Which Currencies Will Do Best Against the U.S. Dollar?

Last updated 3/19/2009 5:43 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

• US DOLLAR: WHICH CURRENCIES WILL DO BEST AGAINST THE U.S. DOLLAR?
• EUR/USD: 8 DAY RALLY, SNB TALKS OF NEGATIVE RATES
• GBP/USD: GROWING BUDGET DEFICIT
• USD/CAD: CANADIAN RETAIL SALES FORECAST
• AUD/USD: GOLD PRICES AT $959.40
• NZD/USD: OIL PRICES HIT 10 WEEK HIGH
• USD/JPY: BELOW 95

EXPECTATIONS FOR UPCOMING FED MEETINGS

US DOLLAR: WHICH CURRENCIES WILL DO BEST AGAINST THE U.S. DOLLAR?

For readers of the Daily Currency Focus, it should be no surprise that the dollar has continued to weaken. On Wednesday, we said that the actions by the Federal Reserve have cemented the downtrend in the U.S. dollar. Given how currency traders have responded to previous Quantitative Easing threats and announcements, the EUR/USD could realistically hit 1.40 (see charts) . Although equities have given back its gains and bond yields have rallied, the moves in the currency and commodity markets indicate that the Fed’s actions will have a lasting impact on the financial markets. As we look forward to more dollar weakness, it is worthwhile to consider how a weaker dollar impacts the global economy.

Global Ramifications of Dollar Weakness

As the most actively transacted currency in the world, the fluctuations in the U.S. dollar have broad ramifications for the global economy. Most obviously, the weakness of the greenback drives other currencies such as the Euro, British pound and Japanese Yen higher. For those countries, a significant rally in their currency has a similar affect on the economy as rate hike. Many commodities are also priced in dollars which explains why oil and gold prices are dramatically higher. Oil prices peaked in July 2008, at the exact same time that the U.S. dollar bottomed. Since July 2008, the price of oil has had a 90 percent negative correlation with the dollar index, which roughly means that when the dollar rises, oil prices fall 90 percent of the time. Higher commodity prices and a weaker dollar will drive inflation higher, but for the time being, this is not a concern for the Fed because weak demand will prevent vendors from raising prices. Finally, the weaker dollar will help U.S. companies selling goods abroad by either increasing the competitiveness of U.S. exports or increasing the value of foreign earnings when converted by into U.S. dollars.

Which Currencies Will Do Best Against the U.S. Dollar?

The currencies that will do best against the U.S. dollar are those with central banks that are not eager to follow in the footsteps of the Federal Reserve, Bank of England and the Bank of Japan. These include the European Central Bank, Reserve Bank of Australia and the Reserve Bank of New Zealand. All 3 of these central banks have interest rates above 1.00 percent and have been slow to cut interest rates, let alone embark on quantitative easing. The parabolic moves over the past 24 hours will inevitably lead to a correction, but in general, we expect further gains in the EUR/USD, AUD/USD and NZD/USD.

Geithner, Obama and Economic Data

Treasury Secretary Tim Geithner has yet to release details on his program to take toxic assets off bank balance sheets. Even the IMF has joined in the criticism of Geithner’s plans, noting that “critical details concerning the valuation of distressed assets remain unclear.” The details are expected any day now and when the announcement comes, we could see a significant reaction in the financial markets. In the interim, President Obama is still scheduled to appear on the Tonight Show with Jay Leno this evening. Like Bernanke who appeared on 60 minutes, we expect the President to err on the side of optimism and use the platform to reassure Americans that his Administration is doing all that it can to restore stability in the U.S. economy. His speech could not have a better background with the Fed’s stunning announcement yesterday and better than expected economic data this morning. Jobless claims, leading indicators and the Philadelphia Fed index all beat expectations. Unfortunately the good data is still a mirage in many ways because even though weekly claims fell from 658k to 646k, continuing claims hit a record high of 5.473 million. Leading indicators fell less than expected but still declined while the details of the Philadelphia Fed Manufacturing index indicated that more components deteriorated than improved in the month of March. The lack of U.S. economic data on the calendar tomorrow could lead to a relief rally in the U.S. dollar.

