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Top 5 Reasons Why EUR Rallied

Last updated 2/1/2012 4:53 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

• TOP 5 REASONS WHY EUR RALLIED
• USD: HIT BY WEAKER DATA
• GBP: MANUFACTURING ACTIVITY EXPANDS
• AUD: SHARP DECLINE IN HOUSE PRICES
• NZD: COMMODITY PRICES ON TAP
• CAD: OIL DOWN 1 PERCENT, GOLD UNCHANGED
• JPY: STRONG YEN ONLY ONE OF THE PROBLEMS

EXPECTATIONS FOR UPCOMING FED MEETINGS

TOP 5 REASONS WHY EUR RALLIED

The EUR/USD consolidated for the past 5 trading days, leaving investors to wonder whether the loss of momentum will be temporary or permanent.   Based on today’s price action, there still appears to be enough demand for euros that the currency pair could make another run above 1.32.  With no less than 5 different factors contributing to its strength, there is reason to believe that the EUR/USD could extend its gains.  On Tuesday, we wrote that good news was needed quickly to prevent currencies from failing at key levels and good news was exactly what we had overnight.  Despite concerns about slowing global demand, the Chinese manufacturing sector expanded at a faster pace in the month of January.  Fears of a hard landing have been allayed by each piece of incoming Chinese data which tell us that at worst the Chinese economy will slow gradually this year.  In the Eurozone, Germany’s PMI manufacturing index was also revised higher indicating the sector expanded at a faster pace last month.  Although many experts including those within the European Central Bank believe that the Eurozone could be headed for recession this year, so far we have seen very little evidence of that in Germany or France, whose economies account for 48 percent of Eurozone GDP.  Until there are consistently weak economic reports from either country, the threat of EZ recession will not be the market’s greatest concern.  At the same time, the euro is taking its cue from the yields of debt laden Eurozone countries.  Over the past few months, the EUR/USD has lived and died by the borrowing costs of Greece, Portugal, Ireland, Spain and Italy.  Today, credit conditions in Europe have eased with the 10 year bond yields of each of these countries falling sharply.  Portugal in particular saw a 79bp decline in its 10 year yield to 14.15 percent.  Although this level is still extremely high, investors were simply relieved to see yields move in the right direction.  According to the Institute of International Finance, who represents the private holders of Greek bonds, an agreement is expected to be reached in “days.” Of course, the IIF also said a deal was expected to be done ahead of the EU Summit and that never happened, but nonetheless they play a key role in the negotiations which is why investors have not discounted their credibility. A deal is close and it will simply be a matter of time before one is announced.  Finally, weaker U.S. economic data also gave investors a fresh reason to sell dollars because it increases the odds of QE3.  So in summary, here are the top 5 reasons why the EURUSD rallied today:

Yet, not all of today’s news has been supportive of the EUR - Belgium fell back into recession last year.  The economy contracted by 0.2 percent in Q4, following a 0.1 percent contraction in third quarter.  Greece and Portugal are already in recession but Belgium is the only EZ member that has not asked for bailout to experience a similar fate.  The European Central Bank has a monetary policy meeting next Thursday and there is a small but valid case for rate cuts or some form of easier monetary policy this month.

USD: HIT BY WEAKER DATA

The U.S. dollar sold off against all of the major currencies following weaker than expected economic data.  According to the ISM index, which rose from 53.1 to 54.1 in January, U.S. manufacturing activity accelerated last month thanks to higher prices paid, increases in inventories, new orders and order backlog. The data fell short of expectations however with employment growth slowing. Private payroll provider ADP also reported slower job growth in the month of January. A total of 170k jobs were added by U.S. companies last month, down from 292k in December.  With U.S. labor market numbers due for release on Friday, the ADP report points to a smaller rise in payrolls. Although ADP has not been the best leading indicator for NFPs, the decline in job growth is consistent with the market's expectations for January payrolls. Challenger Grey & Christmas will be reporting their job cuts tomorrow while the labor department releases its weekly jobless claims report.  The state of the U.S. labor market will be a big focus over the next 48 hours and the magic number for Friday will be 100k. If job growth exceeds 100k, the Federal Reserve will hold on tight and keep monitoring the economy for more signs of weakness before pulling the trigger on QE3. However if payrolls rise by less than 100k, the Fed will be under pressure to announce another round of asset purchases in March. Federal Reserve Board Chairman Ben Bernanke will also be testifying Thursday on Capitol Hill before the House Budget Committee on the U.S. economic outlook.  Bernanke will testify at 10:00am and is likely to be asked to assess the state of the U.S. recovery, the central challenges facing America fiscal policy, the economic impact of Europe’s economic and political struggles, and the Fed’s recent conduct of monetary policy. The Congressional Budget Office will release its updated economic and budget report Tuesday at 10:00am.  The CBO report will cover fiscal years 2013 through 2022 and will include an updated deficit estimate for fiscal year 2012.

