Forex: Decoding the Rally and 3 Reasons Why it is Suspicious

Last updated 2/24/2009 5:35 PM EST (GMT -5) 0 Comments - Add your comment

Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• FOREX: DECODING THE RALLY AND 3 REASONS WHY IT IS SUSPICIOUS
• EUR/USD: IS TRICHET GIVING IN?
• GBP/USD: HOLDING STEADY AHEAD OF GDP
• AUD/USD: HIGHER ON M&A NEWS
• USD/CAD: OIL PRICES AT $39.97
• NZD/USD: INFLATION EXPECTATIONS DUE FOR RELEASE
• USD/JPY: HITS 11 WEEK HIGH

EXPECTATIONS FOR UPCOMING FED MEETINGS

FOREX: DECODING THE RALLY AND 3 REASONS WHY IT IS SUSPICIOUS

Currencies and equities have strengthened across the board suggesting that risk appetite may be improving. The dollar, which has been a refuge for safe haven flows, fell against all of the major currencies except for the Japanese Yen. In fact, the rally in USD/JPY has been voracious with the currency pair rising 2.5 percent to an 11 week high. The move today has been driven by a variety of factors, none of which in our opinion are meaningful enough to sustain the rally.

What Drove Currencies Higher?

Four separate factors have contributed to the rally in the currency market today:

1. Comments from Fed President Fisher – Dallas Federal Reserve President Fisher said the central bank could act to prevent deflation. If prices start to fall aggressively, the central bank could take steps towards reversing price pressures. He also talked about the possibility of buying US Treasuries to help the economy.

2. No Surprises From Bernanke – Federal Reserve Chairman Bernanke was pessimistic but other than that, he delivered no surprises. He said buying US Treasuries is still an option and pressed the importance of stabilizing the financial markets.

3. Speculation that Japanese Government Could Buy Stocks – Nikkei Financial Daily, the largest financial newspaper in Japan is running a story about how the government may buy stakes in Japanese companies directly from the market. Since the beginning of 2008, the Nikkei has fallen more than 50 percent. This possibility has contributed to the global improvement in risk appetite.

3 Reasons Why the Rally is Suspicious

At the same time, none of these factors deliver real solutions. This leaves us skeptical of today’s recovery particularly for the following reasons:

1. Bernanke Warns of Delayed Recovery – According to the Fed Chairman, a recovery in the US economy could take more than 2 to 3 years. A turnaround in 2010 is only possible if the markets and banks stabilize. This is why Bernanke has been a big supporter of focusing relief efforts on the financial sector. He believes that there are still significant stresses in many markets and a sharp contraction in economic activity is expected in the first quarter.

2. Very Weak Economic Data – Incoming economic data confirms Bernanke’s pessimistic view. Consumer confidence hit a record low last month while house prices and manufacturing activity also saw a sharp decline.

3. AIG Risk – There are a lot of fears that AIG who received a massive bailout from the US government last year could report major losses in the fourth quarter. This would put their credit rating at risk and the government may be faced with the tough decision on whether AIG is too big to fail. Deep problems still exist within the financial sector and that will come back to haunt investors. President Obama is expected to address Congress later today and Bernanke will be delivering the semi-annual testimony on the economy and monetary policy to the House tomorrow. Since the only piece of economic data on the US calendar is existing home sales, comments from government officials should continue to drive currencies.

EUR/USD: IS TRICHET GIVING IN?

The Euro strengthened against the US dollar despite weaker economic data and bearish comments from European Central Bank President Trichet. German business confidence dropped from 83.0 to 82.6 in the month of February, the lowest level since World War II. With the region in recession, companies have been forced to limit production and lay off employees. Final fourth quarter GDP numbers are due for release tomorrow and they are expected to confirm that the country has entered its worst recession in 12 years. This weakness as well as the problems in the financial sector could finally be swaying the opinion of ECB President Trichet. This morning, the UK Telegraph quoted Trichet as saying that the financial system is under “severe strain” and “what it is becoming increasingly clear since the intensification of the crisis in mid-September is that strains in the financial sector are spilling over into the real economy." The exposure of Western European banks to Eastern European borrowers and the risk of Ireland defaulting on its loans could force more aggressive rate cuts from the European Central Bank.