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EUR/USD: 8 DAY RALLY, SNB TALKS OF NEGATIVE RATES

The EUR/USD has now rallied for 8 consecutive trading days. We believe that the currency pair will hit 1.40 , but it is important to mention that 1.3850 is a significant resistance level. Fundamentally, the European Central Bank continues to give us reasons to be bullish Euros. Although they have suggested that interest rates will fall below current levels, they are also quick to point out that interest rates are already very low and they stand ready to reverse their rate cuts if inflation accelerates once again. Comments such as these are not reflective of a central bank that is willing to “do all that they can” to stabilize the Eurozone economy. Unfortunately by being frugal with their monetary stimulus over the past few months, their efforts will be set back even further by the strength of the Euro. Meanwhile we are also keeping an eye on the Swiss Franc. After intervening to sell Francs earlier this month, the Swiss National Bank has returned with more threats. This afternoon, SNB member Jordan said that the central bank will not tolerate further franc appreciation and the market realized immediately after their intervention that the SNB is serious. They will now be monitoring the FX markets permanently and will be intervening according to the situation in the currency. However what was most surprising was his comment that the SNB could impose negative rates on deposits. This would be an extremely nuclear action by the SNB but not the first time they have resorted to this option. In the 1970s, Switzerland offered negative interests to discourage foreigners to hold Swiss Francs. Investors should take note that the SNB is very serious about capping the rise in the Swiss Franc because the economy has weakened dramatically. Switzerland’s unemployment rate hit a 3 year high of 8 percent last month while the trade surplus shrank from 1.99B to 0.73B.

Europe Facing Deep Recession

GBP/USD: GROWING BUDGET DEFICIT

The British pound strengthened against the U.S. dollar and Euro despite a wider budget deficit. The recession has hit the U.K. economy hard triggering massive unemployment across the country and when that occurs, a growing budget deficit is a natural consequence. Not only are tax revenues less, but the government will have to spend more money on social benefits. Almost 1.4 million Britons were claiming jobless payments in February, the most since 1998. Don’t forget that the U.K. government is also spending a great deal of money bailing out banks. The only consolation is that the U.K. is not the only country faced with lower tax revenues and higher spending. The Chancellor admits that private sector finances has deteriorated more than previously forecasted, but if unemployment continues to rise as expected, the deficit could increase even further. Meanwhile, there are no signs of improvement in the manufacturing sector as the CBI industrial trends survey fell to a 17 year low.

UK Economy Not Responding

USD/CAD: CANADIAN RETAIL SALES FORECAST

The rally continued for the Australian, New Zealand and Canadian dollars. Economic data from Canada was hot with consumer prices rising 0.7 percent last month and foreign purchases of Canadian securities increasing 10.42B in January. Higher gasoline prices single handedly drove inflation higher, as the annualized rate of core price growth remained unchanged at 1.9 percent. Foreign purchases of Canadian dollar denominated assets were also very strong thanks to new government debt sales. The gains in the Canadian dollar were compounded by the rise in oil prices which exceeded $50 a barrel today. Unfortunately Canadian retail sales tomorrow could halt the rally. Wholesales fell to the lowest level in more than 4 years, signaling weak retail sales in January. The market is actually looking for consumer spending to rebound so if wholesales accurately forecast retail sales, we could see a rebound in USD/CAD. Australian economic data was weak with new vehicle sales falling more than expected. Comments from RBA Assistant Governor Edey were mixed - he forecasted further weakness for Australia but pointed out that the country is in a better position than most to weather the storm. There are no economic releases scheduled for Australia this evening but New Zealand has credit card spending and visitor arrivals due for release.

USD/JPY: BELOW 95

Japanese Yen crosses are weaker across the board as the sell-off in USD/JPY drags everything lower. According to a Reuters Poll, the sentiment of Japanese manufacturers hit a record low of -78 in the month of March, reaffirming claims that the recession is deepening. The Service Index also hovered near a record low as domestic demand faltered. The figures come ahead of the widely anticipated Quarterly Tankan Survey which is due for release on April 1st. Current data supports a sharp deterioration in large manufacturer sentiment in Japan. Adding to the pessimism, the central bank expects the economy to contract by the biggest margin in more than 60 years as lackluster demand for exports leads to production cuts and layoffs. To offset ever deteriorating conditions the Bank of Japan added to monthly purchases of government bonds by ¥1.8 trillion yen or $18.8 billion from a previous ¥1.4 trillion yen. However, Central Bank Governor Massaki Shirakawa warned that there is no much room remaining to raise the amount of purchases. Meanwhile, Nationwide Department Store Sales continued to decline at an accelerated rate signaling weaker consumer confidence. The all Industry Activity Index on the other hand improved slightly from the previous month, but remained at contractionary levels.

EUR/USD: Currency in Play for Next 24 Hours

The currency in play for the next 24 hours will be the EUR/USD. German Producer Prices will be released around 7:00GMT or 3:00AM EST, while Euro-zone’s Industrial Production figures are anticipated at 10:00GMT or 6:00AM EST. After eight consecutive days of advances, the EUR/USD pair is trading within Buy Zone established using the Bollinger Bands. The 61.8% of December highs and this year’s lows represents resistance at 1.3850. Support on the other hand is set at the low for today’s session and 2nd Standard Deviation of the Bollinger Bands between 1.3385 and 1.3415.

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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.