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FX: Failing at Key Levels, Need Good News Quickly

Last updated 2/1/2012 12:50 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: FAILING AT KEY LEVELS, NEED GOOD NEWS QUICKLY
• EUR: THE GREEK TRAGEDY CONTINUES
• GBP: A DANGEROUS SAFE HAVEN
• CAD: SURPRISE CONTRACTION IN GROWTH
• AUD: PMI ON TAP
• NZD: GOLD UP, OIL DOWN
• JPY: AZUMI THREATENS INTERVENTION

EXPECTATIONS FOR UPCOMING FED MEETINGS

FX: FAILING AT KEY LEVELS, NEED GOOD NEWS QUICKLY

It may have been a mixed day for the U.S. dollar but there is no question the rally in the financial market is beginning to run out of steam. Currencies and equities have stalled at key technical levels and without a fresh dose of good news, we could see gains turn into losses.  Investors are running out of patience and unfortunately Greece has yet to reach a deal with its creditors and according to the Guardian, the Prime Minister is calling for a crisis meeting, in a sign that the talks may have hit a brick wall.  This evening, all eyes are on China who has manufacturing PMI numbers scheduled for release.  All signs point to a soft landing for China this year but any major disappointments could tip the risk rally over.  The U.S. reported a barrage of weaker economic data today, validating the Federal Reserve’s concerns and raising the odds of QE3. Manufacturing activity growth in the Chicago region slowed in the month of January, bucking the trend of improvements reported in the NY and Philadelphia regions.  The PMI index slipped to 60.2 from 62.2 due in large part to a decline in labor market conditions. The employment component of the Chicago PMI report fell to its lowest level since August.  Although it is encouraging to see manufacturing activity expanding in Chicago, the slower pace of growth dashes hope that the manufacturing sector will lead the U.S. recovery.  The ISM manufacturing index is schedule for release on Wednesday and the pullback in the Chicago PMI index suggest that we may only see a very small rise.  Consumer confidence is also shaky with the Conference Board's consumer confidence index falling to 61.1 from 64.8 in January.  The problem in the U.S. is that we are seeing a tremendous amount of conflicting reports.  The University of Michigan for example reported the highest level of consumer confidence in nearly a year but today's report from the Conference Board shows Americans growing less optimistic.  While economic data provides little clarity on the outlook for the U.S. economy, there is no ambiguity when it comes to the Federal Reserve's plans for monetary policy.  They intend to keep rates on hold for the next 3 years and are looking for reasons to add more stimulus.  Today's economic reports may not be enough for the Fed to pull the trigger on QE3 but they certainly validate their decision to adopt a more dovish stance in January.  The Fed does not want investors to be misled by any improvements in economic data because they believe it will be temporary especially given the amount of significant downside risks.  The persistent decline in USD/JPY show that investors have very little appetite for U.S. dollars even though the greenback has risen against the euro.

EUR: THE GREEK TRAGEDY CONTINUES

As the Greek Tragedy drags on, the euro ended the day lower against the U.S. dollar.  Greece was expected to reach a deal with her creditors last week before the EU Summit but that target date came and passed without any major progress.  This week, there was talk that a deal would be reached by Friday but now we are hearing that it may not be until mid February.  At this point, it is hard to believe anything that we hear, even if it may be coming from key European officials including the Greek Prime Minister.  In the latest developments, Reuters cited Greek Finance Minister Venizelos as saying “private sector creditors could take a loss of more than 70 percent in a planned debt swap.” He told lawmakers that, "there is a very serious discussion based on new facts. We are talking about a PSI much greater than the original.”  This of course is terrible news for the negotiations because it will spark another debate among private investors, delaying progress on a deal. The Guardian reported that the Greek Prime Minister is calling for crisis meetings with political leaders amidst increasing demands from the IIF’s negotiating team and the refusal of politicians to give way on new demands.  Meanwhile, there was also talk that the ECB could expand their balance sheet by $1 trillion.  Stepping up the size of their next LTRO is good news for the bond markets because the LTRO has successfully capped bond yields and encouraged European banks to buy sovereign debt.  Without the LTRO operations, bond yields in Europe, particularly those of troubled nations would be much higher.  However for the EUR, the LTRO can be both good and bad because it is effectively a lite version of QE.  Unless the Fed pulls the trigger on QE3, a $1 trillion balance sheet expansion by the ECB is bearish for the EUR/USD.  Yet the LTRO operations have provided support for the equity and bond markets in Europe by alleviating concerns about investor demand.  If bond yields hold steady and auctions go successfully, credit conditions will ease, providing support for the EUR.  German unemployment numbers were better than expected with the number of people filing for jobless benefits declining 34k in January.  The unemployment rate also fell to 6.7 from 6.8 percent. Consumer spending on the other hand did not fare as well with retail sales falling 1.4 percent last month.  Final Eurozone manufacturing PMI numbers will be released on Wednesday and no major revisions are expected.

