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FX: Waiting With Bated Breath

Last updated 12/6/2011 4:35 PM ET (GMT -5) 2 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• FX: WAITING WITH BATED BREATH
• USD: NO MAJOR DATA, RISK CONTINUES TO DRIVE FLOWS
• GBP: SIGNS OF WEAKER CONSUMER SPENDING
• CAD: SOARS AFTER BOC RATE DECISION
• NZD: RBNZ COULD RETRACT PLAN FOR RATE HIKE
• AUD: PRESSURED BY 25BP RATE CUT
• JPY: MORE ECONOMIC DATA TO FOLLOW

EXPECTATIONS FOR UPCOMING FED MEETINGS

FX: WAITING WITH BATED BREATH

**Next Publication will be Jan 9th.

Investors around the world, currency traders included are waiting with bated breath for Thursday’s EU Leaders Summit to begin.  Most of the major currencies have consolidated with the EUR/USD ending the North American trading session unchanged for the second day in a row. A lot hinges upon the outcome of this week’s Summit and even though it was obvious that the EFSF rating was at risk after Standard & Poor’s put nearly all of the Eurozone nations on credit watch, the stakes were increased even further by their official warning that a downgrade of any Eurozone nation could lead to a downgrade of the European Financial Stability Facility.  The EFSF is all that the Eurozone has right now.   Currently backed by the guarantee commitments of six AAA rated governments, the EFSF’s credit rating is an important element of the fund’s success.  If it loses its AAA rating, we could be headed for another slippery slope because a lower rating would mean higher borrowing costs which puts greater burden on other Eurozone nations and endanger their own ratings.  This risk can be mitigated if EU Leaders announce on Friday that they have amped up the firepower of the EFSF to more than 1 trillion, agreed to change the Treaty to allow for the introduction of Eurobonds and have convinced the ECB to lend to weaker Eurozone nations through the IMF.   Of course this is wishful thinking because European officials have not made enough progress to make any of these options possible by Friday.  If we are lucky, they will hint that a solution is in the works but at best, we are looking at an agreement on automatic sanctions for any nation breaching the budget deficit and the sparing of private bond holders to future haircuts.   The EU Leaders Summit is not the only volatility inducing event risk for the EUR/USD this week.  The European Central Bank has a monetary announcement Thursday morning and interest rates are expected to be cut by 25bp to 1.00 percent.   With the tensions in the financial markets remaining at such elevated levels, the central bank could come to the rescue by easing monetary policy even further.  Last week, ECB President Draghi said it was the central bank’s responsibility to ensure inflation did not undershoot their target of just below 2 percent, which suggests that he supports lower rates.  The central bank could also extend unlimited short term loans to banks along with extending longer term facilities.  The bottom line is that the ECB has the capability to do a lot more and investors are waiting with bated breath to see how far they are willing to go on Thursday.  In our opinion, they will offer some support to the region but hold back the rest of their ammunition until after the EU Leaders Summit.  German factory orders increased more than expected in October which bodes well for tomorrow’s industrial production report.   Unfortunately IP is not exceptionally market moving and for this reason, we could see more consolidation in the EUR/USD ahead of Thursday’s ECB and EU Leaders meetings.

Meanwhile Swiss consumer prices fell for the second month in a row and the fifth time in the past six months. On an annualized basis, this was the largest decline in CPI in more than 2 years.  With the decline in inflationary pressures, the Swiss National Bank is expected to increase its EUR/CHF peg at their next monetary policy meeting later this month. When the SNB first introduced the EUR/CHF peg, we began to see improvements in Switzerland’s economy.  However since then, economic data has taken a turn for the worse, pressuring the Swiss National Bank to take additional steps to stimulate the economy.

