US Dollar: Impact of Bank Nationalization

Last updated 2/20/2009 5:12 PM ET (GMT -5) 0 Comments - Add your comment

Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• US DOLLAR: IMPACT OF BANK NATIONALIZATION
• EUR/USD: CAN THE RALLY CONTINUE?
• GBP/USD: UK CONSUMERS CONTINUE TO SPEND
• USD/CAD: FALLING PRICES SIGNAL MORE RATE CUTS FROM BOC
• AUD/USD: GOLD PRICES RISE $18 TO $992.9
• NZD/USD: OIL PRICES AT $39.90
• USD/JPY: YEN CROSSES TUMBLE ON RISK AVERSION

EXPECTATIONS FOR UPCOMING FED MEETINGS

US DOLLAR: IMPACT OF BANK NATIONALIZATION

The financial markets capped the week off with an exceptionally volatile trading session. Despite a stronger than expected inflation report, the US dollar has sold off against every major currency. The greenback fell more than 400 pips against the Swiss Franc from its intraday high to low. The volatility in the currency was undoubtedly affected by the big moves in the equity and commodity markets. The Dow Jones Industrial Average hit an 11 year low intraday. All of these moves were significant but not as much as the rally in gold prices. The futures contracts broke above $1000 an ounce, suggesting that investors are losing confidence in the safety of the US dollar and are instead parking their money in gold, the one currency that can’t be printed.

The Impact of Bank Nationalization on the US Dollar

The rally in gold prices tells us one thing and one thing only, which is that the fear has returned to the market. There is currently a lot of speculation that Citigroup and Bank of America could be nationalized by the US government. Although this would drive equities lower, it could also trigger capital flight out of the US dollar. When Northern Rock was nationalized by the UK government in February of 2008, the British pound fell from 1.9638 to a low of 1.9363 over the course of 3 trading days. Although the dollar initially rallied on the news that the US government was taking over Fannie Mae and Freddie Mac in September 2008, it quickly gave back those gains to end the week lower against the Japanese Yen. Nationalization will ultimately be negative for the US dollar because it increases the debt and liabilities of the US Federal Reserve and hence taxpayers. Nationalization is by no means a foregone conclusion especially since it is not a part of the US Treasury’s Financial Stability Plan. Senate Banking Committee Chairman Christopher Dodd floated the idea of short term nationalization around but it will probably be the last option for the US government if the Financial Stability Plan fails to work quickly. In fact, the rebound in US equities was triggered by speculation that the Treasury could release more details regarding their plan to rescue the financial system next week.

Bernanke’s Humphrey Hawkins Testimony and US Data

Although any further announcements from the US Treasury could help relieve fear in the financial markets, the best strategy for forex traders is to be defensive. There are a lot of economic data due for release next week while Federal Reserve Chairman Ben Bernanke is scheduled to deliver his semi-annual Humphrey Hawkins testimony on the economy and monetary policy. Expect him to receive a lot of critical questions from Congress. This is a two day testimony – on Tuesday he will be speaking to the Senate and on Wednesday to the House. Bernanke could use this platform to announce new monetary policy measures aimed at stimulating the economy. This includes the possibility of more definitive plans to buy long term US Treasuries. As for economic data, a number of housing market and consumer confidence reports are due for release in addition to durable goods, Chicago PMI and the secondary release of fourth quarter GDP. Given the onerous terms of buying a home these days, we expect existing and new home sales to be tepid. Massive job losses should leave consumers pessimistic. Meanwhile consumer prices ticked higher last month, but on a year over year basis, inflation was flat.

EUR/USD: CAN THE RALLY CONTINUE?

Despite weaker Eurozone PMI numbers and a stronger US inflation report, the Euro soared against the US dollar. The rally in the currency pair came swiftly and aggressively as the EUR/USD took off right before the London close at (12:00pm ET). Prior to that, weakness dominated. Although the rally in the currency pair was very strong, it remains be seen whether the gains can be sustained in the coming week. The problems in Eastern Europe have not disappeared and could easily return to the forefront in the near future. However if investors continue to shuns dollars in favor of gold, the EUR/USD could extend its gains. Either way, it will be a busy data week in Europe. The German IFO report is due for release on Tuesday along with the current account balance. This is followed by the retail PMI and German unemployment reports on Thursday and then consumer prices on Friday. We expect German businesses to be more pessimistic than analysts. Most of the data should reflect the deteriorating conditions in the Eurozone economy and add pressure on the ECB to cut interest rates.

