What is the Dollar and Gold Rally Telling Us?

Last updated 2/17/2009 5:03 PM ET (GMT -5) 0 Comments - Add your comment

Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• WHAT IS THE DOLLAR AND GOLD RALLY TELLING US?
• EUR/USD: TIME BOMB WAITING TO EXPLODE
• GBP/USD: GEARING UP FOR QUANTITATIVE EASING
• AUD/USD: PLUMMETS AS CENTRAL BANK SIGNALS MORE EASING
• USD/CAD: OIL PRICES AT $34.95
• NZD/USD: GOLD PRICES HIT 7 MONTH HIGHS
• USD/JPY: RISES AS JAPAN’S TROUBLE GROWS

EXPECTATIONS FOR UPCOMING FED MEETINGS

WHAT IS THE DOLLAR AND GOLD RALLY TELLING US?

Capital flight has driven the US dollar higher. On a day when President Obama signed the Economic Stimulus Package into law, the banking turmoil in Europe and the resignation of Japan’s Finance Minister has turned investors away from other major currencies. Even though the greenback is yielding next to nothing, investors are willing to park their money with the US government as long as they keep it safe. The lack of negative game changing news from the US has been very positive for the US dollar. The greenback and gold prices have been moving in tandem since January 14th. This unusual correlation is actually sending a strong message to currency traders.

The Dollar and Gold Rally

It is not very often that we see the US dollar and gold prices move in the same direction. Since gold is priced in dollars, the value of the yellow metal tends to fall when the dollar rises and rise when the dollar falls. However this has not been the case since January 14th as the rally in the US dollar corresponds with the rise in gold prices, which closed today at a 7 month high of $970 an ounce. The last time we saw this traditionally negative correlation turn into a positive one was in 1982. At that time, recession hit many countries including the US. Although the rise in gold prices can be partially attributed to future inflation problems, the cohesive movement in the value of gold and the US dollar suggests that central banks around the world are losing credibility. There are growing concerns that a time bomb could explode in Europe leading to more troubles for the region as a whole. If that is the case, there may not be any safer form of investment than gold. The rally in the US dollar and gold is telling the market that investors are worried about global economic stability outside of the US and therefore they are preparing for the worst.

Stimulus Package and Economic Data Fails to Help

The official announcement of the Economic Stimulus Package helped lift equities off their lows temporarily but was not enough to restore investor confidence. The same was true for the s tronger Treasury International Capital flow report and the rebound in the NAHB housing market index. Having been at a record low last month, the increase was mild at best and does not reflect a turnaround in the housing market. Manufacturing conditions in the NY region fell to the lowest level ever suggesting similar weakness for activity in the Philadelphia region, which will be reported later this week. Import prices, housing starts, building permits and industrial production are due for release on Wednesday. Given warnings from Federal Reserve President Bullard, disinflation and possibly deflation is one of the key risks for the US economy in 2009, import prices should remain soft. Signing the Economic Stimulus Package into law has not helped to stabilize the financial markets and therefore more liquidation in currencies and equities is possible this week.

EUR/USD: TIME BOMB WAITING TO EXPLODE

The Euro fell to a 2 month low against the US dollar on fear that the region is a time bomb waiting to explode. The big story in the financial markets today is the exposure of Western European banks to Eastern European nations. Austria, Sweden, Greece, Italy and Belgium own approximately two thirds of all Eastern European loans. Should any of these nations default on their loans, there could be a domino effect that hits the region as a whole. Polish companies are already suffering greatly from losses on foreign exchange derivative contracts while Ireland is at risk of defaulting on their debt. As a member of the Eurozone, if Ireland defaults, it will mean a massive exodus out of Euros. Furthermore Germany the largest economy within the Eurozone will be faced with the tough decision of whether or not they should help struggling member countries. The Maastricht Treaty forbids Germany from doing so, but Ireland’s default will impact the value of the Euro and confidence in the region as a whole. Even if Ireland does not default, that still leaves the risk of Eastern European nations failing to pay back their loans. If Western European banks get hit with defaults, they will be forced to report major losses or write downs, which could erode their share values and put them at risk as well. The region is intertwined in many ways and the domino effect of a default will send ripples across the region. The German ZEW survey was stronger than expected which was a bit of a surprise considering the dismal outlook for the economy.

