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EUR: Rally Losing Momentum?

Last updated 1/17/2012 5:05 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

• EUR: RALLY LOSING MOMENTUM?
• USD: STRONGER MANUFACTURING ACTIVITY
• GBP: INFLATIONARY PRESSURES BEGIN TO EASE
• CAD: COMFORTABLY ON HOLD
• AUD: OIL AND GOLD HIGHER
• NZD: NEW 2 MONTH HIGH
• JPY: KEEPS ECONOMIC ASSESSMENT UNCHANGED

EXPECTATIONS FOR UPCOMING FED MEETINGS

EUR: RALLY LOSING MOMENTUM?

The euro may have ended the North American trading session higher against the U.S. dollar but the rally is losing momentum.  After a completely illogical reaction to the downgrades by Standard & Poor’s, EUR/USD traders may finally be waking up to the troubles that lie ahead for the Eurozone. We have previously pointed out that even though the downgrades may have been expected by some traders, the impact on borrowing costs will place an undue burden on troubled nations, pushing them to the brink of default. In fact, one of the biggest stories today was the growing possibility of a default by Greece who will be holding discussions with their creditors on January 20 ^th . If the discussions do not go well and additional aid is not disbursed, the country could default on its March loan payments as predicted by rating agency Fitch. Hungary is in its own mess with the European Union threatening to sue the government for trying to sway the central bank. With 80 percent of its exports destined for the EU, the country has been deeply affected by the region’s debt crisis. The country is currently in talks with the IMF for a bailout package but according to the European Bank for Reconstruction and Development, Hungary will not receive the package that they want. Instead, any aid will come with a number of harsh conditions.   The downgrades have continued with Standard & Poor’s slashing the ratings of European banks and insurers. It is our opinion that the crisis will only intensify, forcing additional actions by European policymakers. There have been reports by the Financial Times that the ECB could be contemplating its own large scale asset purchase program that would extend beyond sovereign debt. Whether this is true remains to be seen but it is an example of the desperate measures that European officials are most likely considering at this time. The fading rally in the EUR/USD today suggests that investors are beginning to realize that things could get a lot worse before they improve in the Eurozone.   Even though the ZEW survey showed an improvement in investor confidence, the survey was taken before the downgrade.   The only saving grace for the EUR/USD will be bond auctions. Despite a two notch downgrade, today’s Spanish bill auction went fairly well. Spain sold its bonds at a lower yield which implies that the downgrade did not raise the country’s borrowing costs. Before turning too optimistic however, short term bonds can be sold more easily than long term bonds. Thursday’s 10 year bond auction will be a far more important test of investor confidence. If those auctions go well, then perhaps the downgrades really did not spook investors out of buying euros.

USD: STRONGER MANUFACTURING ACTIVITY

Safe haven flows eased out of the U.S. dollar today, driving it lower against all of the major currencies. There are a number of U.S. economic reports scheduled for release this week and even though some numbers such as Consumer Prices are extremely important to the Federal Reserve, none of the reports are expected to show enough improvement or deterioration to have material effect on Fed policy. The central bank is currently on hold with a bias towards more stimulus and this game plan will not change unless there are consecutive months of improvement in the U.S. economy. A good example is today’s manufacturing sector report which contributed little to the risk rally. The Empire State manufacturing index rose from 8.198 to 13.48 in the month of January, a sign of positive momentum in the manufacturing sector. When the number was released the dollar barely budged against the Japanese Yen. Instead, Chinese economic data had a far greater impact on risk appetite and the U.S. dollar because the world is still banking on steady demand from Asia. The economy slowed in the fourth quarter but not by as much as economists had feared. Retail sales also grew at a faster pace in December which collectively indicates that the economy ended the year on firmer footing. For the central bank, this reduces the need for easier monetary policy and for the world a soft landing is far more palatable than a hard crash, particularly at this vulnerable time in the global economy. Producer prices will be released tomorrow along with the Treasury International Capital flow report, industrial production and the NAHB housing market index. With the dollar benefitting significantly from safe haven flows, we expect the TIC data to show strong demand for the greenback. Inflationary pressures on the other hand are expected to slow but it may be offset by a rise in industrial production.

