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FX: Big Week For Europe And Rest Of The World

Last updated 12/2/2011 4:51 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

• FX: BIG WEEK FOR EUROPE AND REST OF THE WORLD
• DOLLAR TO TRADE AS A SAFE HAVEN NEXT WEEK
• GBP: CONSTRUCTION ACTIVITY SLOWS
• CAD: SECOND MONTH OF JOB LOSSES
• AUD: RBA MEETING NEXT WEEK
• NZD: OIL AND GOLD FLAT
• USDJPY TRICKLES HIGHER ON STRONGER US DATA

EXPECTATIONS FOR UPCOMING FED MEETINGS

FX: BIG WEEK FOR EUROPE AND REST OF THE WORLD

If you thought the financial markets were chaotic this week, just wait until next week when the action really heats up.  Leaders of the European Union are gathering in Brussels on the same day that the European Central Bank meets on monetary policy.  Earlier this week, central banks showered the markets with liquidity and even though U.S. stocks and some of the higher yielding currencies have held onto their gains, the rally in European currencies fizzled quickly.   The divergent price action in the financial markets show that investors are still worried about Europe and realize that the liquidity measures taken this week help to ease the strains in the market but do not resolve the region’s structural problems.  Aside from the EU Leaders Summit and the ECB meeting, four other central banks will hold monetary policy meetings, each of which should trigger volatility in their respective currencies.   We have seen today how speculation about the various plans that the Europeans could be cooking up can affect the euro.   Earlier this morning, renewed talk of an ECB/IMF deal that involves the ECB lending to the IMF who then provides support to other countries in need sent the EUR/USD up 50 pips in 10 minutes.   However once investors realized that the deal was not confirmed by any other news agency aside from the one that initially reported it, the euro began to give up its gains with the rally disappearing completely following the U.S. non-farm payrolls release.  Even if the report proves to be valid, the size of the program they cited (EUR100 – 200 billion) is too small to do any good for Italy.

For the past month, we have been waiting with bated breath for a solution to the European sovereign debt crisis but the only thing that we have had are opposition and roadblocks at every corner.  This past week, the Eurogroup and ECOFIN failed to make any notable progress on the debt deal talks and this morning German Chancellor Merkel tried to manage everyone’s expectations for the EU Leaders Summit by saying that the EU crisis could take years to resolve.  She also reiterated her opposition to Eurobonds, which would have been a quick solution to the crisis if European leaders would simply agree to it.  Unfortunately the options for the Europeans are not endless and Eurobonds have long been at the top of the list followed by a deal between the ECB and IMF.  We are not very optimistic that much progress will be made on both, especially after Merkel’s comments and the price action in the EUR/USD today suggests that other investors share our view as well.  What will most likely happen is that the ECB will buy everyone time by cutting interest rates again on Thursday.  The underperformance of the euro today can be attributed to the expectations for easier monetary policy and disappointing results from the EU Leaders Summit.  Of course, when it comes to big meetings such as these that take place under such severe financial distress, anything can happen.  European leaders could put their differences aside, bite the bullet and commit more funds towards the region’s stability – this may appear to be a long shot right now but it needs to happen eventually.

