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EUR: Prepare For Major Headline Risk

Last updated 1/20/2012 5:09 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: PREPARE FOR MAJOR HEADLINE RISK
• USD: MORE CLARITY OR CONFUSION FROM THE FED?
• GBP: EXPECT BOE TO REMAIN DOVISH
• CAD: WEAKER DATA VALIDATES BOC CONCERNS
• NZD: RBNZ EXPECTED TO KEEP RATES STEADY
• AUD: GILLARD REITERATES COMMITMENT TO RESTORING BUDGET SURPLUS
• JPY: BOJ MEETING NEXT WEEK

EXPECTATIONS FOR UPCOMING FED MEETINGS

EUR: PREPARE FOR MAJOR HEADLINE RISK

As of the New York close, there was no word on the Greek PSI deal. Late night talks are apparently underway but given how long the negotiations have gone on for, we can only assume that Greece and her creditors are squabbling once again.  The euro ended the day lower against the U.S. dollar but the lack of an announcement out of Athens did not extend the currency’s losses which suggests that investors are still holding out hope that a deal will be reached in time for next week’s EU Finance Ministers meeting. At this point however, the odds that negotiations will be dragged out or worse, break down are growing by the minute.  Headlines out of Greece and the rest of Europe will remain the single most important driver of the euro and currencies in general in the coming week. Not only will we continue to be watching for news from Athens, but European Finance Ministers will be meeting on Monday to discuss sovereign debt troubles and debt restructuring terms on new bond issues. If the Greek deal is passed, it would also be on the agenda. This meeting is suppose to pave the way for the EU Leaders Summit later this month and any agreement or opposition to increasing ESM funds could trigger volatility in the euro. Europe desperately needs a deeper safety net and the pressure to commit additional funds will most likely be emphasized at the World Economic Forum on Wednesday. There is no question that we will see a very large focus on Europe so keep an eye out for the headlines from the EU Finance Ministers meeting and the World Economic Forum. These will undoubtedly create more volatility for the EUR/USD as we move into another schizophrenic week of trading. In addition to these two key event risks, Spain has another bill auction on Tuesday and Italy has a bond auction on Thursday. A large part of the EUR/USD& #8217;s resilience has to do with continued demand for Spanish bonds. If next week’s auctions go well, the EUR/USD could hold onto its gains but once again, this also hinges upon the headlines.

As of Tuesday, speculative short positions in the EUR/USD climbed to a fresh record high which suggests that traders continued to sell euros after S&P’s downgrade. Although the EUR/USD rallied on Tuesday, it was on Wednesday and Thursday that it really powered higher and so we suspect that short positions as of today are much lower than shown by the latest CFTC data.  A number of European economic reports are also scheduled for release in the coming week and if the data shows a trend of deterioration, we could see some two way action in the EUR/USD. One of the greatest concerns for the Eurozone is the risk of recession this year. Tuesday’s service and manufacturing sector PMI numbers will show how much the region’s latest troubles has hurt growth, if at all. Despite the improvement in German investor confidence, business sentiment is expected to remain soft with the German IFO forecasted to hold steady in the month of January. Be prepared for another busy week in the currency market where European developments determine risk appetite and with it, the ebbs and tides of the financial markets in general.

USD: MORE CLARITY OR CONFUSION FROM THE FED?

There is no question that Europe will dominate the headlines next week but the U.S. will put up a good fight for attention. We have a Federal Reserve monetary policy announcement on the calendar along with the fourth quarter GDP report. The Fed is not expected to change their QE program but they will be releasing their forecasts on Fed Funds rates for the first time ever. In other words, they will be telling us when and how much they expect to raise interest rates in a chart that will be released four times a year. There will be another chart that breaks down the individual predictions of Fed members for the Fed Funds rate at the end of 2012, 2013 and 2014. The move is aimed at increasing transparency by giving the market a frame of reference but at the end of the day, it may create more confusion than clarity if the economic outlook starts to change due to unexpected shocks to the economy that ends up forcing the Fed to change their forecasts. As a result, Wednesday will definitely be a crazy day with the FOMC statement released at 12:30 pm ET, followed by the interest rate forecasts and quarterly estimates for economic growth, unemployment and inflation at 2pm and then Bernanke’s press conference at 2:15pm ET. The Fed obviously hopes that this new step will lower volatility in the long run, but there is plenty of room for greater confusion. What if the central bank decides in a given meeting to deviate from their forecasts? They are basically pre-committing to interest rate moves as far as 3 years out without knowing exactly how the domestic and global economy will perform. The only thing that we can be certain of for Wednesday is that the FOMC announcement will be an extremely interesting one. Aside from the rate decision, pending home sales, durable goods, jobless claims, leading indicators, new home sales and fourth quarter GDP numbers will be released. Growth in the fourth quarter is expected to accelerate but with lackluster retail sales at the end of the year, we would not be surprised to see growth miss expectations. Meanwhile the only piece of U.S. data released today was existing home sales which rose 4.61M in December, up 5.0 percent from the previous month. Home sales were slightly weaker than expected but still relatively firm and the most encouraging aspect of the report was the rise in prices. Inventory is starting to move and home owners are beginning to feel more confident about asking for more - which is a healthy trend for the housing market. However the labor market needs to stabilize before the housing market can fully recover. The heydays of the housing market are far behind us and it will be a long tough road to recovery. In fact, we still believe that housing will remain depressed for most of the year and the only way the Federal Reserve can help is by keeping interest rates low and monetary policy easy.