GBP/USD: HOLDING STEADY AHEAD OF GDP

The British pound ended the US trading session unchanged against the US dollar ahead of the fourth quarter GDP report. Analysts are looking for a deeper contraction but the resilience of UK consumers and the narrower trade balance suggests that growth may have actually contracted at a slower pace. Meanwhile signs of tight credit still remain as home loan approvals dropped by a staggering 43% from the previous year. Total Business Investments also experienced a rapid decline, but with a healthy stimulus package and an aggressive round of interest rate reductions, quarter on quarter figures were better than anticipated. Andrew Sentance, the BoE’s policy maker, stated that the price declines could intensify if the current recession prolongs, resulting in a deflationary spiral. The economy which is expected to have shrunk by 1.6% in the fourth quarter of 2008, according to Sentance, will need additional stimulus to combat deflationary symptoms. With his comments, Sentance, added to the speculation that the authorities will begin acquiring assets to jumpstart the struggling economy. In addition to GDP, the UK is also releasing data for Private Consumption, Export and Imports.

AUD/USD: HIGHER ON M&A NEWS

An overall improvement in risk appetite drove the Australian, New Zealand and Canadian dollars higher against the greenback. Commodity prices were mixed with oil rallying but gold slipping. According to Australian interest rates swaps, RBA Governor Glenn Stevens will slow his aggressive reduction in interest rates when he lowers it to record low on March 3rd. It is widely expected that the interest rates will be reduced 50 basis points to 2.75%. The prices of the swaps supported by last week’s comments from Glenn Stevens, who said aggressive reductions in interest rates is unlikely. The Australian dollar is also benefiting from news that China plans a $3 billion investment into Fortescue, Australia’s third largest iron ore exporter. The Asian giant is taking advantage of the fall in commodity prices to invest in companies that meet their growing resource needs. This could keep the Australian economy supported. Meanwhile, the RBNZ is expected to report inflation expectations later today; prices are falling globally.

USD/JPY: HITS 11 WEEK HIGH

Yen crosses were the biggest movers in the currency market today thanks to the strong rally in USD/JPY. The currency pair broke key resistance after rising to levels not seen since November of last year. An important factor was a key correlation with Dow Jones Industrial Average which rose 3.32% from 12-year lows. The recoupling along with such an impressive move confirms that risk appetite is improving. The BoJ minutes have revealed that the economy is likely to recover by the end of the year, despite an increased trade deficit and lower expectations for the GDP. We are highly skeptical of these lofty forecasts. The Trade balance which will be released tomorrow is expected to widen by the biggest margin in 23 years, reflecting lack of demand for goods coming from Japan. With the Nikkei reaching 26-year lows and Prime Minister Taro Aso’s approval rating falling to all time lows, the Yen status of safe haven is quickly losing its appeal. Further, Japan’s corporate service prices fell for a fourth consecutive month as lack of demand for goods forced companies to cut spending. The economy which has been eroded by the tightness of credit and lack of demand from abroad may start to experience some relief if this Yen weakness continues.

GBP/USD: Currency in Play for Next 24 Hours

The GBP/USD will be the currency in play for the next 24 hours. Tomorrow, U.K. is set to release its GDP figures along with Personal Consumption, Exports and Imports at 9:30GMT or 4:30AM EST. Later in the day, the U.S. will release its figures for Existing Home Sales at 15:00GMT or 10:00AM EST. The GBP/USD pair is currently lingering within Range Trading Zone which we determine according to Bollinger Bands. The Bands have became extremely tight over the course of two weeks as the pair failed to establish any discrete momentum. Hence, resistance is originating at 1.4850 which is 2nd Standard Deviation of the Bollinger Bands that coincides with upper line of a triangle which proved to be efficient resistance a number of times. Nevertheless, if the pair heads lower, support could be tested around 1.4150. Support represents the 1st Standard Deviation of the Bollinger Bands along with being the lower line of the triangle formation.

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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.