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Daily Currency Market Focus

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Dollar Rallies as Consumer Confidence Hits Record Lows

Tue, Jan 27 2009, 16:29 GMT
by Kathy Lien

In more than 40 years, we have never seen US consumers this pessimistic. The Conference Board's report on consumer confidence fell to 37.7, the lowest level on record. The disappointing consumer confidence report will drag down risk appetite and drive investors into the safety of US dollars. The rally in the US dollar is a reflection of more panic selling and not optimism about US economy. On the heels of the report, we have already seen the EUR/USD and equities turn negative. We may not see a recovery in confidence Until job security is no longer a major concern. Unfortunately with headlines in national papers touting the 74k jobs axed in one day this morning, consumers will not turn optimistic anytime soon. The one silver lining in the report is that we have seen an increase in plans to buy automobiles within the next 6 months. Major discounts are enticing consumers to buy new cars. Looking ahead, discounts and incentives will be the only for businesses to push inventory. Fourth quarter GDP is due for release on Friday and weak consumer confidence supports the market's belief that growth was the weakest in 26 years.

Earlier this morning, S&P/CaseShiller reported that house prices fell 18.18 percent in the month of November, the largest decline on record. Unfortunately house prices still have room to fall as the labor market remains weak and more inventory floods the market over the next few months.

Published on Tue, Jan 27 2009, 16:29 GMT

USD/JPY: Keeping Its Head Above Water Thanks to BoJ

Fri, Jan 23 2009, 14:17 GMT
by Kathy Lien

GFT

There is a lot of talk this morning that the Bank of Japan is checking currency rates. The Japanese Yen has continued to rise over the past 24 hours and by checking rates, the central bank is keeping a very close eye on where the Yen is trading. Given that it is 11pm in Japan right now on a Friday, the central bank is either very serious about intervening in the currency market or they want to keep currency traders on their toes. The 87.00 level for USD/JPY could very well be their breaking point. The risk of intervention is limiting the decline in USD/JPY on a day when the sharp drop in Dow futures (-220) should be driving it much lower. Over the past 6 months, we have seen a significant appreciation in the Japanese Yen to the point where the central bank can no longer ignore it. For example, the Yen has risen more than 40 percent against the British pound, Australian and New Zealand dollars.

The Bank of Japan has not physically intervened in the currency market to sell the Yen since March 2004. If they intervened now it would open up the floodgates and possibly cement a bottom in the Yen crosses. Although physical intervention rarely works in the long run, many traders remember the BoJ's aggressiveness when they did intervene between 2002 and 2004. When the BoJ intervenes, we can see 200 pip movements in USD/JPY within a matter of seconds.

With the global economy slowing and the Yen rising, Japanese corporations are most likely pressuring their government, which already has ultra low approval ratings to take action. The central bank and the Ministry of Finance may no longer be able to turn a blind eye to the recent strength of the Yen that has brought the currency to the highest level in 13 years against the dollar and the highest level ever against the British pound.

US Should Take Cue from Japan

US traders should pay attention to what is going on in Japan. The rapid appreciation of the Yen played a central role in driving Toyota to its first loss in 67 years. Disappointing earnings is a major reason why the US equity market is doing so poorly. Not only are US companies losing more money than anticipated but they are warning of further losses to come. We often said that the strength of the US dollar will weigh heavily on US corporate earnings for the fourth quarter, but if the dollar does not reverse its slide in February, first quarter earnings could be even worse. More weakness in equities will drive more investors into the safety of the US dollar, the Japanese Yen and gold, which is up more than $22. This vicious cycle can continue until traders capitulate or governments step in.

Published on Fri, Jan 23 2009, 14:17 GMT

What's Behind the Big Moves in Currencies?

Thu, Jan 22 2009, 08:17 GMT
by Kathy Lien

GFT

There has been a lot of volatility in the foreign exchange market this morning, driving currencies to historic levels:

GBP/USD - 26 Year Low
USD/JPY - 13 Year Low
NZD/USD - 6 Year Low
EUR/JPY - 6 Year Low
CAD/JPY - 13 Year Low
GBP/JPY - Record Low
NZD/JPY - 8 Year Low

The most significant moves have been in the British pound, which fell to a 26 year low against the US dollar and in USD/JPY, which fell to the lowest level in 13 years. Comments from former Fed Chairman Volcker triggered a wave of risk aversion that led to a technical break in the currency market. He said "we are in serious recession, with no end clearly in sight." Although there is no question that the US economy is in trouble, by saying that there is no end in sight means that there is no hope which coming from the chairman of Obama's newly formed Economic Recovery Advisory Board is significant. By saying that he does not an end to the recession is certainly not good advice. Treasury Secretary Nominee Geithner expects an Obama economic stimulus plan to be released in the next few weeks but unfortunately Volcker's comments overshadowed the prospect of a stimulus plan. Yesterday's sharp sell-off made investors nervous but Volcker's comments pushed them over the edge.