GBP: EXPECT BOE TO REMAIN DOVISH

It has been a great week to be long British pounds because the currency strengthened against the U.S. dollar four out of the past five trading days. Both good and bad data has been released from the U.K. this week and looking at them collectively, they paint a story of continued weakness in the U.K. economy. Although consumer spending rose 0.6 percent in December, this increase is small for the holiday season and barely makes up for the 0.5 percent drop the previous month. To lure customers into their stores, retailers had to cut prices aggressively, a pattern that is hardly healthy because price cuts can only provide a temporary boost to spending as long as the labor market remains weak. The minutes from the Bank of England will be released in the coming week along with the country’s fourth quarter GDP numbers. Retail sales and trade should contribute positively to GDP, but the boost may not be enough to prevent a contraction in the U.K. economy. With consumer price growth easing significantly in December and the ILO unemployment rate ticking up to 8.4 percent, we expect U.K. policymakers to hold onto their easing bias. Being extremely vulnerable to slower Eurozone growth, the U.K. central bank is widely expected to increase asset purchases this year. Therefore it may be difficult for the GBP/USD to hold onto it gains in the coming week against the greenback.

CAD: WEAKER DATA VALIDATES BOC CONCERNS

While the Canadian dollar lost some of its recent gain over the US dollar, the Australian and New Zealand dollar closed higher versus the greenback. Canadian CPI fell 0.6 percent in December while core prices dropped 0.5 percent due to lower gas and auto prices. Wholesale sales declined 0.4 percent versus 0.5 percent eyed. As we mentioned this morning, the Bank of Canada has grown less optimistic about the outlook for the Canadian economy amid signs of weakness, and the drop in CPI number will keep the bank from raising interest rates anytime soon. Furthermore, central bank governor Mark Carney on Wednesday said the European crisis was the biggest threat to Canada by far. But he assured business leaders that no matter how tough the times get, the banks are healthy and willing to lend. However, the Canadian economy remains vulnerable to the external shocks arising from the European debt crisis and possible domino effects rippling through the world economy. The December retail sales releasing on Tuesday could slow further amid a decline in consumer confidence. Meanwhile in Australia, Prime Minister Julia Gillard stated the government’s commitment to a budget surplus despite the gloomy outlook surrounding the country. "We are an economy with strong fundamentals, we've got growth, we've got low unemployment. Look around the world we're talking about unemployment just over five per cent. In the euro zone they're talking about it at 10 per cent, the Americans more than eight per cent,” said Gillard. As the Australian government charged forward with its fiscal policies, Gillard also signaled the government will rely heavily on the Reserve Bank of Australia to insulate the country against global downturn. While the central bank has already cut by 50 basis points since November, the markets have priced in another 100 basis points of easing by September. Furthermore, a further ease in the inflationary pressures could allow the RBA more cushion in providing more monetary stimulus.  Australian PPI and CPI numbers will be released next week along with the leading index. Looking forward to next week, the Reserve Bank of New Zealand is expected to hold its cash rate at 2.5 percent on Wednesday. Although consumer prices have dropped recently, the bank will likely be in a wait-and-see mode. 

JPY: BOJ MEETING NEXT WEEK

With the shift in market sentiment today, the Japanese yen has been quite choppy. While the Australian and New Zealand dollars reached a one-month and two-month high against the yen, respectively, the U.S. dollar and Swiss Franc lost value against the Asian currency.  As the Japanese economy remains dependent on global demand, the all industries activity indices came in lower than expected at -1.1 percent, the sharpest decline since March of 2011. The major factor was the slowdown in industrial production dropping 2.7 percent from the month prior. In addition to a slow recovery, the shortage of energy remains a headwind for Japanese economy. The US sanction on Iran could further complicate the matter. The Japanese Ambassador to Tehran Kinichi Komano has said that an embargo on Iran's oil industry will negatively affect the economic situation of the world in general and Japan in particular. With Japan relying more heavily on fossil fuel since the nuclear meltdown in Fukushima, a decrease in Iranian oil imports could create more problems for the economy. On the monetary front, the Bank of Japan is expected to maintain its overnight rate call at 0.1 percent next week. Despite the easy monetary conditions, the BoJ continues to face calls to loosen policy further to support Japan's export-driven economy which has been showing more signs of strain. Kazumasa Iwata, a former BOJ deputy governor and now a member of a government panel on economic policy, said weakening the yen should be the top priority for the policymakers. The trade balance to be released on Tuesday could also point to more downside risks stemming from the strong yen. Furthermore, the CPI data will be published on Thursday, followed by retail sales.

AUD/CAD: Currency in Play for Next 24 Hours

AUD/CAD will be our currency pair in play for Monday with the Australian producer price index at 7:30PM ET/ 00:30 GMT. From Canada, we expect the leading index at 8:30AM ET/ 13:30 GMT.

AUD/CAD currently trades in an uptrend which we determined using the Bollinger Bands. The nearest resistance is at the 14 Year high of 1.0664. If broken, the 1.07 handle could provide further resistance. On the downside, the 20-day SMA could serve as the first support at 1.0472. Should the pair weaken beyond that level, we could see major support at 1.0395, the lower first std. dev. Bollinger Band.

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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.