GBP/USD: UK CONSUMERS CONTINUE TO SPEND

The British pound extended its gains against the US dollar on surprisingly strong economic data. For the third month in a row and to the envy of retailers around the world, consumer spending actually increased in the month of January. With job losses mounting and the recession deepening, sales have been driven entirely by discounting. However, this does undermine the resilience of UK consumers who continue to shell out money for clothing and online purchases. This pace of consumption is not expected to continue as British central bankers call for a severe recession. The latest comments from Bank of England Deputy Governor John Gieve warned that the bank is struggling in its battle against a recession that could last not only a few years, but for an entire decade. This extended period of depressed growth is likened to that of the Japanese recession that lasted a similar amount of time. Interestingly Gieve also said that “there is a huge amount of easing in the pipelines” which only reaffirms the belief that the BoE is prepared to embark on quantitative easing. Looking ahead, there are a number of economic data expected from the UK next week, the most important of which is fourth quarter GDP. Although the market expects growth to contract at a faster pace, the improvement in retail sales and the narrower trade balance suggests otherwise.

USD/CAD: FALLING PRICES SIGNAL MORE RATE CUTS FROM BOC

The Australian, New Zealand and Canadian dollars appreciated against the greenback as gold prices flirt with the $1000 an ounce level. Inflation in Canada fell for the fourth consecutive month as lower commodity prices and discounts on big ticket items drive costs lower. This is the longest stretch of negative CPI growth for Canada in 80 years. Central Bank Governor Mark Casey stressed that the annual inflation rate could fall below zero percent in the middle of the 2009, largely due to a significant drop in energy prices. Therefore, the BoC is expected to reduce interest rates further in order to avoid a deepening recession and bring inflation back to target. The housing market in Canada is expected to continue its contraction as New Home construction is predicted to drop by 24%. Meanwhile RBA Governor Glenn Stevens continued his optimistic outlook for the Australian economy as he expects aggressive rate cuts and the hefty stimulus plan to counteract the slowing of the economy. Interest rates are likely to be reduced an additional 50 basis points in the March 3rd monetary policy meeting, bringing the overnight cash rate target to 2.75%. Yet, Stevens urged that the interest rates will unlikely to be reduced to UK and US levels. Retail sales are due for release from Canada on Friday.

USD/JPY: YEN CROSSES TUMBLE ON RISK AVERSION

The Bank of Japan stressed that the economy which already is in a severe crisis will deteriorate further as lack of demand for Japanese imports and the credit squeeze continue to cause uncertainty. In response, the BOJ will continue to supply low-cost funds and purchase corporate debt to unfreeze credit in the markets. Japanese Finance Minister Kaoru Yosano stated that more unconventional tools will be implemented in order to revive the struggling economy. Topix, a market capitalization-weighted average of all stocks on the Tokyo Stock Exchange reached the lowest levels in nearly quarter century as corporate profits dwindle. Recent figures for All Industry Activity Index attest to the reaction in equities as it continued to show signs of negativity for the 5th consecutive month. Starting next Monday, the BOJ will begin purchasing bank-owned shares in order to supply financial institution with liquidity, hoping for greater lending. The 1 Trillion Yen plan will be implemented until April 2010 and will focus on companies with a credit rating of BBB- or higher. Furthermore, Bank of Japan will release its minutes from the last meeting which will further elaborate on the future actions for the economy. There are a lot of economic releases for Japan next week ranging from consumer spending, inflation and manufacturing data.

USD/CAD: Currency in Play for Next 24 Hours

The currency in play on Monday is USD/CAD. The Retail Sales are expected to be released from Canada at 13:30GMT or 8:30AM EST.

USD/CAD is currently trading within the Buy Zone, which we determine using Bollinger Bands. Resistance is located at trendline indicated in the following chart which is at approximately 1.2650. This level coincides with 2nd Standard Deviation of the Bollinger Bands. The pattern will be negated if the pair breaks through the support which is placed at 23.6% retracement of September lows and October highs of last year at 1.2435. If the currency pair breaks resistance, we could possibly see a test of the October highs, while a break of support could open up the door for a move to 1.22.

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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.