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Currency Outlook Post FOMC and Bernanke

Last updated 1/25/2012 5:20 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

• CURRENCY OUTLOOK POST BERNANKE AND FOMC
• EUR: BEHIND THE RALLY
• GBP: FOURTH QUARTER CONTRACTION
• NZD: KEEPS RATES UNCHANGED
• CAD: GOLD ABOVE $1700
• AUD: CPI EASES BUT CORE PRICES RISE
• JPY: FIRST TRADE DEFICIT IN 30 YEARS

EXPECTATIONS FOR UPCOMING FED MEETINGS

CURRENCY OUTLOOK POST BERNANKE AND FOMC

Thanks to Federal Reserve Chairman Ben Bernanke, we have enjoyed a very nice rally in currencies and equities. The central bank pledged to keep monetary policy highly accommodative for the next 2 to 3 years and interest rates to remain at extremely low levels until late 2014. Up until December, the central bank had only committed to keeping rates steady until 2013, but today, they not only extended this pledge by one year but Bernanke also said more bond purchases could be necessary. Investors were delighted to hear this news even though it meant that the central bank was less optimistic about the outlook for the economy. The reason is because low interest rates make it more affordable to borrow, lend and spend for consumers and businesses alike. The sharp sell-off in the dollar suggests that many investors had not anticipated such a clear willingness by the Federal Reserve to fire up the printing presses. The central bank’s announcements gave investors strong reasons to sell dollars and there is a good possibility the greenback will extend its losses as long as key resistance levels are breached. The rally in the EUR/USD has been powerful but without a break above 1.32, which is a former support turned resistance level, the downtrend in the EUR/USD remains intact. The GBP/USD& #8217;s rally also stopped short of the 100-day SMA which is an important resistance point while USD/JPY has its own narrow ranges to contend with. From a fundamental perspective, the Fed has planted the kiss of death on the dollar, but the reason why they remain so dovish is because of concerns about Europe.  If its troubles worsen, wrecking havoc on the financial markets, deleveraging could promptly send investors back into the arms of the greenback. In other words the roof can come crashing down at anytime on the EUR/USD rally. Technically, many currency pairs still need to break key levels before they can say that they have shook off their downward momentum. This does not mean that the dollar cannot slip further but it may not be as smooth of a ride as many would expect. 

The goal of today’s announcement was to increase transparency but in many ways, releasing the individual projections for the first rate hike created more confusion than clarity. It wasn’t until Bernanke started to talk about more bond purchases did investors understand the message. While the statement exuded a sense of solidarity, the individual projections show significant division in the central bank. Of the 17 participants in the FOMC, 3 expect the Fed to raise rates in 2012, 3 in 2013, 5 in 2014, 4 in 2015 and 2 in 2016.   In other words, as shown in the following graph from the Fed, 6 FOMC participants see interest rates increased before 2014 and 6 see rates increased in 2014 or later. As confusing as this may be, interest rate hikes are not on anyone’s radar. Instead the key question was whether the Fed would fire up the printing presses this year and according to Bernanke additional bond purchases remains an option. In fact, he spoke about the central bank’s readiness to expand their balance sheet so many times during his press conference that we can’t help but wonder if he is plans to pull the trigger on QE3 in March. Over the next few weeks, we will be listening to the speeches by FOMC voters carefully to hear if there is a consistent message about more bond purchases. If so, the dollar could extend its slide but this would be contingent upon the situation in Europe. If nothing comes out of the EU Leaders Summit next week and CDS spreads in Europe start to rise, then U.S. dollar traders could quickly forget about the U.S.’ easy monetary policy and return to taking its cue from Europe. For more on the FOMC Rate Announcement, please read our Instant Insight .

EUR: BEHIND THE RALLY

After reaching a low of 1.2613 on January 13 ^th , the EUR/USD has staged a remarkable rally. Not only has the pair appreciated 6 out of the last 7 trading days, but it is now trading at a year to date high. The strength euro comes from the resilience of investors who keep buying European bonds, keeping yields and CDS spreads from rising. It also has to do with better economic reports out of Germany and the overall improvement in risk appetite. It is hard for investors to be gloomy when equities continue to rise. Today for example, Germany reported a surprising improvement in business confidence. The IFO index rose from 107.3 to 108.3 as businesses grew more optimistic about the current and future conditions. Many experts predict a recession for the Eurozone this year but so far incoming economic data show more growth than contraction.  With this in mind however, conditions in the Eurozone can get ugly quickly. We cannot ignore the ongoing risks posed by the sovereign debt crisis and inability of European officials to concede and agree.  The European rescue fund needs more money but no one is willing to make the commitment. German Chancellor Merkel expressed her opposition to the idea by saying this morning that increasing the rescue fund will not work. She argues that if they double the size, then they will be asked to triple it. Foreign nations on the other hand refuse to help because they believe that Europe has not done everything in their power which creates a vicious cycle where foreigners are not willing to help Europe and the Europeans are not willing to help themselves.  The European Central Bank is under pressure to take losses on their Greek bond exposure but they refuse to do so because it would damage the credibility of the ECB and its ability to support other vulnerable nations. The market may be getting tired of the European sovereign debt story but in no way shape or form are the troubles over.