USD: NO MAJOR DATA, RISK CONTINUES TO DRIVE FLOWS

Despite the rally in the Dow Jones Industrial Average, the performance of the U.S. dollar was mixed.  The greenback traded higher against the euro, British pound Swiss Franc and Australian dollar but weakened against the Japanese Yen and Canadian dollar. No U.S. economic reports were released today and Fed President Tarullo avoided any mention of the economy and monetary policy. Meanwhile U.S. Treasury Secretary Timothy Geithner supported a German-French effort to create closer economic cooperation in Europe and urged policy makers to work with central banks to create a “stronger firewall” to end the debt crisis.  Geithner spoke in Berlin today and praised commitments to reform programs from Spain, Italy and Greece.  He said that governments and central banks must work together to overcome the debt crisis and restore investor confidence in the region.  However, he refused to comment on what the ECB should or should not do; he only noted that the central bank has played a central role in the crisis and is going to continue to do so.  Democrats in the Senate will seek another vote on a payroll tax cut for workers this week in an attempt to pressure more Republicans to support an extension into 2012.  Legislation proposed by Senate Democrats yesterday would cut the payroll tax paid by employees to 3.1 percent next year from the current 4.2 percent. The $185 billion cost would be offset by a new 1.9 percent surtax on annual incomes exceeding $1 million and by raising the fees charged to lenders by government-owned mortgage giants   Fannie Mae and   Freddie Mac.   Currently there seems little chance that this proposal will pass as only one of seven Republicans needed have expressed support.  President Obama said Republicans would be “leaving 1.3 million Americans out in the cold” next month if they allow the payroll tax cut to expire.  The Federal Reserve Bank of New York entered into paired contracts to buy and sell mortgage securities for the first time since it began reinvesting in the debt in October, in a move that may reduce funding costs.  The so-called dollar roll transactions may be aimed at lowering financing costs for mortgage-bond investors as banks trim their balance sheets before year-end.  The central bank began   reinvesting   proceeds from its holdings of $1.4 trillion in housing debt into government-backed mortgage bonds to help support the real-estate market and homeowner refinancing, shifting from additional purchases of Treasuries.  With no major U.S. economic reports scheduled for release over the next 24 hours, the focus will remain on Europe.  The most important thing to remember for the U.S. is that so far, none of the upside surprises in U.S. data have been significant enough to convince Federal Reserve officials to abandon their plans to ease monetary policy.  With this in mind, the driving force for the dollar this week will continue to be risk appetite.

GBP: SIGNS OF WEAKER CONSUMER SPENDING

The British pound traded lower against the U.S. dollar and the euro as the pace of decline in retail sales and house prices accelerated. According to the BRC Retail Sales monitor, consumer spending was 1.6 percent lower from November 2010 and the worst growth since May.   Weak sales suggest consumers are keeping a tight rein on their spending, despite Christmas being so near.   November’s mild weather contrasted with much lower temperatures last year, hitting sales of winter clothing and footwear particularly hard.  The Halifax house price index also showed dismal results as the price of an average home fell by 0.9 percent in November, after increasing 1.2 percent in October.   The average price of a U.K. home now is only marginally lower than at the end of 2010.  In addition, activity has recently shown a few signs of strength.   The market should remain broadly unchanged over the coming months as demand and supply conditions barely change.   The Bank of England intends to investigate how bankers’ pay is calculated and how banks work out how much capital to hold against certain types of assets as part of its efforts to safeguard financial stability.  Minutes published today of the Financial Policy Committee’s November meeting show that policy makers are concerned that the use of measures like return on equity to assess banks’ performance and determine bankers’ pay may skew incentives for staff and investors and may discourage managers from raising much-need capital.  The Bank of England introduced a new sterling liquidity facility to address potential financial-market strains as Europe’s sovereign debt crisis intensifies.  The central bank announced the move “in light of the continuing exceptional stresses in financial markets,” it said in a statement in London today. “This facility is designed to mitigate risks to financial stability arising from a market-wide shortage of short-term sterling liquidity.”  Essentially the Bank of England created a backstop to insulate itself in the case of a European meltdown.  U.K. real estate investment trusts will be more vulnerable to takeover by investors from outside of the country under new rules being proposed for the tax-exempt companies.  These changes will support more cross-border mergers and acquisitions activity.  The U.K. Treasury plans to propose a draft law today that will allow British units of overseas companies to qualify for REIT tax exemptions by loosening regulations on ownership and stock-exchange listings.  Industrial production numbers will be released tomorrow and unfortunately manufacturing activity is expected to have weakened.