DOLLAR TO TRADE AS A SAFE HAVEN NEXT WEEK

U.S. economic data may finally be having some effect on the U.S. dollar.  The greenback traded higher against all of the major currency pairs after this morning’s non-farm payrolls report. If there was only one piece of U.S. data that would matter to the greenback, it would be NFPs.   However despite the rally in the dollar, investors were not impressed by the drop in the unemployment rate and the rise in job growth.  According to the non-farm payrolls report, a total of 120k jobs were created in the month of November, 140k of which was in the private sector.  The manufacturing sector added 2k jobs which was less than expected.  The big story was the unemployment rate which fell to 8.6 from 9.0 percent and the reason why we believe there is some validity to the drop in the jobless rate is because the U-6 unemployment rate which is a much broader measure of unemployment also declined to 15.6 percent from 16.2 percent.  Unfortunately Americans are making less with average hourly earnings falling 0.1 percent while hours worked remained the same at 34.3.   The data shows that job growth was basically in line with expectations especially when taking into account the 20k more jobs that were added to the October report and the unemployment rate fell to 8.6 percent, its lowest level since March 2009.  However with such a steep decline in the jobless rate, we would expect to see a much stronger reaction in the U.S. dollar and risk appetite.   Risk rallied the minute non-farm payrolls were released but reverted back to its pre-NFP levels quickly thereafter.   With most of leading indicators for non-farm payrolls stacked so heavily in favor of stronger job growth, speculators were front running the number and when payrolls were less than 125k, they were sorely disappointed.  Even though 125k was the consensus forecast, the whisper number was closer to 150k.   Yet the lack of enthusiasm to today’s non-farm payrolls report is still surprising considering how much the unemployment rate declined.  There are flaws to the household survey which generates the unemployment rate including a smaller sample set and greater volatility but at the end of the day, the decline is large enough that it should not be ignored because politicians will point to the number and pat themselves on the back for a job well done. The main takeaway from today’s report is that the labor market is slowly recovering but the pace of recovery is still not strong enough to remove the risk of a double dip in 2012.  Everything is subject to revisions and the unemployment rate could easily spike back up. Although Federal Reserve officials will be relieved to see the jobless rate decline, the level of job growth and the labor market in general is not healthy enough for them to abandon their plans to increase transparency in monetary policy next month, using language changes to make sure investors realize that they will do all that it takes to keep rates low for an extremely long time.

Next week, the dollar should trade almost exclusively as a safe haven currency because the U.S. is the only country without any significant economic reports.  Non-manufacturing ISM, factory orders, the trade balance and University of Michigan Consumer confidence reports are the only pieces of noteworthy U.S. data on the calendar and with non-farm payrolls already out, non-manufacturing ISM will not be as market moving.

GBP: CONSTRUCTION ACTIVITY SLOWS

The British pound weakened against the U.S. dollar and euro.  The monthly survey of U.K. construction purchasing managers showed slight growth in output for November, though at a slower growth rate than in October.  The construction PMI index posted 52.3, down from 53.9 in October.  The survey revealed that house building output finally increased, after a five-month contraction.  The rate of new order growth accelerated to the fastest since May, but postponed and delayed projects restricted the extent of the expansion.  The Bank of England warned that rising wholesale costs could push mortgage rates up next year.  Its Financial Stability Report revealed mortgage lending has seen profitability wane since 2009 as mortgage rates haven’t reflected rising wholesale costs.   But the central bank believes that lenders may start to pass on their higher costs of funding to borrowers next year.   BoE Governor Mervyn King blamed the downturn in the Eurozone for continuing problems at U.K. banks.  King said the U.K. banking system was in a much healthier state than many of the banking systems on the continent, but noted that if there were a downturn in the euro area, then U.K. banks would be badly affected.   Over the past three years, the Bank of England has put pressure on U.K. banks to retain earnings, increase capital, and boost liquidity buffers in low-return investments.  All this is preventative to growing lending.  Next week is heavy with economic releases for the U.K. including services purchasing managers’ index, Halifax house price index, manufacturing production, producer price index for inputs, and most importantly, the BoE will announce the interest rate on Thursday.  Expectations are for the central bank to leave rates unchanged at 0.5 percent.  However, we may see further easing in early 2012 if economic conditions continue to deteri orate and the crisis in Europe intensifies.

