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Daily Market Commentary

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More Weakness May be in Store for Currencies

Wed, Dec 10 2008, 01:57 GMT
by Kathy Lien

GFT

More Weakness May be in Store for Currencies

In Monday’s Daily Currency Focus, we posed the question, Can the Recovery in Currencies Last.At the time, we argued that the rally could be fleeting since it was driven by nothing more than hope and relief. Hope came from President Elect Barack Obama who provided further details on his economic recovery plan while relief came from the lack of any meaningful US economic data until Thursday.However the reality is that the US economy has not improved and the layoff announcements continue to pour in.Despite the possibility that a deal for the automakers will be announced tomorrow, the move in the currency market today suggests that reality may finally be setting in as US companies continue to reduce their profit forecasts.

Dollar Strength Will Hurt Q4 Earnings

Slowing global demand has made life very difficult for US corporations in the third quarter and unfortunately it may get even worse in the fourth quarter.In the first half of the year, multinational corporations benefitted from the weakness of the US dollar.Positive currency translations have helped companies such as Google who earns a substantial portion of their revenue abroad. However it is these same companies that will also suffer significantly from the dollar’s recent strength if they do not hedge completely.In the third quarter, Google said that if the dollar strengthens, revenues invoiced in other currencies become less when translated back into US dollars.Since the beginning of the fourth quarter, the US dollar has appreciated by another 10 percent, which means that for companies that haven’t hedged like Google, their earnings could take a big hit.If you tack on the impact that the strong dollar can have on export demand, the strength of the US dollar is a double blow for many US corporations.

4 Week US Treasury Bills Yield Zero, Negative 3M T-bill Rates

Although currency and stock traders can’t figure out whether this is a bottom or a pause before more losses, the sentiment in the bond market is very negative.For the first time since the US Treasury started selling 4 week T-bills in 2001, the yield hit zero.In other words, bond market investors are willing to buy T-bills at a negative real yield, which means that it earns less than cash.This drove the rates on 3 month bills to negative 0.01 percent, reflecting the market’s hunger for safety.The only reason why anyone would buy Treasury bills at negative real return is if they believe that recession will deepen, driving bond prices higher and yields further below zero. From our experience, the bond markets tend to have it right which suggests that we may see further losses in the currency and equity markets this week.The only thing that they could help would be decision on a bailout for the automakers and even then, the positive impact on investor sentiment may be limited.

Explosion in Forex Trading Ranges

Forex trading ranges have exploded over the past few months. The daily average trading range has doubled for all of the actively traded currency pairs in 2008, with some currency pairs even seeing a 200% rise in their average daily range. However the biggest explosion in volatility has actually happened in the past 9 weeks. EUR/GBP, USD/CAD and the AUD/USD have seen the largest increases to their average daily range, but the range for the EUR/USD and GBP/USD has also increased materially. More specifically, in 2007, the EUR/USD had an average daily range of 84 pips. Since October, its average daily range has been 267 pips, a more than 300 point rise. Understanding trading ranges is very important because it plays a big role in developing effective money management tactics. EUR/GBP which use to be known as one the few range trading currency pairs saw its average daily trading range increase from 36 pips in 2007 to 142 pips since October, a whopping 400 percent rise.

USD/CAD: BANK OF CANADA TAKES INTEREST RATES TO 50 YEAR LOW

The Bank of Canada took interest rates to a 50 year low this morning of 1.5 percent and signaled that further monetary stimulus may be needed. Their next rate decision is on January 20th and there is a strong chance that the central bank will take interest rates down to 1 percent. According to the Bank of Canada’s monetary policy statement, global growth deteriorated significantly, inflation has slowed more than forecast and spending is decreasing on both the corporate and consumer level. The weakness of the Canadian dollar is helping but not enough to make the central bank feel confident that their 250bp of easing year to date will be sufficient to stabilize the economy. The BoC is telling us that more needs to done. The automobile and commodity industries in Canada have been hit hard by slowing US growth and falling oil prices.Meanwhile The weakness in the US equity market drove the Australian and New Zealand dollars lower.Australian business confidence hit a new record low in the month of November.We expect this evening’s consumer confidence and housing market numbers to be weak as well.

EUR/USD: BACKS OFF 1.30

The EUR/USD hit 1.30 today but backed off almost immediately.The rapid ascent and descent from that level suggests that the move was driven by nothing more than flow.Eurozone economic data was surprisingly better than expected with the German ZEW survey of analyst sentiment rebounding and the German trade and current account surpluses increasing.Exports fell less than expected but imports declined more than expected.The weakness of the Euro is probably helping to support external demand while at the same time keeping German demand domestic.As for the ZEW, although analysts are less pessimistic about the outlook for the Eurozone economy, they have grown more pessimistic about the current situation.ECB officials were out in force applauding the improvement in the ZEW survey while at the same time warning that monetary policy has its limits.The ECB is still expected to cut interest rates but not by the degree of easing that we saw earlier this month.

BRITISH POUND: HITS NEW LOWS AGAINST EURO

The British pound hit new record lows against the Euro on increasing evidence of deeper troubles in the UK. The trade deficit was larger than the market expected while activity in the manufacturing sector contracted for the eighth consecutive month, the longest streak in 28 years. Economists have grossly underestimated the weakness of the manufacturing sector with factory orders plunging by 3 times more than the consensus forecast. Despite having lowered interest rates to the lowest level in 57 years, the Bank of England’s work is not done. Interest rates will fall to 1 percent before the BoE draws an end to their easing cycle. Contrast that with the European Central Bank who will probably only take interest rates down to 1.75 percent and you can understand why EUR/GBP has pushed to new highs. Eurozone data was also betterthan expected with the German trade surplus increasing thanks to a smaller decline in exports and the ZEW survey of economic sentiment reporting an unexpected improvement.

USD/JPY: BAD NEWS FAILS TO HURT THE YEN

The sell-off in US equities drove the Japanese Yen higher against all of the major currencies despite weaker economic data.Not only is Japan in a recession, but the annualized pace of third quarter GDP growth was revised down significantly to 1.8 percent.Leading indicators also dropped from 89.2 to 85 in the month of October, reflecting the dismal outlook for the Japanese economy.Meanwhile machine tool orders came in at -62.2% indicating that the businesses are reluctant to start new projects while confidence is continuing to plummet. With a lack of credit in the market and businesses reluctant to spend, Japan’s economy will deteriorate further. Sony stated that they are cutting as much as 16,000 while Nomura Holdings plans to cut more than 100 jobs.This evening, we are expecting the CGPI index which will shed more light on the inflationary or deflationary situation in Japan.

USD/JPY: Currency in Play for the Next 24 Hours

The currency pair in play for the next 24 hours will be USD/JPY. This is due to a Machine Orders and Domestic Corporate Goods Price Index released from Japan today at 7:50Pm EST or 23:50GMT. Tomorrow, we expect Monthly Budget Statement from United States around 4:00PM EST or 19:00GMT.

The USD/JPY still trading in the selling zone which we have derived using the Bollinger Bands. The Yen continued to appreciate against the major currencies and disregarding deteriorating conditions in the economy. Current Support for the USD/JPY stands at the second Bollinger Band which is also an intermediate low at 91.50. With a lack of market moving indicators for the upcoming 24 hours, the pair is set to test the support as investors are pricing in additional interest rate cuts by the Fed which is due December 16th. The downtrend will be negated upon the break of resistance which resonates at the first standard deviation and close to 10-day SMA at price of 93.40.

Published on  Wed, Dec 10 2008, 01:59 GMT