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THE STORIES IN THE CURRENCY MARKET

• EUR: REALITY CHECK FROM S&P KILLS RALLY
• USD: THE NEED FOR SAFETY
• GBP: SERVICE SECTOR ACTIVITY RISES, BUT STRENGTH BENEATH HEADLINES
• AUD: WILL THE RBA EASE?
• CAD: DOVISH COMMENTS EXPECTED FROM BOC
• NZD: COMM DOLLARS HOLD ONTO GAINS
• JPY: SLOWER CHINESE GROWTH TO HURT JAPAN

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%

EUR: REALITY CHECK FROM S&P KILLS RALLY

It has been another busy day for the euro, which traded as high as 1.3485 against the U.S. dollar only to reverse and end the day virtually unchanged.   The problem for the EUR/USD is that every rally has been triggered by nothing more than blind optimism.   When policymakers show any inkling of willingness to cooperate, investors jump back into risky assets regardless of how much of a challenge it will be implement any of the changes.   Then someone says or does something that drags them back to reality and they realize that the Europeans are on a race against time that they could lose because Treaty changes won’t be quick or easy.    The EUR/USD traded higher throughout the first half of the North American trading session after Merkel and Sarkozy said they both support a Treaty change that would impose automatic sanctions on European nations breaching the budget deficit limitations.   Their united front was warmly received by the market as it is essential in paving the way for a more sustainable deficit reduction plan in Europe.   Investors also cheered their agreement that losses imposed on private bond investors would be limited to Greece and not imposed on bondholders of other countries.   Unfortunately the rally in the euro evaporated once the Financial Times and the Wall Street Journal reported that Standard & Poor’s has put the entire Eurozone on watch for downgrade. Shortly after the NY close, S&P confirmed that they put 15 European nations on Credit Watch negative watch.   The only ones spared any changes were Greece and Cyprus. Being put on credit watch negative means there is a 50 percent chance of a downgrade in the next 90 days.   We have previously warned to our readers repeatedly that the greatest near term risk for the euro are downgrades by rating agencies. S&P’s announcement could be aimed at pressuring European leaders for a solution on Friday but we doubt their actions are so noble.   Instead, they are seriously worried about the capability of EU Leaders to come up with a rescue plan that could permanently reverse the rise in European bond yields.   Ten year Italian bond yields fell significantly today, settling below 6 percent but if the Dec 8-9 talks fail to result in any tangible actions, yields could rise once again, pushing S&P to follow through with their threats.   European leaders know that there is a lot at stake and for Germany and France, losing their AAA rating would be disastrous because it would affect not only their own borrowing costs but would also lower rating of the European Financial Stability Facility.   What investors want is a hard number this week – they want to know exactly how much European nations are wiling to commit to prevent contagion and save the region.   The rumor mill was on full blast today with talk of the Fed and 17 central banks from Europe providing a triple digit billion dollar loan to the IMF and the ECB working on a trillion dollar intervention plan for the European bond market. We won’t know if there is any merit to these claims but at this point, investors will not be satisfied with anything less than a clear euro or dollar commitment from the Europeans. 

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USD: THE NEED FOR SAFETY

With stocks extending their gains, safe haven flows eased out of the U.S. dollar, pushing it lower against all of the major currencies.   This morning’s U.S. economic data were disappointing, particularly after Friday’s better than expected non-farm payrolls report and last week’s manufacturing ISM numbers.   Service sector activity expanded at a slower pace in November according to the non-manufacturing index, which slipped to 52.0 from 52.9.   The decline was not material but the rise in job growth last month, the strong Black Friday / Cyber Monday sales and increase in manufacturing activity had everyone looking for stronger service sector ISM.   Unfortunately the employment component of the report declined along with imports and backlog of orders.   New orders, inventories and export orders on the other hand increased, keeping the index from an even deeper pullback.   Factory orders also declined 0.4 percent in October, which was more than expected.   Reports such as these confirm that the U.S. economy is not out of the woods and explains why Federal Reserve officials continue to scream for more transparency and in some cases, easier monetary policy.   Fed President Evans spoke this morning and said further monetary stimulus cannot be ruled out. As a voting member of the FOMC, his views matter more than some other Fed officials.   Like many other central banks around the world, the outlook for the U.S. economy and the financial markets in general hinge upon how European policymakers handle the debt troubles in Europe.   With very little in the way of market moving economic releases on the U.S. calendar, the main driving force for the dollar will be risk.   If investors focus more heavily on the potential for downgrades in Europe, the dollar could gain traction quickly.   

