USD: An Opportunity To Reevaluate Positions

Posted by: Kiara Eva / On: April 19, 2011 / No Comments »

It has been a topsy-turvy day in the foreign exchange market with the dollar selling off against all of the major currencies. The weakness of the greenback was so pronounced that it reached fresh year to date lows against everything except for the Japanese Yen. Although the dollar remained weak against the British pound, Yen, Australian and New Zealand dollars, it recovered a large part of its losses against the euro, Swiss Franc and Canadian dollar. In fact, the reversal in the euro was so strong that many investors are wondering whether this will mark the top in the currency. Given the holiday in the U.S., U.K. and Japan tomorrow and the small but realistic risk of Greek restructuring surprises over the weekend or some type of policy change from the People’s Bank of China, profit taking has certainly contributed to the reversals. Whether or not the move becomes a more significant turn will hinge upon this weekend’s event risks. If nothing happens, the rally in the U.S. dollar should fizzle but if there are any surprises over the weekend, deleveraging could lead to a more significant rally in the greenback.

There are no major economic reports on the calendar tomorrow which means that it should be a quiet trading. U.S. markets are closed but the foreign exchange remains open, giving traders an opportunity to reevaluate their positions before the weekend. Although the greenback strengthened after today’s U.S. economic reports, the data did not help the U.S. recovery story.  Jobless claims retreated to 403k after blowing out to 416k the prior week. Although this represented an improvement, the decline was less than economists had anticipated. Continuing claims on other hand reached its lowest level since September 2008.  Manufacturing activity in the Philadelphia region also slowed materially after rising to its highest level in more than 25 years. The Philly Fed index dropped to 18.5 for the month of April from 43.4 with the underlying components of the report showing just how weak manufacturing activity really is. Aside from an increase in prices received, the prices paid, new orders, employment and future indices fell significantly. Leading indicators growth also slowed in March while house prices declined for the fourth straight month. The recent weakness of the dollar has not provided much support to the U.S. economy but don’t expect the Fed to stand in the way of dollar weakness because with muted inflationary pressures, they could use any help that they can get.

A weak recovery, easy monetary policy and balance sheet problems are 3 very serious issues for the U.S. dollar. Unless there is a strong catalyst for a reversal, it will be very difficult to convince investors to buy dollars. In fact, as we had said in our daily report last night, the dollar could fall another 3 percent before it finds any support. The dollar index has already broken its 2009 lows, opening the door for a move down to its 2008 low of 70.70 which would be approximately 4 percent. For the dollar to regain its momentum, one of 3 things need to happen – the Fed expresses concern about inflation and shows willingness to unwind emergency stimulus, the ECB calls the euro move brutal or a shock causes the market to collapse, triggering a fresh wave of deleveraging that sends investors back into the arms of the low yielding U.S. dollar. The first and second scenarios are unlikely but the third is probable given the uncertainties in the global economy. It could come in many forms such as fresh concerns about sovereign debt troubles in Europe, disappointing stress tests results from the EU, a round of surprisingly weak economic data outside of the U.S., or a rare event such as a revaluation by China.

EUR: GERMAN IFO REPORT SHOWS CONCERN OF BUSINESSES

Although the euro ended the North American trading session stronger against the U.S. dollar, the high flying currency lost value against the British pound, Swiss Franc and Japanese Yen. Economic data from Eurozone was strong but concerns about sovereign debt troubles and the risk of more serious problems has led to profit taking in the currency.  The much anticipated German IFO survey printed a tad weaker than anticipated coming in at 110.4 versus 110.6 forecast. The drop was entirely due to the decline in future expectations which fell to 104.7 from 106.5. The Current assessment component hit a new record high of 116.3. As crude oil futures climbed to as high as 112.79 a barrel this month, German business confidence fell for a second month in April, diminishing the economic outlook and possibly hinting at a reduced level of consumer spending going forward. As inflation concerns begin to force the ECB to take further action and raise rates in order to curb prices, such action would strengthen the euro and inadvertently hurt German exports. Of greater concern however is the effect of a rate hike on the worst of the European sovereigns, mainly Ireland, Greece, and Spain whose countries hold massive amounts of private-sector debt that is directly tied to short-term interest rates. To these countries, a tightening in monetary policy through rate hikes means higher borrowing costs and lower growth prospects going forward. In regards to the issue, ECB President Jean-Claude Trichet said “… on the impact of an interest rate increase on specific countries in the euro area, let me clarify first that the ECB’s monetary policy is geared towards maintaining price stability in the medium term for the euro area as a whole,” meaning he believes that the overall strength of the larger sovereigns will outweigh the possible negative effects of a rate hike on the weaker ones; Trichet’s main goal is to control inflation and as long as he feels to need to be proactive, interest rate differentials should limit any correction in the euro.