We are continuing to see flight to safety into the US dollar and Japanese Yen. Investors are looking to hide in the lowest yielding currencies.

Will the Bank of Japan Intervene?

With the Japanese Yen hitting levels not seen against the US dollar in more than a decade, the question hanging over the markets is whether the Bank of Japan will intervene to weaken the Japanese Yen. They have tried verbal intervention and it hasn't worked. Up until now, the Japanese have been reluctant to physically intervene because they may not have support from the US or Europe. However there comes a point when they may have to stop thinking about other people and start thinking about themselves. Japanese corporations like Toyota have suffered greatly from the strength of the Yen and these companies may be exerting pressure on the government to take action. The risk of BoJ intervention is growing and if USD/JPY falls below 85, the BoJ may have to step in.

Intervention by Swiss National Bank?

We also had comments from ECB President Trichet and SNB President Hildebrand. Trichet defended the ECB's monetary policy and said they haven't decided if 2 percent is the lowest level for rates.

The Swiss franc collapsed after Hildebrand said that the central banks is considering selling francs to halt the currency's gains. With interest rates already at 0.5 percent, they have no room to ease monetary policy. Therefore they may have to resort to fixed rate currency intervention but for the time being, we think that they are testing out verbal intervention rather than committing to physical intervention.

Published on Thu, Jan 22 2009, 08:17 GMT

British Pound: How Much Further Can It Fall?

Tue, Jan 20 2009, 14:49 GMT
by Kathy Lien

GFT

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, so what has fueled this 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 impact it has on 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 before 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 will be speaking later today and he will probably attempt to calm the markets. But with employment data and the minutes from the latest monetary policy meeting due for release, his impact may be limited.

How Low Can the GBP Fall?

The British pound 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 1.3865, 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.

Monthly Chart of GBP/USD:

Published on Tue, Jan 20 2009, 14:49 GMT

Euro Tanks as Spain Gets Downgraded: What Does It Mean to Be Downgraded?

Mon, Jan 19 2009, 15:18 GMT
by Kathy Lien

GFT

With the US markets closed for Martin Luther King's Day, the odds were skewed towards a quiet trading. However, big news in Europe has made it anything BUT quiet.

After hitting an intraday high above 1.33, the EUR/USD has sold off aggressively on news that Standard and Poors downgraded the sovereign debt rating of Spain from AAA to AA+. The outlook is stable which means that further downgrades for the country is unlikely. However this could be the beginning of more downgrades in the Eurozone. Last week, Greece's sovereign debt rating was downgraded as well to A- while Ireland and Portugal have been placed on credit watch. The reasons for the downgrades are obvious. The Eurozone is in recession and those countries have suffered greatly. Also, public finances have deteriorated materially since the governments are trying to spur growth by spending.

What Does It Mean to Have Your Credit Rating Downgraded?

To have your credit rating downgraded means higher costs of borrowing. The Euro is slipping as we are seeing an exodus out of Spanish bonds because some global funds are mandated to invest only in AAA debt. A credit rating reflects the risk of default. Therefore a lower credit rating means that a country is at greater risk of defaulting on their debt. On a local level, we expect investors to shift their money out of Spanish debt and into countries with a higher credit rating such as Germany or even outside of the Eurozone. Spanish Bond prices have dropped significantly since the beginning of the year, driving yields higher. The gap between the interest rates on German and Spanish bonds have hit the highest level in 10 years, reflecting the sharp divergence in economic performance. Talk of Spain leaving the Eurozone is irrelevant because their cost of borrowing would skyrocket if they chose to do so. I think that there is a greater chance the countries being downgraded will be kicked out of the Eurozone.

British Pound Below 1.45 After New Announcements by UK Government

The British pound has also fallen below 1.45 after the UK Treasury announced more groundbreaking measures to stimulate the UK economy. They have set up a program to guarantee bad debts and buy up to GBP50 billion in private sector assets. They will also be increasing their stake in the Royal Bank of Scotland. This is aimed at pumping more money into the economy and may be a step towards quantitative easing. Although the UK government has been the most aggressive in coming up with measures to turn the economy around, the British pound has sold off because investors fear that the step was taken because the outlook for the UK economy was worst than feared. They are also doubtful that the government's efforts will pay off.

Published on Mon, Jan 19 2009, 15:18 GMT

BoA News Helps Currencies Rally Despite Weak Economic Data

Fri, Jan 16 2009, 14:37 GMT
by Kathy Lien

GFT

The theme in the markets this morning is a return of risk appetite. The US government has bailed out Bank of America for the second time, reminding investors that they are still here and ready to help the banking sector. BoA received another $20B to ease their absorption of Merrill Lynch. So far, they have received $138B in government aid even though their market cap is only approximately $50B. The additional funds provided to BoA is the only reason why the dollar is rallying against the Japanese Yen and why we are seeing a recovery in all of the higher yielding pairs such as the EUR/USD and GBP/USD.

