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How Obama's First 100 Days Can Impact Currencies

Wed, Jan 21 2009, 01:31 GMT
by Kathy Lien

GFT

How Obama's First 100 Days Can Impact Currencies

In yesterday’s Daily Currency Focus we warned that investors should not bank on an Obama bounce. Based upon 5 decades worth of data, the Dow Jones Industrial Average fell more often than it rose on Inauguration Day. In fact stocks fell more on Barack Obama’s Inauguration Day than any other President. Since currencies are taking their cue from equities, we have seen a sharp slide in almost all of the major currency pairs. The dollar has outperformed the Euro and British pound but it has declined against the Japanese Yen indicating that the dollar’s rally is a reflection of pessimism and not optimism. We are seeing a flight to safety into US dollars but bonds are the instruments of choice and not equities. President Obama inherits a very troubled economy and he certainly has his work cut out for him over the next few years. However brighter times may lie ahead for US stocks based upon the performance of the Dow in the first 100 days on a President’s term. 

The first 100 days of an Administration can define a President.  Barack Obama is expected to usher in a number of reforms that may help to reinvigorate the American economy and boost consumer confidence.  The fact that stocks have fallen more than 8 percent since the beginning of the year provides a low base for any bounce. More importantly however we typically see the Dow rise in the first 100 days of a new President’s Administration as investors become optimistic about new policies.  Stocks rose in the first 100 days of a President’s term 11 out of 16 times.  Political party doesn’t really matter but of the 5 times that equities dropped in the first 100 days, 4 out of the 5 were during Republican Presidencies.  So even though President Obama is handed an ailingeconomy, the silver lining is that history is on his side and most likely he will be celebrating a stronger stock market after his first 100 days. A stronger stock market should mean a recovery of risk appetite, which could help reverse some of the losses that we have seen today in the EUR/USD, GBP/USD and USD/JPY.  It is important to keep in mind that a rally is not guaranteed as the recession in the US economy is the worst since the Great Depression. The economic outlook can weigh on equities which would diminish the significance of the historical price pattern.

EUR/USD: HEADED FOR 1.25

A day after Spain’s sovereign debt rating was downgraded, the Euro continued to fall.  Many funds are mandated to invest in only AAA assets and the decline in the Euro partially represents those funds liquidating out of their exposure to Spain.  There is a lot of concern that Ireland may be next with banking stocks plummeting.  Their financial sector is a mess and the Irish government may have to step and nationalized all of the banks.  If this happens, the country’s fiscal position would deteriorate immediately which could lead to a downgrade by Standard and Poor’s.  In the Eurozone, it is everyone for himself.  Individual nations have been forced to fix their own problems and are unfortunately suffering for it.  Interestingly enough, despite the dismal outlook for the Eurozone economy, analysts grew less pessimistic in the month of January.  Now that the EUR/USD has broken below the psychologically important 1.30 price level, the next major support for the currency is not until 1.25.  German producer prices are due for release tomorrow and even if they fall less than expected, it may not be enough to offset the bearish sentiment in the EUR/USD.

GBP/USD: HITS 7 YEAR LOW, HOW MUCH FURTHER CAN THE GBP FALL?

The British pound has fallen to a 7 year low against the US dollar and a record low against the Japanese Yen. Over the past 3 trading days, the GBP/USD has dropped more than 1000 pips or 7 percent. Consumer prices were hotter than the market expected, leading investors to wonder what has fueled the aggressively selling? One answer – FEAR. The market is afraid that the UK will turn into the next Spain or Greece. Over the past few months, they have been working overtime to inject more stimulus into the economy, but the more that they spend, the worse the UK’s fiscal position. Deteriorating public finances has been the primary motivation for the recent downgrades of sovereign debt ratings by Standard and Poor’s. The FSA has dismissed this rumor but that doesn’t mean that the UK can’t be put on credit watch negative which would be one step closer to a downgrade. Investors are selling now and asking questions later because a downgrade would mean more losses for the British pound. Whenever a country loses its AAA rating, funds that are mandated to invest in only AAA assets need to liquidate and shift their positions elsewhere. We have seen this with Spain and could see it again with the UK.  Bank of England Governor Mervyn King appears to be undeterred by the sell off in the British pound as he openly discussed the need to consider more ways to fix the UK banking sector.  He expects to start buying corporate bonds and commercial paper in the next weeks.  More interest rate cuts are expected but rate cuts alone are not enough.  Expect more action in the British pound with employment data and the minutes from the latest monetary policy meeting due for release on Wednesday. The GBP/USD has broken 2 key support levels - 1.45 and 1.40.  Trends can last for a very long time in the currency market which is why there is a decent chance that we could see the GBP/USD slip to 1.3685, the June 2001 low. If that price level is broken, it would be a 16 year low for the currency pair. The 1.40 level is pretty critical on a closing basis. If the GBP/USD closes above 1.40 today, we may actually see a larger bounce, but don’t expect the currency pair to revisit the 1.45 level any time soon.

