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THE STORIES IN THE CURRENCY MARKET
* US DOLLAR: HEADED HIGHER?
* EUR: NO HELP FOR EASTERN EUROPE
* GBP: TESTING 1.40
* AUD: WILL THE RBA CUT INTEREST RATES?
* CAD: BOC TO CUT RATES BY 50BP
* NZD: OIL PRICES AT $40.07
* USD/JPY: TEMPORARY WEAKNESS?
EXPECTATIONS FOR UPCOMING FED MEETINGS
| CURRENT US INTEREST RATE: 0.25% | Rates Expected to Remain Unchanged in Feb and March | ||||
| 03/17 Meeting | 04/29 Meeting | ||||
| NO CHANGE | 96% | 88.6% | |||
| CUT TO 0BP | 0.0% | 0.0% | |||
| HIKE TO 50BP | 4.0% | 7.7% | |||
| CUT TO 75BP | 0.0% | 0.0% | |||
US DOLLAR: HEADED HIGHER?
It has been a rough day in the financial markets with the Dow Jones Industrial Average and S&P 500 falling to the lowest level in 12 years. Even before the US markets opened, the tone for trading was already set by the massive sell-off in Asian and European equities. This weakness drove the US dollar and Japanese Yen higher across the board. Risk aversion has contributed to the safe haven demand for US dollars, not because the US economy is healthy, but because investors fear that more trouble lies ahead for other countries. There is also widespread belief that the US needs to recover first before everyone else can follow suit.
First In, First Out (FIFO) Mentality
In accounting, First In, First Out or FIFO is a common valuation method. The premise is that what is acquired first is disposed first. In today’s markets, FIFO may also apply, but not in the same way as it does in accounting. Instead, the first countries to fall into recessions could also be the first to rise from it (the US was the first G7 country to fall into recession in December 2007). In response to rapidly slowing growth, the US government has delivered ferocious interest rate cuts and enormous liquidity injections which could pave the path to recovery. The other way to look at the current economic situation is that if the US economy does not recover, no one else will. Globalization has increased the mutual dependency of many countries. For export dependent countries in the Eurozone and Asia, a rebound in US demand is essential for a recovery. Today’s better than expected US economic data provides a glimmer of hope despite underlying weakness. Although we are not arguing that the turn in the economy is happening now, but in the midst of a turn, economic data is never clean cut as improvements can always contain some underlying weakness.
ISM Manufacturing, Personal Income, Spending and Savings
Despite deterioration in nearly all of the regional manufacturing indices, the national ISM manufacturing index actually rebounded in the month of February. The improvement was the first since June 2008. The uptick came primarily from production and supplier deliveries as the employment component hit a record low while the new orders index remained below 40 for the sixth straight month. Personal income and spending also rose, but the increase was primarily due to higher federal transfer payments from things like social security and unemployment benefits. The personal savings rate hit the highest level since March 1995. Unfortunately higher savings is being driven by fears about job security which is not a positive thing. AIG also reported a $61.7 billion loss in the fourth quarter, prompting more capital injection from the Obama Administration. The US economic calendar is light tomorrow with only pending home sales due for release. However more action is expected with Federal Reserve Chairman Ben Bernanke and Treasury Secretary Tim Geithner scheduled to testify before the Senate and the House on the US economy and the Federal Budget tomorrow. The budget is expected to hit 12 percent of GDP. The stress tests for banks have also begun, prompting many related commentaries by Federal Reserve Presidents. Although the US government has taken larger stakes in banks, they have been reluctant to resort to full scale nationalization.
Is the Dollar Headed Higher?
The question of whether the dollar is headed higher is really a question of how much more bad news is in store for the global economy. If we see a repeat of the subprime crisis with Eastern Europeans defaulting on their loans, capital flight out of Euros could drive the dollar higher. As for the British pound, the dollar could also rise as the threat of Quantitative Easing weighs on the UK currency. We even believe that the dollar’s strength could extend to the Japanese Yen which has held up well considering the 300 point drop in the Dow.