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GBP: SERVICE SECTOR ACTIVITY RISES, BUT STRENGTH BENEATH HEADLINES

Stronger economic data and an improvement in risk appetite drove the British pound higher against the U.S. dollar.   Service sector activity accelerated in the month of November due to higher input prices, rising volume of incoming work and more advertising / marketing. Although the PMI index of services rose from 51.3 to 52.1, the details of the report were far less encouraging.   The new business and future business indices declined along with the growth in new orders, which unfortunately points to weaker activity going forward. The employment component of the report also dropped to its lowest level in 15 months.   The only thing keeping the sector from a deeper contraction is next year’s Olympic games in London, which should contribute positively to consumer demand, tourism and overall economic activity.   With that in mind however, the U.K. is feeling the pain of slower global growth and for this reason, the Bank of England will remain cautious.   Like the ECB, the BoE also has a monetary policy announcement on Thursday and even though rates are expected to remain unchanged, when the minutes are released, they will most likely show growing concern within the central bank.   Despite today’s rally in the GBP/USD, the currency pair is making lower highs and potentially lowers lows as well which suggests that today’s rally may not last.   EUR/GBP on the other hand has been stuck in an 80 pip range for the past week and this shows how intimately tied the pound’s fate is to the euro.

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AUD: WILL THE RBA EASE?

Two of the three commodity producing countries will be holding a monetary policy meeting over the next 24 hours and the market expects one to ease.   The Reserve Bank of Australia is expected to cut interest rates by 25bp to 4.25 percent.   Although the Australian economy is in much better shape than other economies, the RBA is in precautionary mode and with the situation in Europe still very uncertain, the majority of economists expect the RBA to cut.   In our opinion, a rate cut is not a done deal.   There have been signs of weakness in the Australian economy including last night’s service sector activity report and the Treasury recently slashed their economic forecasts significantly, but the last rate cut was seen only as insurance because the RBA statement contained positive comments about the terms of trade.   We do believe that the RBA will ease again but are skeptical about whether back to back rate cuts are necessary.   They may find it more prudent to wait for the outcome of the EU Summit before deciding just how aggressive they need to be.   There is no question that the RBA will be dovish and express greater concern about the outlook for Australia but they could forgo a rate cut, which would be initially positive for the Australian dollar.   In fact, the rally in the AUD/USD today could reflect prepositioning ahead of the RBA announcement. Meanwhile the Bank of Canada is expected to leave rates unchanged at 1.00 percent.   The labor market in Canada has deteriorated and inflationary pressures have eased but having just removed a reference to withdraw stimulus from their monetary policy statement in October, the BoC is in more of a neutral than easing bias.   The Canadian dollar is also trading higher ahead of the BoC rate announcement.   We don’t expect much from the BoC but Carney’s comments are still worth watching to see if the recent turn of events has made him more dovish.   Without any major economic reports on the calendar and stocks edging higher, the New Zealand dollar appreciated against the greenback as well.    @import url(/css/cuteeditor.css);

JPY: SLOWER CHINESE GROWTH TO HURT JAPAN

An improvement in risk appetite has driven the Japanese Yen lower against most of the major currencies.   The outperformance of the Yen against the greenback shows that investors prefer dollars over yen in times of uncertainty and when they feel less pessimistic like today, they will sell dollars more aggressively.   No major Japanese economic reports were released overnight.   This is a relatively quiet week for Japan and for this reason, the Yen will trade almost exclusively based on risk.   There are a few pieces of Chinese economic data on the calendar that could affect how investors feel about the Asia Pacific region in general.   Chinese service sector activity for example expanded at a slower pace in the month of November and because Japan counts China as one of their most important trading partners, slower growth for China could raise concerns about slower growth in Japan.   Later this week, Chinese retail sales, industrial production and inflation numbers will be released. Most of these economic reports are expected to reflect slower growth which does not bode well for an export dependent country like Japan.   Last week, USD/JPY enjoyed a bit of rally that will make Japanese officials feel less worried about the need for intervention.   Although the current levels of the Japanese Yen is difficult to bear for many Japanese corporations, forcing them to seriously consider building more production facilities overseas to limit currency risk, the Japanese government also knows that unilateral intervention rarely works and now is not the right environment to ask other central banks for help because they are far too occupied on the greater problems in Europe.    

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AUD/CAD: Currency in Play for Next 24 Hours

Our currency pair in play for the next 24 hours will be the AUD/CAD.   Australia will be releasing its current account numbers at 7:30 PM ET / 00:30 GMT and this will be followed by the Reserve Bank’s monetary policy announcement at 10:30 PM ET / 3:30 GMT.   Canada also has a monetary policy announcement at 9:00 AM ET / 14:00 GMT followed by the IVEY PMI report at 10:00 AM ET / 15:00 GMT.  

 

The uptrend in AUD/CAD has been renewed by last week’s rally and the currency is not reentering an uptrend according to our Double Bollinger Bands.   The rally appears poised to continue but last week’s high 1.0525 should serve as resistance.   If this level is broken, 1.06 could come in as a more signficant level.   If the rally fades, AUD/CAD should find support at 1.03, where we have the 10 and 100-day SMA converging.   

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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.