CAD: SECOND MONTH OF JOB LOSSES

All three of the commodity currencies weakened against the greenback today with the loonie leading the losses.  Canada, Australia, and New Zealand central banks all have rate decision announcements next week.  Weak jobs numbers from Canada drove the Canadian dollar lower for the first time in seven days.  Canadian jobs fell by a net 18,600 in November, following October’s drop of 54,000.   The unemployment rate rose for a second straight month, increasing to 7.4 percent from 7.3 percent.  The two month decline of 72,000 jobs wiped out Canada’s September surge of 61,000 jobs.  Canada, the country furthest from meeting its commitment to cut carbon emissions under the Kyoto Protocol, may save as much as $6.7 billion by exiting the global climate change agreement and not paying for offset credits. The country has the third-largest proven oil reserves and would be the first of 191 signatories to the Kyoto Protocol to annul its emission-reduction regulations.   Canada’s international reputation is at risk and the $6.7 billion cost of complying with Kyoto compares with an estimated $74.8 billion in combined budget deficits projected through the fiscal year ending March 2015.  By rejecting the accord, Prime Minister Stephen Harper is putting Canada’s economy at risk.  The Reserve Bank of Australia is set to announce its rate decision on Monday.   Economic data released lately, showing consumer spending slowed and building approvals dropped, strengthens the case for interest rate cuts but not as quickly as next week.  An index of Chinese manufacturing indicated a contraction for the first time since February 2009.  China is Australia’s largest trading partner and New Zealand’s second-biggest export destination.  However, housing and the consumer are still a very large part of the Australian economy and for this reason we anticipate dovish comments from the RBA.   Australia’s biggest banks were downgraded by Standard & Poor’s as the ratings company applied its revised criteria to Asia-Pacific financial institutions.  Yet the banks are still in the AA band, and remain among the highest rated banks globally.  The costs of credit-default swaps on the four banks were unchanged after the announcement.  On the docket for New Zealand next week is the interest rate decision, manufacturing sales, and the REINZ house price index.  Expectations are for the Reserve Bank to leave rates unchanged at 2.5 percent.

USDJPY TRICKLES HIGHER ON STRONGER US DATA

The Japanese yen lost ground to the U.S. dollar while gaining on the euro, British pound and Swiss Franc. With the U.S. economy showing signs of improvement, USD/JPY tested the 78 handle during the early North American session. However, as the market turned back to the looming European crisis, the yen provided security to risk-averse traders.  The declining global demands were reflected at the latest capital spending report published by the Ministry of Finance. In Q3, capital investment among Japanese businesses dropped by 9.8 percent compared to Q3 of last year. While Japanese firms showed strong resilience in bouncing back from the March disaster, the faltering global economy recovery pointed to a murky forecast. The pessimism added to the argument for a downward revision in the nation’s Q3 GDP figure due out on December 9 ^th . To battle the slow recovery, some officials support a more aggressive role for the Japanese government. Yukio Edano, the Minister of Economy, Trade and Industry said that the country should turn to offensive policies and come up with a strong Japanese economy which is in balance with a strong yen. The trade minister urged the country to adopt a new type of economic and industrial policies with the focus on demand creation. He suggested that Japan would create new industrial areas to stimulate the potential demand, win the global demand and improve its energy productivity. Nonetheless, the country’s economy remains vulnerable to the shifts in global demand in the short and medium term. Without the much needed resolution from the European leaders, the Japanese yen could appreciate further amid the increases in risk-aversion flows. Looking forward to next week, in addition to Q3 GDP number, we also expect leading index, machine orders, and trade balance reports on Wednesday, followed by Eco Watcher survey on Thursday.

GBP/USD: Currency in Play for Next 24 Hours

GBP/USD will be our currency pair in play for Monday. From the U.K., we expect Services PMI at 4:30 AM ET/ 9:30 GMT. From the U.S., we expect the ISM Non-Manufacturing index and factory orders at 10:00 AM ET/ 15:00 GMT.

While GBP/USD gave back some of its gains from earlier this week, the pair remained the in the range-trading zone which we determined using the Bollinger Bands. The nearest support sits at the lower first std. dev. Bollinger Band, 1.5546. Any further decline, GBP/USD could see major support at 1.5272, the pair’s swing low in October. On the flip side, the 20-day SMA could contain the pair’s rally at 1.5740. Further up, GBP/USD could see significant resistance at the 61.8% Fibonacci level – 1.5880. We drew our Fibonacci retracement from the low in December 2010 to pair’s YTD high in April.

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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.