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FX: And The Strength Begins To Fade

Last updated 1/26/2012 4:10 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

• FX: AND THE STRENGTH BEGINS TO FADE
• EUR: LATEST EUROPEAN HEADLINES FAIL TO IMPEDE RALLY
• GBP: SIGNS OF WEAKER CONSUMER DEMAND
• NZD: TO MAINTAIN A TRADE DEFICIT
• CAD: FLIRTS WITH PARITY
• AUD: GOLD PRICES CONTINUE TO RISE
• JPY: CPI AND RETAIL SALES NUMBERS ON TAP

EXPECTATIONS FOR UPCOMING FED MEETINGS

FX: AND THE STRENGTH BEGINS TO FADE

The Federal Reserve’s commitment to easy monetary policy kept the U.S. dollar under pressure throughout the European and North American trading sessions. Not only did the greenback end the day unchanged or lower against all of the major currencies but it also fell to a fresh one month low against the euro, British pound and Swiss Franc and a two month low against the Canadian, Australian and New Zealand dollars intraday. Whether the greenback continues to slide will largely depend on tomorrow’s GDP report. The U.S. economy is expected to have grown by 3 percent in the fourth quarter which would be the fastest pace in more than a year. Recent improvements in the labor market has helped to support consumer demand but with spending rising less on average in the fourth quarter compared to the third quarter, we are concerned about whether growth will meet up to expectations. If it falls short, investors will have a stronger reason to sell dollars but also reason to offload risk. The main reason why the EUR/USD failed to hold onto all of its earlier gains is because U.S. stocks retreated from their highs and the reason for that was because the second set of U.S. data was not nearly as good as the first. Initially the dollar fell on the release, which in turn helped the euro extend its gains but eventually investors realized that disappointing U.S. data is as bad for the rest of the world as it is for the U.S. economy and this explains why the dollar began to recover towards the end of the U.S. session.

New home sales fell 2.2 percent. The decline was a big shocker even after taking the prior month's upward revision into consideration. The housing market is one of the weakest parts of the U.S. economy and an area of serious concern for the Federal Reserve. Leading indicators rose 0.4 percent which was less than expected but was nonetheless an increase from the previous month. However with a downward revision in November the overall report points to a slow recovery.  Jobless claims increased last week from 356k to 377k. This rise was larger than anticipated, but as long as claims remain comfortably below 400k, the U.S. labor market is still moving forward. Continuing claims increased to 3.554 million from 3.466 million the previous week. Orders for big ticket items made to last for more than 3 years rose 3.0 percent last month in a sign that consumers did not hibernate this winter. In fact excluding orders for transportation equipment, which tend to be volatile, durable goods rose 2.1 percent, the highest level in 9 months. The Federal Reserve may be worried about the "significant downside risks" but the latest economic reports reassure the market that even though growth is slow, parts of the U.S. economy is still improving.

EUR: LATEST EUROPEAN HEADLINES FAIL TO IMPEDE RALLY

The EUR/USD continued to power higher, rising 7 out of the past 8 trading days. Stronger German consumer confidence contributed to the rally by easing concerns about a recession in the Eurozone this year.  Low unemployment helped to boost sentiment for the fifth month in a row and according to GfK, the agency that conducts the survey, morale in Germany should increase further in the month of February. This upbeat outlook is not unique to consumers – earlier this month we saw similar reports of stronger investor and business sentiment. These reports show that confidence is not completely lost in the Eurozone even if it means that Germany decouples from the rest of the region. As the largest economy in the Eurozone, they control the purse strings. They are forcing austerity on other Eurozone nations while enjoying for themselves the benefit of a weaker euro.  The EUR/USD continues to shake off all EUR negative news including the sharp rise in Portuguese bond yields and reports that the ECB is split on how to handle their holdings of Greek debt. European Union leaders continue to look to the IIF and Greece to solve their own problems – they announced today that there will be no plans to hold a special meeting on Greece at the EU Summit.   There was also talk that a Greek deal could be close to a deal with creditors ready to accept a lower coupon payment. Given how many times these “rumors” about Greece end up unsubstantiated, we remain skeptical about the accuracy. In the meantime the EUR/USD has cleared its 50-day SMA but has yet to break above 1.32, which is the key level mentioned yesterday. As a former breakdown and support turned resistance point, this is a critical level for the EUR/USD to break before further gains are possible.

