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U.S Dollar: Fed Remains Worried

Last updated 4/8/2009 5:50 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: FED REMAINS WORRIED
• GBP/USD: NO RATE CUTS FROM BOE
• EUR/USD: SHRUGS OFF DOWNGRADES
• USD/CAD: EMPLOYMENT, TRADE AND HOUSING
• AUD/USD: JOB GROWTH EXPECTED TO TURN INTO JOB LOSSES
• NZD/USD: REBOUNDS AFTER SHARP DECLINE
• USD/JPY: TRADE NUMBERS MASK WEAKNESS

EXPECTATIONS FOR UPCOMING FED MEETINGS

U.S. DOLLAR: FED REMAINS WORRIED

The foreign exchange market has been relatively quiet today with most major currency pairs fluctuating within a tight trading range. Although the U.S. dollar continued to lose value against the Japanese Yen, it remained virtually unchanged against the Euro, British pound, Australian and Canadian dollars. Since the beginning of the month, volatilities in the currency market have fallen significantly. For example, at the money 3 month EUR/USD volatilities dropped from 18 percent down to 15.35 percent. To put these levels into perspective, volatilities hit a high of 24.6 percent in December 2008 when the EUR/USD rose from a low of 1.2580 to a high of 1.4719 in a course of 2 weeks. The unconvincing rally in U.S. equities has helped the dollar hold onto its gains as Nouriel Roubini aka Mr. Gloom joined to the chorus of experts characterizing the recent turn in equities as a bear market rally.  

FOMC Minutes Highlights Fed’s Concerns

The undeniably bearish tone of the FOMC minutes adds to the evidence that the bear market rally may lose steam.  Most of the recent improvements in U.S. economic data have come from the housing market and unfortunately the Fed threw cold water on a housing recovery by saying that the gain in housing starts is not the beginning of a new trend. They also revised down their growth forecasts for the second half of 2009 and 2010. According to the minutes, GDP is expected to flatten out for the rest of this year and expand slowly in 2010. The problems lie in many sectors of the U.S. economy. Despite the efforts by the Obama Administration, credit remains tight while fragile markets are pressuring banks. The slowdown in the global economy also reduces demand for U.S. exports, preventing a meaningful recovery for manufacturers. The economy has worsened more than the Fed anticipated and further deterioration could be possible with U.S. companies expected to increase lay offs.  However the most important part of the FOMC minutes was their rationale for buying longer term U.S. Treasuries. The Fed was willing to risk their credibility of maintaining long-run price stability in order to achieve the benefits of purchasing Treasury Securities. Unlike purchases of other specific assets, purchasing Treasuries would have effects across a variety of markets and should ease financial conditions generally while minimizing the central bank’s influence on the allocation of credit. FOMC members agreed that substantial purchases of a range of longer-term assets are appropriate. 

Reacting to FOMC

Economic Data: Trade Balance and Jobless Claims

Despite the bearish outlook for the U.S. economy, mortgage applications rose for the fifth week in a row to the highest level in 3 months. The central bank and Treasury’s efforts are helping to boost sales even if they do not believe that the housing market has hit a bottom. Wholesale inventories also fell by 1.5 percent, the sharpest decline ever while sales rose 0.6 percent, the first increase since June. In the current environment, falling inventories is positive because it means that wholesalers are actually selling off their inventories and if this trend continues, they may have to start purchasing new inventory once again. If sales continue at the current pace, it would take 1.31 months for distributors to sell everything that they have on hand. The trade balance, import prices and jobless claims are due for release tomorrow. After shrinking to the smallest level in 6 years, we could actually see a mild increase in the trade deficit because oil prices increased and the dollar index strengthened in February. A stronger dollar could hurt exports while higher oil prices could boost the value of imports. It will also be important to keep an eye on jobless claims which hit the highest level since 1982 last week. A dip is expected but if claims continue to rise, it would be extremely worrisome.

GBP/USD: NO RATE CUTS FROM BOE

The British pound is holding steady ahead of the Bank of England’s interest rate decision on Thursday. The central bank is widely expected to leave interest rates unchanged at a record low of 0.5 percent which means that the rate decision should be a nonevent. Quantitative Easing is underway in the U.K. but unfortunately we won’t know whether the Bank of England is pleased or frustrated with the results until the MPC minutes are released in a few weeks. Annualized consumer prices rose back above the central bank’s target in February and could very well rise again in March following the rebound in commodity prices. Producer prices are due for release tomorrow along with the trade balance. The trade deficit could widen given the sharp decline in new orders and the continual drop in export orders.  Although economic data in general has been better than expected with the NIESR GDP estimate holding steady at -1.5 percent, we did see some disappointments last night with consumer confidence deteriorating in March. The spotlight will be on the British pound tomorrow and therefore the pair has a decent chance of breaking out of its recent trading range. 

