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EUR: The Potential Catalysts For A Breakout

Last updated 2/3/2012 5:05 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: THE POTENTIAL CATALYSTS FOR A BREAKOUT
• USD: STRONG JOBS NUMBER ELIMINATES EXPECTATIONS FOR QE3
• GBP: WILL THE BOE INCREASE QE?
• AUD: RBA EXPECTED TO CUT BY 25BP
• CAD: SHRUGS OFF WEAK EMPLOYMENT NUMBERS
• NZD: KEY ANNOUNCES STRATEGY TO BOOST NZ-CHINA TRADE
• JPY: INTERVENTION RISK FALLS AFTER US DATA

EXPECTATIONS FOR UPCOMING FED MEETINGS

EUR: THE POTENTIAL CATALYSTS FOR A BREAKOUT

Currencies and equities ended the week on a strong note thanks to the better than expected U.S. labor market report. All of the major currencies traded higher against the U.S. dollar on Friday with the exception of the Swiss Franc which came under pressure after SNB acting Chairman Jordan promised to defend the 1.20 EUR/CHF peg with “utmost determination.”  This week, many currencies including the British pound, Japanese Yen, Canadian, Australian and New Zealand dollars rose to their highest levels in months against the greenback, leaving the EUR/USD as the only currency pair failing to reach even a one month high. On an intraday basis we have seen quite a bit of volatility in the EUR/USD but since the beginning of the week, the pair has been trapped in a 2 cent range. The main reason why the euro has not enjoyed the same gains as other risky assets is because at the end of the day, investors are still unsure how the whole European sovereign debt crisis will play out. There is a good chance that a Greek PSI deal could be announced next week but this same possibility had existed week after week. The only difference this time around is that the Institute for International Finance’s Dallara will be headed for Athens this weekend along with his co-chair of the Greek creditors committee, Jean Lemierre from BNP Paribas. With the big wigs flying in, either tough decisions need to made or a deal is ready to be closed. If it is the latter and a deal is announced in the coming week, the EUR/USD could finally breakout to the upside.

Unfortunately even if Greece needs more help, Euro-area countries don’t appear willing to provide it. The region’s top rated countries met in Berlin to discuss Greece and according to Finland’s Finance Minister, the “130 billion euros agreed in October must be enough.” Originally the Eurogroup was planning to hold a meeting to talk about Greece on Monday but the meeting has since been scrapped. Although March 20 ^th is the day on which Greece will officially default on their loans if the next bailout funds are not released, they have agreed to submit a final debt swap offer to their private sector bondholders by February 13 ^th with the exchange of new Greek bonds scheduled to be completed by March 6th. This timeline would give creditors enough time to disburse additional aid to Greece before a major EUR14.4 billion bond redemption is due on March 20 ^th .

According to the latest CFTC report, speculators trimmed their net short EUR positions over the past week.  Aside from the outcome of the Greek PSI negotiations, next week’s ECB monetary policy meeting could also be a potential catalyst for a breakout in the EUR. If the European Central Bank decides to add to its LTRO program, the EURUSD could experience steep losses as the prospect of near term balance sheet expansion makes the euro less attractive against the U.S. dollar. However, based upon recent economic data and the fluctuations in the financial markets, there is no need for the ECB to overreact. At one point, Portuguese 10 year bond yields had risen above 16.5 percent but now yields have fallen back down to 13 percent. Equities around the world have performed well over the past month while the EUR/USD rebounded off earlier lows. Retail sales contracted in December but consumer, business and investor confidence increased and for the time being, this improvement in sentiment may be enough for the ECB to wait to see how the market responds to the negotiations in Greece before stepping up their liquidity offerings.

USD: STRONG JOBS NUMBER ELIMINATES EXPECTATIONS FOR QE3

Today was a classic example of how rate hike expectations can turn on a dime. Going into this morning’s non-farm payrolls report, many investors expected the Federal Reserve to announce another round of asset purchases in the first or second quarter. Even Fed Chairman Ben Bernanke made it crystal clear after last month’s FOMC meeting that their gun was locked and loaded.  However, once the non-farm payrolls report was released and investors saw how strong job growth was in January, they began to price in a rate hike in 2014. There is no question that the U.S. labor market is stronger than even the most optimistic economist on Wall Street had predicted but QE3 is not off the table. It was only yesterday that Fed Chairman Ben Bernanke warned of the weakness in the U.S. economy, the high level of unemployment and the sensitivity of the U.S. to shocks. According to the central bank’s latest economic forecasts , the unemployment rate this year is expected to be somewhere between 8.2 and 8.5 percent. With the jobless rate now at 8.3 percent, this means that the Fed has either underestimated the strength of the labor market or the positive momentum in job growth will begin to fade quickly. For the average American, it is still difficult to attain jobs and many would even argue that it feels like the U.S. is still in recession. Until this mindset reverses, the Fed will not be able to tighten monetary policy. Nonetheless, everyone from the Federal Reserve to the Bank of Japan and President Obama will breathe a sigh a relief after seeing today’s jobs report. Thanks to a 243k increase in non-farm payrolls, the unemployment rate has fallen for the fifth consecutive month to 8.3 percent, the lowest level in nearly 3 years. Instead of slowing, the number of jobs grew by 50 percent more than the previous month.  The Bank of Japan and the Ministry of Finance will be rejoicing because the Japanese are the single biggest beneficiaries of today’s strong jobs number. If non-farm payrolls were abysmally weak, USD/JPY would have probably broken 76, forcing the MoF to intervene in the Yen but now, the pressure to intervene has been instantly lifted. President Obama’s chance of reelection has also increased thanks to the decline in the unemployment rate. If come November, the jobless rate is below 8 percent, President Obama will be a shoo-in for reelection.  Next week’s U.S. economic calendar is light with only the December trade balance and the February University of Michigan Consumer Sentiment report scheduled for release.  A number of Fed officials will be speaking including Bernanke who will be testifying to the Senate Budget Committee. For the most part, we expect the dollar to take its cue from risk appetite and Europe.