GBP: INFLATIONARY PRESSURES BEGIN TO EASE

The British pound gave up all of its earlier gains to end the day unchanged against the U.S. dollar. Weaker inflation numbers prevented sterling from holding onto its gains and kept it under pressure against the euro. Consumer prices grew 0.4 percent in December but on an annualized basis, CPI growth slowed to 4.2 from 4.8 percent. Over the past year, the central bank has argued that the increase in price pressures were temporary and would fade quickly when the VAT increase starts to drop out of the inflation rate. Based upon the drop in year over year CPI, their projections have been accurate, validating their prior decision to ease monetary policy. As the global economy faces more headwinds in 2012, inflation in the U.K. could drop even further, giving the central bank ample flexibility to ease monetary policy as they deem fit. At 4.2 percent, inflation is still well above the Bank of England’s 2 percent inflation forecast and 3 percent pain threshold, but as long as prices are moving down and not up, the central bank will have no qualms about increasing their asset purchase program. In fact, the last time the BoE raised their Quantitative Easing Program was when CPI was running around 5 percent. As a result, we expect the minutes from last week’s monetary policy meeting to show a central bank still looking to provide additional support to the economy. U.K. employment figures will be released tomorrow where jobless claims could rise slightly. According to the PMI reports, there have been no major improvement or deterioration in the labor market and for this reason the unemployment rate should remain unchanged at 5 percent. 

CAD: COMFORTABLY ON HOLD

All three commodity currencies appreciated against the greenback thanks to better than expected economic data around the world and an overall improvement in risk appetite. The Bank of Canada left interest rates unchanged at 1 percent and according to the tone of the monetary policy statement they are comfortably on hold for the time being. They upgraded their growth forecasts for 2012 which means they are looking for a stronger, “more modest recovery” but they are in no rush to raise interest rates because the outlook for the global economy has deteriorated while uncertainty has increased since the last monetary policy statement. In fact, it can even be argued that the central bank toned down their optimism this month. Regardless of whether this is true, because it is still unclear, we do know that the Bank of Canada is comfortably on hold and will probably remain so for the next few months. Meanwhile foreign demand for Canadian dollar denominated securities was very strong in November, which is a sign that some investors may have sought safety in the loonie. No economic data was released from Australia but weaker credit card spending and deterioration in business opinion failed to dent the rally in the New Zealand dollar. NZD/USD climbed to its highest level in 2 months, stopping right at the 200-day SMA. Australian consumer confidence numbers will be released this evening followed by new motor vehicle sales.

JPY: KEEPS ECONOMIC ASSESSMENT UNCHANGED

The Japanese Yen traded lower against all of the major currencies. The latest economic reports out of Japan showed consumer confidence improving for the first time in 3 months. Although encouraging the uptick was small because Japanese citizens remain concerned about the economy and the global financial outlook.  These worries are shared by the central bank who said the economy was picking up slowly but remains in severe state after last year’s earthquake. Contrary to yesterday’s reports by Jiji Press, the Bank of Japan left their economic assessment of the economy unchanged but cut their outlook for exports for the first time in 3 months. The ongoing financial crisis in Japan and the strong Yen has posed a major problem for Japanese exporters over the past year and unfortunately these pressures are not expected to go away anytime soon.   In recent weeks, USD/JPY has not seen much volatility but EUR/JPY has suffered greatly, falling to its lowest levels ever. This has led Finance Minister Azumi to say that they are closely watching the impact of the weak euro on Japanese exporters and will examine the movements carefully before deciding whether to intervene in EUR/JPY. Industrial production numbers are due for release this evening but these are final figures which mean their impact on the Yen should be nominal. 

GBP/USD: Currency in Play for Next 24 Hours

GBP/USD will be our currency pair in play for the next 24hrs. U.K. employment numbers will be released at 4:30AM ET/ 9:30 GMT. From the US, we expect producer prices at 8:30AM ET/ 13:30 GMT, followed by the Treasury International Capital Flow report at 9AM ET/ 14 GMT and Industrial Production at 9:15AM ET / 14:15 GMT. 

The GBP/USD currently trades in a downtrend, which we determined using the Bollinger Bands. The pair’s nearest support is at 1.5233, its year to date low. A break below that level would open the door for a move to the psychologically significant 1.50 handle. On the flip side, if the pair begins to rally, the 10-day SMA at 1.5410 could contain its gains. Above that the 20-day SMA at 1.55 could be more significant resistance. 

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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.