GBP/USD: GEARING UP FOR QUANTITATIVE EASING

On a day when there has aggressive selling of all high yielding currencies, the British pound is only modestly lower. Although consumer prices dropped to a 9 month low, the decline was smaller than the market had anticipated. Bank of England officials continue to credit a weak currency for helping the economy as Deputy Governor Charlie Bean puts his weight behind the currency’s recent decline. The minutes from the most recent Bank of England meeting are due for release on Wednesday. After the dovish quarterly inflation report, we fully expect a similar tone at the February meeting. The Bank of England cut interest rates by 50bp to 1 percent earlier this month. More rate cuts are expected as Bean confirmed that the central bank will start buying government bonds to help the economy – in other words, Quantitative Easing. Bank of England Governor Mervyn King also stated that the bank may need to inject money into the economy if the inflation falls below 2%. King further elaborated that the bank will need to extend the money supply by buying government and corporate bonds, as the bank projects inflation to fall to 0.5% by the end of 2010.

AUD/USD: PLUMMETS AS CENTRAL BANK SIGNALS MORE EASING

The close to 300 point sell-off in US equities has triggered a massive wave of risk aversion that has driven the Australian, New Zealand and Canadian dollars significantly lower. Commodity prices were mixed with gold surging to a 7 month high while oil prices dropped 6.8 percent to $34.95 an ounce. The Reserve Bank of Australia in their latest minutes hinted that interest rates, which currently stand at a 45 year low, will likely to be reduced further in order to prevent the economy from slipping into a recession as global demand contracts. The RBA expects the economy to expand by 0.5% as fiscal and monetary policy compensate for the lack of exports, while a moderate rise of unemployment in the upcoming fiscal year should also be expected. This evening, Australia is set to release Leading Indicators, Retail Sales and BoP Imports which could add pressure on the Australian dollar. With a lack of economic data and disappointing releases at the beginning of the week, the New Zealand currency could be largely affected by a move towards risk aversion. Finance Minister Bill English stated that the New Zealand economy will contract for the 5th consecutive quarter as lack of demand from major trading partners affects the economy. English stated that export prices are a major risk while zero growth is expected from their trading partners. There was also no economic data from Canada but Prime Minister Stephen Harper indicated that he is willing to help out struggling General Motors with long term funding in order to save manufacturing jobs within Canada. Canada will be releasing wholesales sales tomorrow which are expected to fall as businesses and consumers cut back spend.

USD/JPY: RISES AS JAPAN’S TROUBLE GROWS

The Japanese Yen has strengthened against all of the major currencies outside of the US dollar. In the past, risk aversion has led to broad based demand for the low yielder, but today, growing problems in Japan boosted investor demand for US dollars over the Japanese Yen. This morning, Shoichi Nakagawa resigned as Finance Minister of Japan this morning and he will be replaced by Kaoru Yosano, the current Economics Minister who will hold both posts. Japan has been plagued with political and economic problems. Prime Minister Aso is considered a lame duck and the resignation of his Finance Minister has dealt a further blow to his approval ratings. Earlier this week, Japan reported the largest contraction in growth in 34 years. As the Yen continues to rise, the problems in Japan will exacerbate.

GBP/USD: Currency in Play for Next 24 Hours

The currency in play for the upcoming 24 hours will be GBP/USD due to the release of Bank of England Minutes at 9:30GMT or 4:30AM EST. Later in the day, U.S. is expecting the release of Import Price Index as well as Housing Starts figures at 13:30GMT or 8:30AM EST. Due to a lack of momentum in either direction, GBP/USD is currently trading within Range Trading Zone established through the Bollinger Bands. With the pair in a discrete downtrend in the intermediate to longer timeframes, resistance is originating at 1.4610 which is a 1st Standard Deviation as well as 50-day SMA. The downtrend could resume if the support is broken which is structured around 1.4000. The support level represents a psychological level along with a 1st Standard Deviation of the Bollinger Bands, a break of which would place the pair into the Sell Zone.

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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.