GBP: WILL THE BOE INCREASE QE?

The British pound ended the week higher against the U.S. dollar and euro thanks to better than expected economic data. This week, we learned that the manufacturing, service and construction activity expanded in the month of January. At a time when many countries around the world are seeing contraction in both manufacturing and services, the U.K. is enjoying something unique. Consumer confidence also increased last month, which suggests that underlying demand could be recovering as well.  For the Bank of England who has a meeting on monetary policy in the coming week, these improvements will reduce the pressure to ease. The U.K. economy may have contracted in the fourth quarter, but the PMI reports suggest that things are brighter in the first quarter which could be enough motivation for the central bank to postpone increasing their Quantitative Easing program next week. The majority of economists currently expect the BoE to boost their asset purchase program by GBP 50 billion – recent comments from policymakers also suggests that they are actively discussing the possibility of expanding their balance sheet. However with stocks performing well and risk appetite improving, there is a reasonable chance that the central bank will stand pat on Thursday. Aside from the BoE meeting, U.K. industrial production, trade and inflation numbers are also scheduled for release this coming week.

AUD: RBA EXPECTED TO CUT BY 25BP

All three of the commodity currencies strengthened against the US dollar. Despite a disappointing jobs report from Canada, the higher yielding Canadian dollar became more attractive to the traders in a risk-on trading session. The change in employment came in at 2.3K versus the forecast of 23.3K. The unemployment rate rose to 7.6 percent, the highest level since April 2011. While the Canadian economy created 129K jobs last year, close to 90 percent of those were in the first six months. The pace of recovery has slowed substantially with consumers cutting back on spending and housing market hitting a soft patch. According to the Bank of Canada, consumers will account for more than half of Canada’s 2 percent economic growth this year. Nonetheless, the latest employment data suggests that the consumers could continue to pare back dragging the pace of recovery slower. The IVEY PMI report, building permits, new housing prices, and trade balance scheduled for release next week could point to more risks in the country’s economy as the demands for goods and housing contract. Meanwhile, New Zealand Prime Minister John Key today launched a formal strategy to improve ties with China, including more investment from Chinese SOEs, and attracting more Chinese students and tourists. As the two countries remain on track to reach the trade target set in 2010, New Zealand and China expect to double two-way trade from $10B to $20B by 2015. The foreign investment could further stimulate New Zealand’s growth and diversify the country’s reliance on Australia. Looking to next week, we have the employment data from New Zealand on Thursday. Meanwhile over in Australia, the central bank will be making a monetary policy announcement and currently, economists are looking for the RBA to cut rates by 25bp. If they follow through it would be third 25bp rate cut in a row.  Looser monetary policy is not a done deal however with latest PMI numbers showing manufacturing and service sector activities expanding in the month of January.

JPY: INTERVENTION RISK FALLS AFTER US DATA

The Japanese yen lost ground to all of the major currencies today thanks to the improvement in U.S. data. For the BoJ and the MoF, this is very good news because the pressure to intervene has been lifted. Nonetheless, the IMF is still calling on the central bank to expand stimulus. According to IMF Deputy Managing Director Naoyuki Shinohara “Japan’s economy has many downside risks, so depending on the circumstances, the BOJ should always be ready to expand quantitative easing.” After the BoJ Deputy Governor Hirohide Yamaguchi called for responsible fiscal policy, Shinohara also emphasized the importance of fiscal sustainability in his speech. According to another IMF official, the fund welcomes the government’s plan to double the consumption tax to 10% from a mid-term perspective, hinting that the rate may need to eventually rise further. "We're certainly very supportive of the announced plans," said Michael Keen, deputy-director of the IMF's fiscal affairs department, in an interview with Dow Jones Newswires. "We think that really is an important step in the right direction." However, the Prime Minister Yoshihiko Noda’s tax proposal faces criticism from both the opposing Liberal Democratic Party and the divided ruling party. The political battling presents more uncertainties amid cooling oversea demands. Looking forward to next week, the current account on Tuesday is expected to be at 0.63 trillion yen. On Thursday, we have the core machinery order and household confidence, and both could show more signs of weakness in the Japanese economy.

AUD/CAD: Currency in Play for Next 24 Hours

AUD/CAD will be our currency pair in play for Monday.  Australia will be releasing retail sales at 7:30PM ET/ 05:30 GMT which will be followed by Canada’s IVEY PMI data at 10:00AM ET/ 15:00 GMT.

AUD/CAD has been making new all time highs for the last few days, and it is currently trading in an uptrend, which we determined using our Double Bollinger Bands. The closest resistance is at today’s high of 1.0734. If the pair advanced beyond the record high, the psychologically significant 1.08 handle could provide further resistance. On the downside, the 10-day SMA could support the pair’s decline at 1.0646. A break below, AUD/CAD could target the 23.6% Fibonacci level at 1.0541. We drew our Fibonacci retracements from the swing low in August 2011 to the record high today.

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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.