GBP: FOURTH QUARTER CONTRACTION

The British pound strengthened against the U.S. dollar but weakened against the euro. The U.K. economy shrank more than expected in the fourth quarter as manufacturers cut output and services sputtered, leaving Britain teetering on the brink of a double dip recession. Gross domestic product fell 0.2 percent from the third quarter, when it increased 0.6 percent and expectations were for a contraction of 0.1 percent. Bank of England Governor Mervyn King said that policy makers can increase stimulus again if needed to guard against another downturn. While a technical recession – an instance in which GDP contracts for two consecutive quarters – cannot be ruled out at this point, there are still signs of a slow recovery. A look at the minutes of the central bank’s Jan.11-12 meeting published today shows policy makers increasingly saying more quantitative easing is “likely.” Policy makers fear undershooting the inflation target and expressed that another round of asset purchases will likely be required. But the central bank felt no pressing need to increase the program before completing the purchases that have already been announced. All nine of the monetary policy committee’s members agreed to keep the interest rate at a record low of 0.5 percent and to leave its asset purchases at 275 billion pounds. Their outlook remains that U.K. output is likely to be broadly flat over the six months to the end of the first quarter. The CBI retail sales numbers are due out tomorrow. The index posted a 9 in December and is expected to show a negative 2 for January. A positive surprise would provide hope that the U.K. could avoid a double dip.

NZD: KEEPS RATES UNCHANGED

All the commodity currencies strengthened against the U.S. dollar today as risk appetite improved. Australia’s core inflation rate accelerated above the middle of the central bank’s 2 percent to 3 percent annual target range last quarter. As a result, traders pared bets on another interest-rate reduction next month. The trimmed mean consumer price index advanced to 2.6 percent from the third quarter, when it rose to a revised 2.4 percent. European debt troubles remain a possible catalyst for another interest rate cut later down the road as inflation figures don’t seem to warrant back-to-back cuts. The Reserve Bank of New Zealand announced today that it is keeping its official cash rate unchanged at 2.5 percent. Since the last central bank meeting financial market sentiment has slightly improved, however, concerns about global growth still loom. Reserve Bank Governor Alan Bollard noted that exports have remained elevated, but the appreciation in the New Zealand dollar is cutting into exporters’ profits. As for the economic outlook, the central bank sees a modest recovery in household spending and the housing market. Furthermore, repairs and reconstruction in Canterbury will provide a material boost for the economy. Inflation in the New Zealand economy remains well contained and is not a concern at the moment. The Business NZ performance of manufacturing index for December printed at 51.9, which was 5.9 points higher than in November and the highest level of activity since August 2011. The uptick underscored the previous view that October’s and November’s reading were probably overstated. However, concerns still linger around inventory management as firms struggle to clear out and maintain more efficient levels going forward. The Canadian dollar erased earlier losses after the Federal Reserve announced its benchmark rate would stay low until 2014. Prime Minister Stephen Harper is gaining support among Canadians for his plan to ship oil to China after President Barack Obama rejected TransCanada Corporation’s $7 billion Keystone XL pipeline to the U.S. Gulf Coast. Harper is pushing energy exports to Asia to reduce the country’s dependency on the U.S. and to make Canada a global energy player.

JPY: FIRST TRADE DEFICIT IN 30 YEARS

The Japanese Yen weakened against all of the major currencies today due to weaker Japanese data and stronger risk appetite. Japan’s first annual trade deficit in more than 30 years raises questions on how much longer the nation can rely on exports to help finance its huge public debt without having to turn to foreign investors. In December 2011 Japan posted a trade deficit of 0.57 trillion yen as expectations were for a 0.36 trillion yen surplus. For 2011, Japan logged a trade deficit of 2.49 trillion yen ($32 billion), the first time since 1980 as the economy was hit by the shock of rising oil prices. Japan also faced significant headwinds from the aftermath of the March earthquake. Furthermore, slowing global growth and the yen’s strength are stifling exports. When Japan runs out of savings, and that point is nearing, it will have to become dependent on global investors to fund its deficit. That means either the yen will weaken or interest rates will rise. Much of the concerns raised by the annual trade deficit were mentioned in the Bank of Japan’s monthly report of recent economic and financial developments. The central bank notes that economic activity has been more or less flat and holds that view for the medium-term outlook. While domestic demand has been moderately increasing and public investment has stopped declining, exports and production are hurting. Any meaningful economic recovery would be led by emerging and commodity-exporting countries, and reconstruction-related demand. Japan’s corporate services price index is scheduled for release tonight. Prices fell 0.2 percent in November and are expected to remain flat for December.

USD/JPY: Currency in Play for Next 24 Hours

Our currency pair in play for Thursday is USD/JPY. Economic data we expect for release from the United States includes December durable goods orders and capital goods orders at 8:30 AM ET / 12:30 GMT. Also from the U.S. are leading indicators and new home sales for the month of December at 10:00 AM ET / 14:00 GMT. From Japan, we expect the December national consumer price index at 6:30 PM ET / 22:30 GMT. Then the Bank of Japan will release the minutes from its December’s board meeting, large retailers’ sales numbers, and retail trade numbers at 6:50 PM ET / 22:50 GMT.

USD/JPY has risen significantly over the past two trading sessions and even though it gave up most of today’s gains, it remains in an uptrend, which we determined with Double Bollinger bands. Nearest support is at 77.35, where the upper first standard deviation Bollinger band lies. Should the pair decline through that level, significant support will be found at the 2-month low of 76.54. To the upside, nearest resistance is at 78.28, which is today’s high price. If the pair breaks out of that level, heavy resistance should be encountered at 79.00, which is both psychologically significant and the 2-month high.   

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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.