GBP: SIGNS OF WEAKER CONSUMER DEMAND

According to recent economic reports, the U.K. economy is not doing well, but weaker data has not stopped the British pound from rising. Like the euro, the British pound strengthened against the U.S. dollar 7 out of the past 8 trading days and there is no question that the rally was driven by the market’s overall appetite for risk. The CBI Retail Sales survey was the only piece of U.K. economic data released today. According to the Confederation for British Industry, consumer spending plunged in the month of January.   The index which measures the number of retailers reporting an increase versus decrease in spending fell to -22, the lowest reading since March 2009. In December, the CBI index was at 9 and a pullback was expected this month, the only problem was that economists were looking a milder decline. With the holiday shopping season behind us, consumers are no longer rushing into the stores. At the same time, concern about job security and weaker growth is making everyone in Britain more frugal. Unfortunately, this does not bode well for the U.K. economy which is at the brink of recession. Growth contracted by 0.2 percent in the fourth quarter and unless there is a significant pickup in consumer demand and/or trade in Q1, the country could fall back into recession.

NZD: TO MAINTAIN A TRADE DEFICIT

All three commodity currencies strengthened versus the US dollar amid the possibility of more quantitative easing from the U.S.. As Australian and New Zealand dollar both reached highs not seen since October, the Canadian dollar broke the parity line during today’s trading. Despite banks being on holiday, Australia still garnered some headlines today with IMF downgrading the country’s growth outlook. According to the IMF’s report, their 2012 growth estimate for Australia was reduced to 3 from 3.3 percent. The report suggests that a major risk for the Australian economy would be that governments, businesses and households all try to reduce spending and debts at the same time. The fund says the Gillard government should not be trying to achieve a surplus in 2012-13 amid a weakening global economy. Too many austerity measures could dampen the consumer confidence posing more downward pressure on the Australian economy. In Davos, Canadian Prime Minister Stephen Harper outlined significant policy changes to buoy growth in Canadian economy. "In the months to come, our government will undertake major transformations to position Canada for growth over the next generation," Harper said in an address to the some of the 2,600 forum delegates. In addition to increasing oil exports to Asia, the government’s priorities will include negotiating free trade agreements and making government spending more sustainable. The major policy overhaul will boost Canada’s competitiveness amid an aging population. As New Zealand releases its trade balance tomorrow, the market expects a print of -74M. However, the trade balance could surprise to the downside with the strength of kiwi in December.

JPY: CPI AND RETAIL SALES NUMBERS ON TAP

The Japanese yen traded higher against all the major currencies including the US dollar. Japanese corporate service prices were unchanged on a monthly basis after revising downwardly to 0.1 percent in November. For all of 2011, prices declined an annual rate of 0.5 percent. Meanwhile, instability in the Japanese government continues to loom over the economy. According to a recent survey, Prime Minister Yoshihiko Noda’s approval rating fell to 32 percent from 38 percent, and is down 24 percentage points since taking helm last year. The stalled tax legislation is one of the key proposals being pushed ahead by Noda. The prime minister says doubling the consumption tax is a necessary remedy to address soaring debt and social welfare costs. The main opposition Liberal Democratic Party refused the ruling party’s latest request to join preliminary reform discussions and called for new elections. The political impasse could further damage Japan’s credit rating. In November, S&P said it may be preparing to lower the sovereign rating in light of Noda’s lack of progress in tackling the debt issue. S&P rates Japan AA- and has maintained a negative outlook since April. If Noda fails to pass the tax reform, there could be more significant shocks to the Japanese economy. In addition to yen’s appreciation and contracting global demand, bond yields could rise amid political squabbling. Looking forward, the CPI number could point to more deflation but retail sales figures are expected to rebound.

USD/JPY: Currency in Play for Next 24 Hours

USD/JPY will be our currency pair in play for the next 24 hours. From Japan, we expect the consumer price index at 6:30PM ET/ 23:30 GMT, followed by retail sales and BoJ meeting minutes at 6:50PM ET/ 23:50 GMT. The US will release advance GDP and personal consumption at 8:30AM ET/ 13:30 GMT, followed by U. of Michigan consumer confidence at 9:55AM ET/ 14:55 GMT.

Despite the pullback today, USD/JPY continues to trade in an uptrend, which we determined using the Bollinger Bands. The nearest support is at 77.19, the 100-day SMA. A break below that level, the pair could target the 2-month low at 76.54. On the flip side, yesterday’s high of 78.28 could contain its rally. Further up, the psychologically significant 79 handle could provide major 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.