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US Dollar: 3 Big Threats

Mon, Jan 26 2009, 02:20 GMT
by Kathy Lien

GFT

US Dollar: 3 Big Threats

The US dollar continues to rise, but the rally is tempering.  After sharp losses this past week, the Euro, Japanese Yen and Australian dollar are beginning to stabilize against the greenback.  US equities have been in the red throughout the day, which is why most currencies remained negative despite sharp intraday reversals.  Over the next week, the US dollar faces 3 big threats that all traders and investors should be aware of – a bad bank plan, central bank intervention and economic data:

1.    Bad Bank Plan - There is no question that equities are still leading currencies for the time being and over the next few weeks, the Obama Administration could announce a plan to create an “aggregator bank” that would soak up the bad debt sitting on bank balance sheets.  This would free up capital for the banks which would hopefully encourage lending and restore investor confidence.   If Obama announceS a bad bank plan, it could squeeze shorts in financial stocks and take the entire index higher.  Since currencies are still moving in lockstep with equities, a rebound in stocks could help reduce risk aversion and take some of the steam out of dollar rally.  

2.    Central Bank Intervention – As we indicated in our intraday comment on USD/JPY this morning in FX360.com, fear of Bank of Japan intervention helped the currency pair keep its head above water.  The risk of central bank intervention is growing and the BoJ is not the only one that could take action. Earlier this week, the Swiss National Bank also threatened to intervene in their currency.  Although a BoJ intervention would be far more significant than a SNB intervention, any physical intervention period could stabilize the Yen crosses, lifting the US dollar, Euro and British pound.  

3.    FOMC Meeting and GDP Report – This past week, currency traders were off the hook when it came to US economic data but in the coming week that will change significantly.  The US economic calendar is extremely busy with the Federal Reserve interest rate decision, fourth quarter GDP and other reports due for release.  Economists currently expect growth to contract by 5.5 percent, which would be the largest decline since the first quarter of 1982.  This means that the US economy would have undergone the weakest pace of growth in 26 years.  The sheer reality of this could hurt the US dollar especially since growth in the Eurozone and the UK for example are not expected to contract as much.  For the first time in more than a year, the Federal Reserve is not expected to cut interest rates, as indicated by our Fed expectations table above.  However the FOMC could remind traders that interest rates will remain low for a long time or even make new announcements regarding policy measures, inflation targeting or introduce more creative acronyms like TALF, CPFF and TARP.    

What are Gold Bugs Telling Us

The other big story in the financial markets today is the sharp move in gold prices.  The price of the yellow metal rose more than $42 an ounce to an intraday day high of $903.80.  Gold is typically seen as a recession and inflation hedge so today’s move suggests that gold bugs are telling us they think more trouble lies ahead.  With central banks around the world firing up their printing presses, it was only a matter of time before gold prices rebounded.  Bond yields are also rising, confirming the bearish sentiment shared by investors.  

GBP: BANKING SECTOR WOES

The UK economy fell into recession with growth contracting by the largest amount since the 1980s. Fourth quarter GDP fell 1.5 percent, 2 times more than the previous quarter.  The UK skirted recession in 2008, but would not be able to do the same this year with the global economy still in a downward spiral.  To everyone’s surprise, consumer spending jumped in December with retail sales rising 1.6 percent.  Despite the weakening labor and housing markets, UK consumers cannot stop spending.  Holiday shopping is certainly a contributing factor but Americans celebrated their Christmas holidays by cutting spending 2.7 percent.  The UK economy will continue to slow but the weakening currency will help.  Many Britons look at the falling pound as a bitter pill that is necessary for recovery.  There are no major UK economic releases next week but everyone is keeping an eye on the banking sector.  Banking shares have been under assault and there is rampant speculation that another rescue may be needed.  There is also fear that the Royal Bank of Scotland, Lloyds and Barclays could become fully nationalized even though Prime Minister Gordon Brown rejected suggestions that the government will be nationalizing more banks.  A bank rescue plan could be underway and it remains to be seen whether that would be accepted warmly by investors and currency traders because recent announcements have not.  

