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Is a Global FX War Possible?

Last updated 3/12/2009 5:32 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

• U.S. DOLLAR: IS A GLOBAL FX WAR POSSIBLE?
• EUR/USD: EURO PUSHED HIGHER BY SNB INTERVENTION
• GBP/USD: STRUGGLING TO RECOVER
• USD/CAD: IRAN TALKS OF $75 OIL
• NZD/USD: RETAIL SALES DUE FOR RELEASE
• AUD/USD: UNEMPLOYMENT RATE HITS 4 YEAR HIGH
• USD/JPY: REPATRIATION AND WEAK DATA DRIVES JPY LOWER

EXPECTATIONS FOR UPCOMING FED MEETINGS

U.S. DOLLAR: IS A GLOBAL FX WAR POSSIBLE?

Volatility has ripped through the foreign exchange market as the U.S. dollar gave back its earlier gains.  Safe haven flows drove the dollar higher at the beginning of the U.S. trading session, but the currency lost value when equities took off.  The big story in the foreign exchange today was the Swiss National Bank’s controversial and nuclear decision to intervene in the currency market, raising fears of a global FX war.  By coming into the foreign exchange market to sell Swiss Francs, the central bank has driven the Euro and U.S. dollar sharply higher.  The gains in these currencies were exacerbated by the rally in U.S. equities and a stronger retail sales report.  The rally in the foreign exchange market today indicates that risk appetite has improved.

Is a Global FX War Possible?

In an environment of slowing growth and falling prices, every central bank wants a weak currency.  However up until now, most major central banks have been reluctant to intervene in the foreign exchange market to artificially weaken their currencies because of the burden it would put on other countries.  Japan is a perfect example – the Japanese Yen has been skyrocketing but the BoJ did not sell Yen because they know that it would be counterproductive to the U.S. and Eurozone’s efforts to boost their own economy. In order for the Japanese economy to recover, their trade partners need to recover first.  However, today Switzerland has broken that unspoken truce of letting the market determine who gets to benefit from a weaker currency and who doesn’t.  By becoming a massive seller of Swiss Francs, they are in effect artificially driving other currencies higher.  This means that they are putting their own interests ahead of everyone else’s and unfortunately that may trigger retaliation by other central banks.  A global FX war where central banks around world start selling their own currencies, countering each other’s efforts is possible but still not all that probable.  Switzerland is less of a threat to the U.S. than to the European Union because they are a leading trade partner for the EU and not for the U.S.  What could get interesting however is this Saturday’s G20 meeting of finance ministers and central bankers, where currencies could now become a big topic of discussion.  

Is this a Bottom in US Equities?

Over the past 3 trading days, the S&P 500 has risen approximately 10.5 percent.  This recovery has helped to drive the Euro and commodity currencies higher.  Today’s rally has been sparked by the positive comments from Bank of America Chief Ken Lewis who said the bank was profitable in the first two months of the year and should be profitable for the full year.  However on a day when General Electric’s debt gets downgraded from AAA to AA+, we cannot lose sight of the problems ahead for the U.S. economy.  In all likelihood, we have not seen a bottom in stocks and are only witnessing a bear market rally.  There were many bear market rallies during the Great Depression.  Between 1929 and 1932, when the S&P 500 fell 86.5 percent, bear market rallies ranged from 12 to 110 percent with a 25 percent rebound being the norm.  With that in mind, another 10 percent rally in equities still keeps stocks in an overall downtrend.  When equities reverse, it is important to remember that the Swiss Franc is no longer an attractive safe haven currency because of its potential depreciation – the only safe havens left are the U.S. dollar and gold.  

Retail Sales Beat Expectations, Trade Numbers Could Follow Suit

Consumer spending in the month of February was stronger than the market expected with retail sales falling only 0.1 percent and if you exclude car purchases, consumer spending actually rose 0.5 percent ( full synopsis of Retail Sales report ).  Jobless claims on the other hand continued to rise, indicating that this pace of spending cannot continue.  The trade balance and consumer confidence numbers are due for release on Friday.  An improvement in export orders suggests that we will see the trade deficit narrow once again. Consumer confidence on the other hand is more difficult to call.  The market expects the weak labor market and falling equity prices to weigh on confidence, but if consumers were really that pessimistic, they would not have increased spending on core goods in both January and February.  