GBP: LIFTED BY SURPRISE INCREASE IN RETAIL SALES

Surprisingly strong consumer spending numbers drove the British pound sharply higher against the euro and U.S. dollar. Despite a decline in demand for clothing and household goods, spending on food was very strong. Retail Sales for the month of March grew by 0.2 percent versus an expected contraction of 0.5 percent; excluding autos and fuel, consumer spending rose 0.9 percent. As our colleague Boris Schlossberg pointed out “The increase was hardly buoyant, but given the fact that the market expected a contraction of the wake of very weak BRC Retail Monitor report earlier in the month, today’s data proved to be a relief indicating that consumer spending albeit cautious remains positive. The unit was further lifted by news that Public Sector Net Borrowing came in at 16.4B versus 18.8B indicating that the austerity measures enacted by PM Cameron are having a positive impact on the UK budget.”  However the stronger economic reports do not draw away from the fact that the monetary policy committee is in no rush to raise interest rates. Despite an acknowledgement of rising inflationary pressures, the minutes from the most recent monetary policy meeting showed that the MPC is reluctant to raise rates in light of the weak economic situation plaguing the UK, which faces lagging consumer demand coupled with higher prices, high unemployment, low wage growth and a still-troubled UK housing sector.  Minutes from the meeting hinted that the next possible rate hike won’t be until the middle of the year. The market is currently pricing in a 25bp rate hike from the BoE in the fourth quarter, which is a dramatic change from the last month when investors were looking for as much as 75bp of tightening by November.

CAD: REVERSES EARLIER GAINS, MIXED RETAIL NUMBERS

The Australian and New Zealand dollars ended the day not far from its year to date highs against the greenback. The Canadian dollar on the other hand gave up all of its earlier gains to end the day unchanged. Canadian retail sales increased 0.4 percent in the month of February after falling 0.4 percent the previous month. Excluding purchases of autos, demand was stronger, rising 0.7 percent. Yet the impact on the Canadian dollar was limited because of the downward revision in January. The latest consumer spending report shows that the Canadian economy is improving but so far the momentum is lacking. Given the rise in oil prices however and the pickup in manufacturing activity along with the drop in the unemployment rate, the outlook for Canada remains promising. We expect more improvements in Canadian data in the coming months. Australian economic data on the other hand continues to be strong with business confidence and producer prices increasing significantly in the first quarter. Although the Reserve Bank has no plans to raise interest rates, the latest economic reports still show how well the Australian economy is performing relative to other countries. New Zealand economic data was disappointing with credit card spending falling and consumer confidence remaining flat but the strength of the Aussie and weakness in the U.S. dollar helped to lift the NZD. No major economic reports are due for release from the commodity producing countries tomorrow which means that it should be a quiet trading day. 

JPY: BOJ SUGGESTS THE NEED FOR FURTHER STIMULUS

The Japanese Yen ended the North American trading session higher against all of the major currencies. Household Confidence fell more than expected following the quake to 38.3, hitting the lowest mark in over 14 months ending in March. The report which was released earlier this week reflects a general sentiment across Japanese households on overall livelihood, income growth, and employment expectations. Traders should care about the outcome of this report because financial confidence is a leading indicator of consumer spending, which accounts for a majority of overall Japanese economic activity. The current level below 50 marks a pessimism from household consumers compared to previous month’s reading of 41.2, and has stayed below the 50-level mark since mid-2006. Japan’s Tertiary Industry Index posted a healthy monthly gain in February, while January’s strong 2.1% figure was unexpectedly revised downward to -0.1%. The report, which measures the total value of services purchased by businesses and is thought to be a leading indicator of economic health, printed an increase of 0.8% to a seasonally adjusted level of 99.3. This level shows that spending in the service sector, pushed up significantly by retail and wholesale sales, which account for about 26% of the index and rose 5.3% in February from a year ago. Unfortunately the data reflects a strength that does not take into account the effects of the March 11 crisis and the nuclear aftermath. Looking ahead, the index is expected to fall sharply as current economic conditions are reflected into the index. As seen from the Trade Balance report, which hit the lowest in 18 months, the March 11th disaster took a major toll on Japanese economic activity. Exports in Japan fell by more than that 1.1% drop to print a decline of 2.2% during the month of March. This is particularly the kind of “downward pressure” that Bank of Japan Governor Masaaki Shirakawa warned about on April 11th. Shirakawa also commented Thursday, saying that the BoJ will continue its efforts to bring Japan out of deflation, perhaps through further monetary easing over the following weeks. Given the recent price action of the dollar and renewed signs of weakness in the US economy, the Bank may not wait much longer before the overwhelming need for action takes forces its hand.

EUR/USD: Currency in Play for Next 24 Hours

The EUR/USD will be our currency pair in play for the upcoming 24 hours. From the Eurozone, we expect French April Business Survey, Production Outlook and Business Confidence figures at 2:45 AM NY TIME / 6:45 GMT, followed by Italian Retail Sales for the month of February at 4:00 AM NY TIME / 8:00 GMT.

The EUR/USD gained for the third consecutive day and remains back within the uptrend for the second straight day, after briefly trading range-bound earlier this week, which we determined using Bollinger Bands. The pair appears to be headed on a correction path to its decline from November 2009 to June 2010. Since its 2009 peak, the pair fell nearly 3,300 pips or 24 percent to its 2010 low. As of today, the EUR/USD has recovered to within 600 pips or 4 percent of its peak. The nearest level of support is the 78.6% Fibonacci Retracement of 1.4440, drawn from the 2009 high of 1.5143 to the 2010 low of 1.1876. If this strong support level is broken, the 20-day simple moving average of 1.4314, which is just above the point of completion to the pair’s recently completed correction of the decline from November 2010 to January 2011, should provide further support. If the pair crosses above today’s high of 1.4648, the nearest levels of significant resistance are the 1.4715 level followed by the 1.4815 level, both at which previous highs and lows were established in late 2009.

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