GBP: MANUFACTURING ACTIVITY EXPANDS

The British pound strengthened against the U.S. dollar but weakened against the euro.  Manufacturing in the U.K. jumped to an eight-month high in January and unexpectedly returned to growth after a quarter of contraction as production rebounded.  The manufacturing index rose to 52.1 from a revised 49.7 in December, and expectations were for a 50 print.  Separate reports today showed manufacturing indexes for Europe, China and India also rising in January.  Yet, the debt crisis in the euro area, the U.K.’s biggest export market, has dimmed the outlook for manufacturers, and Bank of England Governor Mervyn King said last week that policy makers can increase stimulus again if needed to aid the economy.  As for the U.K.’s strong manufacturing performance in January, it is still too early to say whether this trend is sustainable.  A closer look at the situation reveals that the index was bolstered by manufacturers working through backlogs, which historically has been only a short-term fix.  In the housing sector, prices started the year with a slight decline, falling by 0.2 percent in January from a month earlier.  As the U.K. economy contracted in the final three months of 2011, it is no surprise that house price growth softened at the start of 2012.  Housing demand has been kept under pressure by the difficulties that buyers face in getting a mortgage.  The economy is not expected to gather much momentum until the second half of 2012 at the earliest, which suggests that the labor market conditions and buyer sentiment may be slow to recover.  Scheduled for release tomorrow is the construction purchasing managers’ index and a speech by MPC member Posen.

AUD: SHARP DECLINE IN HOUSE PRICES

The Canadian, Australian, and New Zealand dollars all traded higher against the greenback today.  Australian house prices plunged by the most on record in 2011 as global economic uncertainty and concerns about its impact at home kept a lid on demand.  An index measuring house prices plummeted 4.8 percent from a year earlier, the biggest annual drop since the index began in March 2002.  Reserve Bank of Australia Governor Glenn Stevens lowered the benchmark rate by a quarter of a percent on November 1 and again on December 6.  Since then Australia recorded its worst annual job growth in 19 years in 2011, as consumers boosted savings, and traders are pricing in a 60 percent chance of another rate cut next week.  Manufacturing activity remained in positive territory for January as the performance of manufacturing index expanded slightly in the month, up 1.4 points to 51.6.  Important economic releases coming out of Australia tonight include building approvals and the trade balance.  No new economic data came out of Canada or New Zealand last night.  Oil gave up earlier gains after an Energy Department report showed that U.S. inventories climbed more than expected and gasoline demand fell to a 10-year low.  The market has received bearish reports on oil week after week and it looks like oil could fall below the 97.50 mark.  On the other hand, gold is trading higher on increased uncertainty over the global economic recovery.  New Zealand will release their commodity prices for January later tonight.  In December prices fell 0.8 percent, but we expect to see a recovery as the release is tightly correlated with Australian commodity prices which rose 6.0 percent.

JPY: STRONG YEN ONLY ONE OF THE PROBLEMS

The Japanese yen weakened against all the major currencies with the exception of the greenback.  Intervention risk has increased today as USD/JPY traded as low at 76.02 before recovering.  Finance Minister Azumi is watching the market very closely and could ask the Bank of Japan to sell yen at anytime once the pair falls below 76.  The total average monthly cash earnings per employee in Japan remained in a downtrend, falling 0.2 percent on the year in December after slipping at the same rate in November and staying flat in October.  While the data was better than the expected 0.3 percent decline, monthly wages remained under pressure and dropped in eight of the 12 months last year primarily due to the March earthquake and following tsunami.  A closer look at the data reveals a slight drop in special pay – bonuses and other irregular earnings – outpaced a modest gain in overtime pay.  However, Japanese businesses continue to recover at a modest pace as evidenced by the increase in overtime pay.  The strong yen has been a significant headwind and has caused many companies, especially exporters, to shift operations abroad or to scale back altogether.  Japanese financials are also under pressure as Europe’s debt crisis is the main driver behind job cuts at Mizuho and Daiwa Securities Group.  Reversing previous expansions, the banks will trim costs after posting consecutive quarterly losses.  Japan’s biggest banks are also seeking ways to offset declining loan profitability as an export slump and stronger yen threaten an economic rebound at home.  Brokerage firms are also scaling back because of poor investment banking business, lower trading volumes, and a decrease in the IPO business.   Japan’s monetary base numbers for January are due out later tonight.  The money supply expanded 13.5 percent in December and is expected to have expanded 14.6 percent in January.  So far inflation has not been a concern in the economy, so we should continue to see an increase in spending and investment.

AUD/USD: Currency in Play for Next 24 Hours

Our currency pair in play for Thursday is AUD/USD.  Economic data we expect from Australia tonight is December building approvals and the trade balance at 7:30 PM ET / 24:30 GMT.  Tomorrow morning, from the United States, we expect jobs numbers at 8:30 AM ET / 13:30 GMT.  Ben Bernanke, chairman of the Federal Reserve, will testify before the house budget committee at 10:00 AM ET / 15:00 GMT.  Then, from Australia, the AIG performance of services index for the month of January is scheduled for release at 5:30 PM ET / 22:30 GMT. 

AUD/USD has been steadily on the rise lately and is trading in an uptrend, which we determined with double Bollinger bands.  The nearest level of support is at 1.0565, the convergence of today’s low, the upper first standard deviation Bollinger band, and the 10-day SMA.  Should the pair fall below that price, significant support will be found at 1.0400, where the 200-day SMA lies.  To the upside, nearest resistance is at October’s high of 1.0752.  If the pair breaks out from there, heavy resistance will be encountered at July’s high of 1.1079.

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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.