EUR/USD: EURO PUSHED HIGHER BY SNB INTERVENTION

It is extremely rare for Switzerland and the Swiss Franc to dominate flows in the currency market.  However that is exactly what we have seen today with EUR/CHF surging 3.4 percent or more than 500 pips to mark the single biggest one day rally ever for the currency pair since the introduction of the Euro.  A big buyer with deep pockets of Euros and seller of Swiss Francs has now entered the market which should lead to further gains in EUR/CHF.  In addition to intervening in the foreign exchange market, the Swiss National Bank also cut interest rates by 0.25 percent and announced that they will be adopting a Quantitative Easing program that involves buying domestic and foreign bonds.  As for the Euro, its gains were limited by weaker economic data and mixed comments from ECB President Trichet.  Eurozone producer prices and German industrial production disappointed which is not all that surprising considering the sharp drop in factory orders.  In a speech today, Trichet said the ECB has not decided if 1.5 percent interest rates is the low, but deflation is a negligible risk and a recovery is expected in 2010.  Eurozone retail sales are due for release tomorrow and most likely the data will also be Euro negative considering the sharp contraction in German consumer spending.  

GBP/USD: STRUGGLING TO RECOVER

For the second day in a row, the British pound has registered marginal gains.  Compared to many of the other major currencies, the recovery in the pound has been lackluster at best.  The Financial Times reported this morning that there has been a stampede to sell U.K. government bonds as the central bank begins Quantitative Easing. BoE policy maker Kate Baker proclaimed that the quantitative easing program is a necessary tool to prevent deflation. According to the Bank of England, the inflation rate is expected to slow below 1% as the recession deepens. Furthermore, the central bank will buy £5 Billion Pounds or $6.9 Billion of gilts early next week, after having already spent £2 billion on governments bonds yesterday pushing the 10-year yield to a two decade low. Ideally, the plan is structured to create better lending conditions while increasing demand for stocks and commercial debt.  The U.K. does not expect any economic releases for the remainder of the week, yet traders will closely monitor comments, if any, from BoE about the future of quantitative easing.

USD/CAD: IRAN TALKS OF $75 OIL

The Canadian, Australian and New Zealand dollars are all sharply higher thanks to the rise in equity and commodity prices.  Oil prices rose 10 percent as comments from Iran’s oil minister suggests that OPEC could cut production soon and that a price of $75-100 a barrel is the “collective opinion” of oil producers and companies. However the gains in the currency may be stifled by tomorrow’s Canadian employment report. We expect another month of massive job losses as the employment component of IVEY PMI, which is a strong leading indicator for overall employment continued to decline.  Australian employment numbers were mixed with the economy generating 1800 new jobs and the unemployment rate hitting a 4 year high.  The Australian economy is holding up better than its peers but it is still suffering from weakness.  New Zealand retail sales are due for release this evening.  A smaller decline in credit card spending and visitor arrivals suggests a possible improvement in consumer spending.  

USD/JPY: REPATRIATION AND WEAK DATA DRIVES JPY LOWER

Japanese Yen crosses have rallied on the combination of higher equities, weaker Japanese economic data and repatriation.  With global interest rates at zero and the Yen rising, Japanese investors have a number of reasons to repatriate their capital back home.  Meanwhile there still seems to be no light in the end of the tunnel for Japan’s economy which contracted 12.1% in the last quarter. Comments from Finance Minister Kaoru Yosano about the likelihood of a steep decline in production leading to a significant adjustment in the labor force added to the pessimism about the economy.  In order to navigate through the rough times ahead, Japan’s third and fifth largest non-life insurers, Sompo Japan Insurance and Nipponkoa Insurance are in talks to merge. Mitsubishi UFJ, Japan’s biggest bank, will sell roughly ¥97.4 billion yen or $1 billion in stock to increase capital as tumbling equities erode the value of its investments.  Tomorrow, Consumer Confidence is due for release and it is likely to decline as job losses continue to mount.

USD/CAD: Currency in Play for Next 24 Hours

The currency in play for the upcoming 24 hours is USD/CAD. Canada is expected to release its figures for unemployment at 11:00GMT or 7:00AM EST. Thereafter, U.S. and Canada will release Trade Balance and International Merchandise Trade at 12:30GMT or 8:30AM EST. USD/CAD is currently lingering within the Range Trading Zone, which we determine using Bollinger Bands after failing to close above 1.30 late last week. Current resistance originates at 1.30, a level that the pair failed to close above on four distinct occasions since October 2008. As for support, the 20-day SMA represents a level to watch at 1.2680. If the pair manages to break above 1.30, a new uptrend could emerge. An uptrend will be negated if the pair accelerates to the downside after breaking the 20-day SMA.

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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.