EUR: NO HELP FOR EASTERN EUROPE
The Euro came under another round of selling pressure as the European Union rejected Hungary’s pleas for help for newer Eastern European members. Under the Maastricht Treaty, members of the Eurozone are actually forbidden from helping each other but investors held out hope that Germany, the largest nation within the Eurozone would overturn the “no-bailout” clause. The Chancellor of Germany said that it is not feasible to implement a blanket bailout and instead countries should be dealt with it on a case by case basis. Such are the pitfalls of a region that has opted for fragmented responses to the economic crisis. The members of the Eurozone are bounded by a currency but not country. Unfortunately a lack of assistance to Eastern European nations could have similar consequences as the US overlooking subprime exposure. Defaults could lead to major losses in Western Europe and maybe then a coordinated response will be implemented. In the meantime, in addition to brewing problems in the financial sector, the Eurozone economy is deteriorating. Manufacturing PMI dropped from 33.6 to 33.5 as activity slowed in Germany, France and Italy. Consumer prices were actually stronger than expecting, rising 1.2 percent in the month of February. There are no Eurozone economic releases on the calendar tomorrow, which leaves the price action of the EUR/USD dependent upon the market’s risk appetite and more speculation surrounding Eastern European woes.
GBP: TESTING 1.40
The British pound fell to a 5 week low against the US dollar on weaker economic data and speculation about Quantitative Easing. Manufacturing PMI fell to 34.7 from 35.8, the lowest level since November’s record low. The employment and output components of the report also fell to the weakest levels ever, reflecting the overall vulnerability of the UK economy. Construction sector PMI is due for release tonight and we expect similar weakness from the report. Consumer credit, net lending and mortgage approvals were all weak. The Bank of England is expected to cut interest rates to 0.5 percent this week and unveil a Quantitative Easing program. The size of the program is unclear but that should be the most market moving aspect of the monetary policy decision. The larger the program, the more money the government may have to print to pay for it. The British pound fell to an intraday low of 1.3957 and is currently flirting with the 1.40 level. We expect that critical level to be tested again before the BoE’s rate decision.
AUD: WILL THE RBA CUT INTEREST RATES?
The Reserve Bank of Australia has a monetary policy decision this evening and there is a not so remote chance that they could leave interest rates unchanged. The market is looking for only a quarter point cut, which would be the smallest for the central bank since September. Comments from Reserve Bank officials have been relatively optimistic and their optimism has been confirmed by stronger economic data. Growth is positive in Australia and Australians are seeing net job growth. Before the rate decision, the current account balance for the fourth quarter and retail sales in January will be released. The improvement in the sales component of service sector PMI skews the odds towards stronger numbers. Therefore the RBA could leave interest rates unchanged, which would be a big surprise for the Australian dollar. Even if they cut interest rates, less dovish comments could drive the Australian dollar higher, particularly against the New Zealand and Canadian dollars. In contrast to Australia, Canada has been doing horribly. GDP dropped 3.4 percent in the fourth quarter, the steepest slide since 1991. These hard times will drive the Bank of Canada to cut interest rates by 25 to 50bp on Tuesday. Given their recently pessimistic and dovish comments, we expect the larger rate cut from the BoC.
USD/JPY: TEMPORARY WEAKNESS?
For the past month, the correlation between USD/JPY and Japanese equities has broken down completely. As the Dow the tumbles to a 12 year low, USD/JPY has risen to a 10 week high. Interestingly enough, the correlation has resumed today with the massive sell-off in global equities. Yet the sell-off is relatively unconvincing considering the big drop in the Dow. The the latest weakness in USD/JPY could be temporary as the currency pair finally begins to react to Japanese fundamentals. Labor cash earnings dropped 1.3 percent in the month of January. According to the latest data of retail positioning from the two largest FX brokers in Japan, traders are actually joining the USD/JPY rally. A shift in sentiment is confirmed by the CFTC who reported the fourth consecutive weekly decline in Yen long positions.
AUD/USD: Currency in Play for Next 24 Hours
AUD/USD will be the currency pair in play for the next 24 hours with the current account balance and retail sales due for release at 7:30pm ET or 00:30 GMT. The Reserve Bank of Australia also has an interest rate decision at 10:30pm ET or 3:30 GMT.
Technically, the AUD/USD is trading in the sell-zone. Stiff resistance exists at 6400 as it is the combination of the 10-day SMA and the first standard deviation Bollinger Band. Support is at 0.6250, the year to date low. If that level is broken, the next area of support is the psychological 60 cent level.