CAD: SOARS AFTER BOC RATE DECISION

The Canadian and New Zealand dollars appreciated against the greenback while the Australian dollar lost value.  The loonie was one of the day’s best performing currencies and its strength can be attributed entirely to the positive comments from the Bank of Canada and stronger manufacturing activity.  The BoC’s decision to hold rates steady was in line with the market's expectations but the central bank's tone was surprisingly optimistic.   With second half growth in Canada and the U.S. slightly strong than expected, the BoC did not share the same degree of pessimism as the Fed and other central banks.   They acknowledged that the troubles in Europe are more pronounced than anticipated which could have negative spillover effects on the U.S economy.   However with inflationary pressures slightly stronger than forecast, the BoC did not feel the need to grow more dovish and the fact that they did not even hint about the possibility of lower interest rates was enough to send the CAD sharply higher.  Gains in the loonie were compounded by the IVEY PMI index which rose to 59.9 from 54.4 in the month of November. The Australian dollar on the other hand remained pressured throughout the North American trading session after the Reserve Bank cut interest rates by 25bp for the second month in a row.  Tomorrow afternoon the Reserve Bank of New Zealand will be making its own monetary policy announcement.  Expectations are for the RBNZ to keep the official cash rate steady at 2.50 percent.  The RBNZ is likely to revise its growth and rates trajectories lower on the back of weaker Q2 GDP, recent softening in NZ leading indicators and continued elevated global uncertainties and bank funding stress.   Since the last monetary policy meeting, business confidence has recovered from a five-month low while building consents bounced back from the worst contraction in six months.  However at the time, the RBNZ signaled an intention to raise rates and given how the global economy has performed since then, we expect the central bank to retract this comment.

JPY: MORE ECONOMIC DATA TO FOLLOW

The Japanese yen strengthened against most of the major currencies today after Standard & Poor’s said it may cut the long-term credit ratings of Germany, France and 13 other members of the euro, spurring demand for the relative safety of Japanese assets.  No new economic data was released from Japan today.   Demand for the Bank of Japan’s dollar loans surged 25 times after six central banks cut borrowing costs for the U.S currency last week to ease credit amid Europe’s sovereign debt crisis.  The BOJ said today it accepted all the bids for its seven-day dollar loans totaling $25 million, the most since March, and will charge borrowers a fixed rate of 0.6 percent.  The cut in rates is clearly the reason for the increase in bids when compared with the total of $1 million in bids to borrow last time it offered one-week dollar loans at 1.08 percent on November 29 ^th . The Bank of Japan posted to its website the text of a speech Deputy Governor Yamaguchi delivered at the JCIF International Finance Seminar on November 22.  It is titled ‘Recent financial and economic developments and challenges of revitalizing Japan’s economy.’  The speech highlighted Japan’s downtrend in growth rates which could be further exacerbated by worsening demographics. Yamaguchi noted “the pace of decline in the working-age population is projected to further accelerate” in the medium- to long-term for Japan.   On the docket tomorrow are leading indicators, core machinery orders, and the current account balance for the month of October.  Machinery orders are expected to be positive following an 8.2 percent decline in September as firms continue to near the end of recovery efforts from the earthquake.

NZD/USD: Currency in Play for Next 24 Hours

NZD/USD is our currency pair in play for Wednesday.  No major U.S. economic reports are scheduled for release but the Reserve Bank of New Zealand will announce its interest rate decsion at 3:00 PM ET / 20:00 GMT.  Then at 4:45 PM ET / 21:45 GMT, New Zealand will release manufacturing activity for the third quarter.

NZD/USD has recovered most of its losses over the past month and is currently trading range-bound, which we determined using Double Bollinger bands.  Nearest support may be at 0.7640, where the 10- and 20-day SMAs converge.  Should the pair fall through that level, significant support may be found at 0.7498, where the lower first standard deviation Bollinger band lies.  If the pair trends higher, first resistance may be at 0.7800, where the 50% Fib level rests.  We drew our Fibonacci retracement from the high on October 28 to the low on Novemebr 25.  Should the pair break out of this level, heavy resistnace may be found at 0.8000, which is psychologically significant and where the 200-day SMA lies.

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Comments (2)

Thai

December 07, 2011 at 10:06 PM ET

Hi Kathy

Have a good vacation
We are waiting for you

Thai

moonie

December 12, 2011 at 12:33 PM ET

I miss your insights. Have fun.

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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.