USD/CAD: CUTS INTEREST RATES TO RECORD LOW

The Bank of Canada cut interest rates to 1.00 percent, the lowest level ever for the 75 year old central bank. They also signaled that they could bring interest rates down to US levels.  The historic move was motivated by the sharp downturn in the US economy and the continual slide in oil prices.  Not only are Canadians making less, but they are seeing their household wealth plummet as well.  The Canadian economy is not expected to grow in 2009, which is why more rate cuts are needed.  The BoC is far from done and could realistically match US rates.  Inflation is not a problem since consumer prices are expected to be negative for the next 2 quarters.  The prospect of lower interest rates should continue to weigh on the Canadian dollar in the coming weeks.  Risk aversion has also weighed on the Australian and New Zealand dollars.  New Zealand consumer prices dropped more than the market expected, driving the kiwi within a pip of its 2 month lows. Retail sales are due for release tonight.  Although consumer spending is expected to drop as well, visitor arrivals have increased which may have supported spending.  

USD/JPY: POLITICAL GRIDLOCK DOESN’T HELP

Japanese yen crosses collapsed today as risk aversion continues to guide the markets.  The economy is in trouble and unfortunately it is not getting much help from the government.  Prime Minister Aso has proposed a Y5 trillion or $55.2 billion stimulus package but political gridlock in Japan is preventing the package from being passed.  The upper house dominated by the opposition party and they appear to be more focused on politics than economics.  A stimulus package is desperately needed to help offset Japan’s downward spiral.  The appreciation of the Japanese Yen will weigh heavily on the overall economy.  USD/JPY is below 90, NZD/JPY is trading at an 8 year low while GBP/JPY is at a record low.  Consumer confidence is continuing to deteriorate as lack of exports is putting pressures on the labor market.  Japanese consumers have not been this pessimistic in more than 26 years.  The Tertiary Industry Index also fell by a larger amount than anticipated.  The only positive economic news coming from Japan was the increase in the convenient store sales, which were guided by the new regulation restricting access to cigarettes from vending machines. Sales rose by the largest margin in 8 years, as day to day goods are starting to replace once purchased luxury items. With an increase in uncertainty within the government adding to the pressures of economic woes, Japan might be in deeper trouble than previously forecasted. Tomorrow, the Bank of Japan begins their two day monetary meeting.  Actions beyond interest rate cuts will be discussed but no easing is expected.

GBP/USD: Currency in Play for Next 24 Hours

The currency in play for the upcoming 24 hours will be the GBP/USD. The UK has an overwhelming amount of data released tomorrow which can sway the markets in either direction.  This includes the BoE Minutes, Jobless Claims, and Public Sector net borrowing which are all expected to be released tomorrow at 9:30GMT or 4:30AM EST. The pound fell to the lowest levels against the dollar in 7 years after a break of downward triangle. Currently, the pair is trading well within the Sell Zone which we establish using Bollinger Bands. Support is placed at 1.3685 the 2001 low. If support is broken, the pair will be in the territory not seen since 1986. Yet, the pair could continue to go lower as a bearish head-and-shoulder pattern was formulated within the downward triangle. If counting from the base of the head-and-shoulder formation to the head and adding it to the break of the formation, the next level of support will be around 1.3350. The sell pattern will be negated after a break of resistance which is placed at the First Standard Deviation of the Bollinger Bands at 1.4420, which coincides with the base of the downward triangle.

Published on  Wed, Jan 21 2009, 01:33 GMT