EUR: HANGS TIGHT DESPITE WEAK DATA

The euro shows some surprising resilience in its ability to rally after some significant losses earlier in the day. At one point the EUR/USD was down more than 200 pips.  On a positive note PMI data coming from the entire Euro-zone showed some signs of stabilization. The PMI Composite report rose to 38.5, which is slightly higher than last month’s 38.2. However, the news is not entirely good as any reading below 50 still reflects contraction. Problems from Germany, the largest of the EZ countries, were only offset by France’s improved PMI performance.  In response to worsening economic conditions, German policy makers are toying with the idea of extending banking guarantees from three to five years. This should ultimately prove to lighten the load on Germany’s most important lending institution. However, complete solace cannot be found in France’s exhibition of mild economic strength. There is an unfortunate possibility that France will be the next European country to suffer from a credit downgrade. Such a blow would be devastating as the country is becoming more and more dependent on its debt to finance activities; its budget deficit has swelled to 4.4% of GDP. A drop in its credit rating would send borrowing costs through the roof for the ailing economy. EZ data to look out for next week includes German IFO, EZ Current Account, German Unemployment, and the Consumer Price Index.

CAD: CANADIANS ARE SUFFERING FROM DEFLATIONARY VIRUS

A couple of weeks ago, RBA Governor Glenn Stevens warned that there was significant risk of the country talking itself into recession. Comments made by former RBA Governor Bernie Fraser certainly pose significant challenges to such risk. The former central bank head believes that the recession will be so bad that the central bank will have to cut its target rate dramatically, perhaps below 2.0%. Australian indices responded to this premonition with dismay, as stocks slid to a five-year low. The Aussie is flat while the kiwi is up marginally on the day, after recovering from earlier losses. Price action in USD/CAD far surpasses that of fellow commodity currencies. Despite a weaker inflation report, USD/CAD collapsed. The Canadian Consumer Price Index showed prices fell for the fourth time in five months. The cause of this continuous inflationary assault is obviously closely correlated with the extreme declines in oil prices. The advance in the CAD is a bit counter-intuitive as lower inflation usually means a greater chance of a rate cut.  The rally in CAD may be tied to the rally in oil.  Important commodity currency data for next week will include AUD Producer and Consumer Prices, AUD Westpac Leading Index, NZD Trade Balance, and CAD Gross Domestic Product.  The Reserve Bank of New Zealand also has a monetary policy decision at which they are expected to cut interest rates by another 100bp.  

JPY: SONY WARNS OF RECORD LOSSES

The Japanese economy is contracting at an accelerated rate, which is reflected by a reduction in assessment of the domestic economy coming from BoJ’s monthly report. Economic figures seem to support BoJ’s claim as All Industry Activity Index has contracted to the lowest level in nearly 3 years. BoJ stated that the effects of lower interest rates have become significantly limited for businesses. The following leaves the central bank with few options, while a stronger yen and a slump of demand for exports will add to speculation of foreign exchange intervention. The threat of deflation that has eroded the domestic economy during 1990’s has been labeled as a concern by BoJ. The problems within the economy are being reflected by losses at major corporations. Sony, the second largest consumer electronic company, has warned that they will be reporting record losses this coming year. Summing up all of the negatives economic figures, in addition to political troubles, the central bank may need to resort to drastic measures in order to navigate from a deepening recession.       

USD/JPY: Currency in Play for Next 24 Hours

The currency in play for Monday will be USD/JPY. The US is set to release its figures for Existing Home Sales at 15:00GMT or 10:00AM EST. While the Bank of Japan will release its Policy Meeting Minutes for December at 23:50GMT or 6:50pm EST. USD/JPY is currently trading within the Sell Zone which we establish using Bollinger Bands. After retracing from a 13-year low reached earlier this week, the pair appears to be carving out a double bottom. Current support is placed at the 13-year low of 87.10. While the pair was depreciating for the past few month sit followed a strict downward line as resistance, almost perfect 45 degree line, and that resistance now creates a triangle.  The level to watch on the topside is 89.60, the high for the day, which coincides with 10-day SMA. If resistance is broken the pair will exit the Sell Zone and breach the triangle formation. If risk aversion continues to dominate the markets the pair could test the support, while a deviation away from safe havens could push the pair higher.

Published on  Mon, Jan 26 2009, 02:23 GMT