would expect a stronger rally in the EUR/USD but unfortunately the currency pair is up less than 1 percent.   The reason is because Europe’s troubles are far from over.   The influx of liquidity is a welcome distraction from the lack of progress on the EU debt talks but it does not eliminate the need for structural reforms, more commitment from European nations and a bigger bailout plan.     European Union Finance Ministers made very little progress in Brussels today which is not surprising so even though central banks have come to the Eurozone’s rescue, rallying the EUR/USD in the process, they have not eliminated the downside risk in the euro.   With that in mind however, the risk rally could still last for a few more days because today’s action by central banks eases conditions in the financial markets and more importantly, shows that central banks are willing to work together to avoid another financial catastrophe.  

 

Better than expected economic data from Germany suggest that the debt crisis has not weighed too heavily on the domestic economy. Retail sales rose 0.7 percent in October while the number of people filing for unemployment benefits declined by 20k, pushing the unemployment rate down to 6.9 from 7.0 percent.   Despite this improvement in data, one year German bond yields turned negative for the first time ever.   This is a big deal because it means investors will receive less money than they paid for the bonds when they mature.  The reason why short dated German bond yields turned negative is because investors expect the ECB to cut interest rates in the near future.  There were reports this morning citing unnamed ECB sources that the central bank is open to more rate cuts which should not surprise anyone because the ECB is one of the very few agencies still able to support the Eurozone economy. Cutting interest rates to lower yields is a much easier decision than lending to the IMF or taking greater role in the European crisis. More rate cuts are inevitable especially if the Eurozone falls into recession next year. Final Eurozone PMI numbers are scheduled for release tomorrow along with Swiss GDP.   The Swiss economy is expected to have slowed materially in the third quarter due to the burden of a strong currency.   Leading indicators continued to fall in November, showing very little relief for the economy.   

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USD: SOLID DATA ADD FUEL TO RISK RALLY

The coordinated action by central banks this morning triggered a very strong rally in the financial markets but as a safe haven currency, the greenback weakened significantly.   Even though the stability created by the increase in liquidity will also be good for the U.S. economy, what is more important is that it reduces the pressure in the financial market which in turn makes investors less nervous about putting their money into risky assets such as high yielding currencies.   Upside surprises in U.S. data added fuel to a rally that was strong to begin with.   Non-farm payrolls are scheduled for release on Friday and according to this morning's leading indicators for NFPs, there are many reasons to believe that the labor market improved in November.  Challenger Grey & Christmas reported a 13 percent drop in layoffs yoy which was the steepest decline in 7 months.  According to the ADP employment change report, U.S. companies added 206k workers to their payrolls last month, compared to 130k in October. For the past few weeks, jobless claims have also been less than 400k so even though ADP is not the best leading indicator for NFPs, the message is consistent because all signs point to greater job growth in November. Investors are currently looking for 125k jobs to have been added to the U.S. economy last month.   Manufacturing activity in the Chicago region also accelerated significantly with the Chicago PMI index rising from 58.4 to 62.6, a 7 month high in November.   The manufacturing sector is clearly leading the recovery and we expect this strength to be echoed in the national ISM manufacturing index scheduled for release tomorrow.   Pending home sales also jumped 10.4 percent in October, which is a sign of strength for the housing market.    Lower prices and borrowing costs are slowly helping to move inventory in the housing market and explains why the central bank wants to keep interest rates at an extremely low level for as long as possible.   Even though Federal Reserve officials continue to express concerns about the U.S. economy, they are enjoying the best of both worlds right now – and that is stronger data and a weaker currency.   Unfortunately much more growth is needed before Fed officials will abandon their calls for easier monetary policy.   According to the latest Beige Book report, 11 out of the 12 Fed districts saw slow to moderate growth compared to last month.   There were improvements in manufacturing activity and consumer spending but hiring was generally subdued.   

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GBP: CONSUMER CONFIDENCE REMAINS WEAK

The British pound strengthened against the U.S. dollar but weakened against the euro today.  Consumer confidence remained at its lowest level in more than 2 ½ years in November as Britons’ pessimism over the economy increased amid continued turmoil in the euro area.  The GfK index of sentiment rose one point to minus 31, barely recovering from the weakest reading since February 2009.  The long-term trend of the index is still very gloomy as the U.K. economy struggles to recover.  Bank of  England  governor  Mervyn King  said this week that the U.K. is being “increasingly threatened” by the euro crisis, while Chancellor of the Exchequer  George Osborne  said yesterday that growth will be slower than forecast next year. The weaker outlook means Osborne plans additional restraint on public-sector pay and will extend his austerity program by two years.  U.K. Foreign Secretary William Hague ordered the closing of the Iranian Embassy in London following the storming of the British Embassy in Tehran, saying the attack happened with the consent of Iran’s government.  Political risk is uncertain going forward as more developments continue to materialize.  U.K. housing equity withdrawal came in worse than expected at minus 9.1 billion pounds in the second quarter.  This follows a downwardly revised minus 8.9 billion pounds in the first quarter.  The negative figures indicate a continued injection of housing equity by households overall, with the net flow of lending secured on dwellings remaining weaker than their investment in housing.  On the docket tomorrow is the Halifax house price index, manufacturing PMI, and the Bank of England Financial stability report.  Inflationary pressures for manufacturers are expected to have eased slightly, but should remain materially unchanged. 