GBP: A DANGEROUS SAFE HAVEN

Weaker economic data out of the U.K. did not stop investors from bidding up the British pound.  In recent months, sterling has been looked at as a safe haven for Europe even though it has its own host of problems. The U.K.’s debt to GDP ratio is extremely high but the U.K. is not ground zero for the continent’s troubles.  The Bank of England is openly considering the idea of more stimulus and could announce additional asset purchases as quickly as next month but the size of any new purchases will pale in comparison to the additional support that the European Central Bank needs to provide to the Eurozone.  With this mind however, it is dangerous to look at the pound as a safe haven because the economy is very weak. Earlier this week, we learned that growth contracted in the fourth quarter – putting the country at risk of falling back into recession.  Mortgage approvals increased less than expected last month while net consumer credit contracted 0.4billion.  According to our colleague Boris Schlossberg, “This was the worst reading since 1993 and serves as a harsh reminder of the impact of the fiscal austerity measures undertaken by the UK government. The news today escalates the probability of additional QE by the BOE in the foreseeable as UK central bankers attempt to reverse the credit contraction in the economy.”  U.K. manufacturing PMI numbers will be released on Wednesday and based upon the improvement in the CBI survey, there is scope for an upside surprise.

CAD: SURPRISE CONTRACTION IN GROWTH

Weaker than expected economic data from Canada prevented the Canadian dollar from rallying alongside the Australian and New Zealand dollars.  According to the latest GDP report, the Canadian economy contracted by 0.1 percent in the month of November.  The decline in economic activity caught the market by surprise because trade activity was quite healthy that month.  Unfortunately lackluster consumer demand and lower crude output prevented the economy from expanding. With the contraction coming on the heels of nearly zero growth in October, the fourth quarter is shaping up to be a weak one for Canada. The decline in raw material and industrial product prices indicates that inflationary pressures are abating.  The combination of weaker growth and lower inflationary pressures explain why the Bank of Canada grew more dovish earlier this month.  Stronger business confidence helped to encourage the rally in the Australian dollar but both the AUD and NZD benefitted primarily from USD weakness.  As of the end of the NY close, the rally in both currencies appears to be losing momentum.  The sustainability of the rallies will largely hinge upon this evening’s Chinese manufacturing PMI report.  If the data shows a sharp pullback in manufacturing activity, the AUD and NZD could give up part of their recent gains.  However if the Chinese economy once again proves to be more resilient than everyone expects – the commodity currencies will enjoy a risk rally. Australia also will be releasing its own manufacturing PMI report along with their house price index.  No economic data is expected from New Zealand or Canada.

JPY: AZUMI THREATENS INTERVENTION

To the frustration of Japanese officials, USD/JPY has fallen to its lowest level in 3 months.  This would not be significant if it wasn’t for fact that the decline in USD/JPY has brought the pair within 100 pips of its record low.  As an export dependent country, Japan suffers significantly from a rising currency but there is little that they can do when the source of the Yen’s strength comes from the weakness of the U.S. dollar.  The Bank of Japan can intervene to sell Yen but all of their past efforts have proved futile.  The last time they intervened was in November 2011 and on the day of intervention, USD/JPY rose from a low of 75.57 to a high of 79.53. If we fast-forward 3 months later however the pair is trading back at 76.16. Nonetheless the Japanese government cannot just sit by idly and watch the Yen rise with attempts at stopping the move.  Finance Minister Azumi made the first attempt today to curb the Yen’s rise by pledging to take firm action against excess volatility and speculative moves in the foreign exchange market.  The market quickly ignored the verbal intervention because it lacks punch but as USD/JPY continues to fall, the Ministry of Finance could ask the Bank of Japan to step into the market to sell Yen.  Once USD/JPY falls below 76, intervention could happen at anytime.  Even though it may not stop the Yen from rising in the long term, intervention by central banks can trigger a 4 to 6 percent move in a currency pair in a matter of minutes which is why anyone short USD/JPY at these levels need to be very careful.  Japanese labor cash earnings and vehicle sales are scheduled for release tomorrow but these economic reports will have minimal impact on the Yen.

GBP/USD: Currency in Play for Next 24 Hours

The currency pair in play for the next 24 hours is the GBP/USD. U.K. construction sector PMI is scheduled for release at 4:30 AM ET / 9:30 GMT followed by U.S. manufacturing ISM at 10:00 AM ET / 15:00 GMT.

The GBP/USD currently trades in an uptrend, which we determined using the Bollinger Bands. The nearest resistance is at 1.58, which is a former support turned resistance level and the 61.8 percent retracement of the November to January sell-off.  If this level is broken, then the psychologically significant 1.60 level becomes next resistance.  Support is at 1.5660, where we have the first standard deviation Bollinger Band and the 100-day SMA converging.  Below that 1.55 will be the next support.

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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.