NIESR Talks About Expectation for Decline in U.K. GDP

EUR/USD: SHRUGS OFF DOWNGRADES

The euro was surprisingly resilient in the face of credit downgrades and weaker economic data. Ireland, Estonia, Latvia and Lithuania all saw their sovereign ratings downgraded by Fitch. The only one that really matters for the euro should is Ireland because it is a member of the Eurozone but problems in Eastern Europe can also spill over into Western Europe.   Ireland has been plagued with problems over the past few months and therefore it is not entirely surprising to see the country’s rating fall from AAA to AA+. This follows a similar downgrade by ratings agency Standard & Poor’s on March 30 ^th .  Ireland was once known as the Celtic Tiger, but recession has hit the country hard. The downgrade comes on the heels of an emergency budget announced by the government yesterday which basically raises taxes on the middle class and reduces government spending.  Gross government debt is expected to rise to around 80 percent of GDP by 2011, more than 3 times higher than 2007 levels. The Eurozone economy is facing a number of problems that will force the ECB’s hand next month. In addition to the downgrades, German factory orders dropped 3.5 percent in February while the improvement in the current account surplus fell short of expectations. The trade surplus increased more than expected, which may be the only reason why the euro has managed to keep its head above water. German industrial production is due for release tomorrow and we expect a similar decline in manufacturing activity. 

Ireland's Finance Minister Talks About Emergency Budget

USD/CAD: EMPLOYMENT, TRADE AND HOUSING

There should be a lot of volatility in the Canadian dollar tomorrow with employment, trade and housing market numbers due for release. Last month, 82,600 Canadians lost their jobs, marking the fourth consecutive month of net job losses. Although Canada will not be able to escape another month of job losses, the pace of attrition could slow because the employment component of IVEY PMI rebounded significantly in the month of March. As for trade, the decline in the overall IVEY PMI index suggests that the deficit could widen but house prices may have stabilized as housing starts rise.  USD/CAD has been under pressure since the beginning of the month which is in line with seasonal trading patterns of the currency pair . The Canadian dollar outperformed the U.S. dollar in each of the last 7 years. If the employment number surprises to the upside like we expect, a further gain is likely. Meanwhile, the lack of New Zealand economic data has helped the currency pair rebound against the U.S. dollar. The Australian dollar on the other hand held steady despite a sharp improvement in consumer confidence. Australian employment numbers are due for release this evening and the decline in the employment component of service and manufacturing PMI suggests that job growth may have turned into job losses last month.

USD/JPY: TRADE NUMBERS MASK WEAKNESS

With no major U.S. economic data on the calendar, the Japanese Yen has appreciated against every major currency pair thanks to stronger than expected economic data. The current account and trade deficits became surpluses once again in the month of February which should be something to cheer about. Unfortunately the better trade numbers masked underlying weakness as exports plunged by a record 50.4 percent. The only reason why the country managed to return to a surplus was because there was also a record drop in imports. Crippling conditions continue to plague the Japanese economy which is part of the reason why the Japanese government announced a new stimulus plan yesterday. In order for exports to really recover however, we need to first see a recovery in China and the U.S. Interestingly enough, the Eco Watchers survey which measures the sentiment of barbers, taxi drivers and other people who deal with consumers jumped to an 8 month high in March. Unless the index remains at these levels, we remain skeptical of their significance. 

GBP/JPY: Currency in Play for Next 24 Hours

The GBP/USD will be the currency in play for the next 24 hours. From the U.K. we expect producer prices and the trade balance at 8:30 GMT or 4:30am ET and the Bank of England rate decision at 11:00 GMT or 7:00am ET. From the U.S. we expect the trade balance, import prices and jobless claims to be released at 12:30 GMT or 8:30am ET. 

The currency pair has been consolidating for the past week and is currently hovering between the Buy Zone and Range Trading Zone, which we determine using Bollinger Bands. As long as the currency pair does not close below today’s low of 1.4635, the uptrend remains intact. Significant support resides at 1.4555, which is not far from current levels. This area is important because it is where the 100 and 10 day SMA converge and is slightly below the 50 percent Fibonacci retracement of the December to January sell-off. Should the 1.4635 level break, that would be the next level of support. If the GBP/USD remains within the Buy Zone, there is scope for a move up to the one month high of 1.4960. 

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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.