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CAD: QUARTERLY GDP GROWTH ACCELERATES

The Canadian, Australian, and New Zealand dollars all traded higher against the U.S. dollar as investors increased their risk appetite.   Canada’s economy rebounded at a faster pace than expected in the third quarter as the biggest jump in exports since 2004 more than offset slower domestic spending.   GDP grew at a 3.5 percent annualized pace from July to September.   Exporters are being supported by the 3.7 percent decline in the Canadian dollar versus the U.S. dollar in the last six months.   Bank of Canada Deputy Governor Murray said independent actions by developed and emerging countries have failed to maximize global economic growth.   He suggested that coordination strategies may be better than independent strategies.   Between September and October, the Industrial Product Price Index and the Raw Materials Price Index declined 0.1 percent and 1.2 percent, respectively in Canada.   The declines were largely the result of a sharp drop in the price of metals.   Crude oil and other commodities advanced today buoyed by the news of central banks to reduce dollar swap rates.   A number of economic data points were released from Australia last night.   Total Australian capital expenditure rose 12.3 percent in the September quarter.   This marks the fifth straight quarter of increases and was the fastest pace since the first quarter of 2003.   New home sales recovered moderately in October, following the lowest result in more than a decade.   The number of new homes sold in October increased 5.5 percent following a decrease of 3.5 percent in September.   With falling interest rates and a competitive building market, now is an attractive time to build a new home in Australia. Total credit provided to the Australian private sector rose by 0.2 percent, less than the expected 0.5 percent.   Building consents in New Zealand increased 11.2 percent in October, following a 17.2 percent decline in September.   The number of new dwellings showed large increases for October.   They follow substantial decreases in September, which reverse most of the increases in July and August.   Overall, for 2011 there exists an increasing trend in the number of new dwellings, which bodes well for sustained economic growth.   Manufacturing PMI and retail sales numbers from Australia 

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JPY: CONTRACTION IN MANUFACTURING

The Japanese yen weakened against all the major currencies with the exception of the U.S. dollar as central banks across the globe flooded the market with liquidity. A number of economic data were released from Japan last night.   The manufacturing PMI index showed that Japanese manufacturers recorded the fastest decline in output since April.   The November number printed 49.1 from 50.6 in October and shows that the manufacturing sector of Japan is now contracting.   The report revealed that input cost inflation eased to a 13-month low amid weak manufacturer demand.   Japanese wages ticked up 0.1 percent in October from a year earlier.   This is the first increase in 5 months and a tentative sign that wage declines could stabilize.   Overtime pay rose 1.8 percent in October for the consecutive month of gains and is a potential indicator that businesses may be gearing up to hire more full-time employees.   Industrial production in October increased 2.4 percent from the month earlier, showing an increase for the first time in two months.   The index came in at 92.7.    Transport equipment, general machinery, and chemicals lead the gains, in that order.   The Japanese housing market continues to remain weak as housing starts slumped 5.8 percent in October.   This was the second straight fall, as demand dried up after the government ended its subsidies for building energy-saving homes in July.   The October figure was slightly better than expectations.   It followed a 10.8 percent drop in September and a 14.0 percent rise in August.   On the docket tomorrow is capital spending and the monetary base figures.   Capital spending is expected to drop 3.4 percent as businesses continue to struggle to recover from the March natural disasters.

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GBP/USD: Currency in Play for Next 24 Hours

Our currency pair in play for Thursday is GBP/USD.   U.K. will release its manufacturing PMI for the month of November tomorrow at 4:30 AM ET / 9:30 GMT.   From the U.S. we expect jobless claims at 8:30 AM ET / 13:30 GMT followed by construction spending and the ISM manufacturing index and prices paid for the month of November at 10:00 AM ET / 15:00 GMT.  

 

GBP/USD recived a boost today and is currently trading range bound which we determined by using Double Bollinger bands.   Nearest support is at today’s low of 1.5525.   Should that level be broken, significant support may be found at the October low of 1.5271.   To the upside, first resistance may be found at 1.5779.   The 20-day SMA also lies here.   If that level is taken out, heavy resistance may be encountered at the psychologically significant 1.6000 handle.   The upper first standard deviation Bollinger band also lies here.

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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.