As for this morning's economic data, consumer prices continued to fall, foreign demand of dollar denominated investments was the weakest since September 2007 and industrial production fell for the fourth time in five months. The overwhelmingly dollar bearish news only had a limited impact on the dollar because much of the bad news has already been baked in. Most people are expecting a weak set of economic data this month. The bigger surprises will come from earnings which is why we are keeping a close eye on equities.

Taking a look at the data in more detail, headline consumer prices dropped 0.7 percent last month while core prices held steady. The annualized pace of CPI growth slowed to 0.1 percent. This is smallest increase in consumer prices that we have seen in 54 years. Discounts on clothing and lower gasoline prices have driven inflation lower. For the Federal Reserve, this will support their plans to keep interest rates at ultra low levels for at least the next 6 months. In terms of the Treasury International Capital flow report, net long term flows declined by $21.7B. The numbers show that China is still buying US assets, but at an increasingly slower pace. Japan was a net seller but in general, we saw a large exodus out of all debt instruments including treasuries, corporate and agency bonds. Clearly the dollar's low yield is turning foreign investors away. The manufacturing sector still has its problems as indicated by the 2 percent decline in industrial production. The US economy and will remain weak but what is mattering these days is risk appetite.

Published on Fri, Jan 16 2009, 14:37 GMT

US Dollar: The Good News and Bad News on Christmas Eve

Wed, Dec 24 2008, 16:51 GMT
by Kathy Lien

GFT

Thin market conditions continue to dominate in the currency market on the eve before Christmas. Trading ranges for all of the major currency pairs have been relatively narrow, especially when compared to the large swings that have been characteristic of the third and fourth quarters of 2008. There were both upside and downside surprises in this morning’s economic data but even the upside surprises were numbers that reflected a contraction in US economic activity. This has fueled the mild sell-off in the greenback that began at the European open.

The Good News

Since it is the holidays, we will start with the good news. Durable goods orders fell less than the market expected in the month of November. The third decline in four months was primarily driven by a drop in Boeing orders. A strike that ended in the first week of the month could have also contributed to the lower output. Stripping out the transportation component of the report, durable goods orders actually increased 1.3 percent, the first rise in 5 months. The rebound in durable goods ex transportation suggests that corporate investments may be recovering. Another upside surprise was in personal spending which fell less than the market expected, but this was still the fifth month in a row that consumers have reduced their spending. The 30-year mortgage rate also fell to a record low today and that will hopefully help to stabilize the housing market. Low mortgage rates really do matter as applications increased 48 percent last week. Although applications can fluctuate a lot, this is the second largest rise since March and is the fourth increase in five months. Meanwhile we are also continuing to watch the move in oil prices which remains near 4 year lows.

The Bad News

As for bad news, personal income dropped 0.2 percent while jobless claims soared to 586k, the highest level in 26 years. Claims have been above 500k since the beginning of November and the US labor market is on track to lose 2 million jobs this year. Given that 1.91 million jobs have already been lost in 2008, 2 million will be easily surpassed in the month of December. US unemployment is expected to rise from 6.7 percent to 7 percent in December. There are no economic releases due for the remainder of the week. The next day that we expect US data is Tuesday December 30th.

All the financial markets are closed on Christmas Day. Foreign exchange trading with GFT will reopen on December 26 at 6:00am ET.

EUR/USD: HOW JANUARY SEASONALITY IMPACTS THE EUR/USD

Technical analysis is based on the idea that past price patterns repeat themselves and Seasonality is rooted in this very same concept. Stock market traders may be familiar with the concept of Seasonality if they have ever heard of the term Sell in May and go away. Interestingly enough, Seasonality also happens in the currency market. According to the following chart, over the past 10 years the EUR/USD depreciated in the month of January 70 percent of the time. If we expand the chart to include 1997, the EUR/USD actually dropped in the month of January 8 out of the past 11 years. Of course, like all technical analysis, the pattern does not always repeat itself which is why we saw the EUR/USD rose in the month of January during 2003, 2006 and 2008. There are a lot of factors working against the US dollar in the beginning of 2009 but seasonality is one factor that may help.

Published on Wed, Dec 24 2008, 16:51 GMT

EUR/USD: Headed for 1.35

Fri, Dec 12 2008, 08:56 GMT
by Kathy Lien

GFT

The not so dovish comments from ECB member Weber is driving the EUR/USD through the roof. The currency pair is up close to 2.5 percent or more than 300 pips.

After cutting interest rates by 75bp earlier this month, ECB member Weber said today that a January rate cut is not a done deal. He pointed out that the ECB has never taken interest rates below 2 percent and that the central bank doesn’t have enough info to decide on a January rate cut. Market tensions are expected to ease next year and he really wants to avoid negative real interest rates. More importantly, he added that when the economy recovers, the ECB will need to raise rates promptly.

In terms of monetary easing, the ECB has been one of the least aggressive central banks this year. They have only cut interest rates by 150bp, compared to the 325bp by the BoE. Interest rates are behind the move in EUR/GBP as the spread between 3 month euro rates and 3 month UK rates go from negative to positive territory (see the tight correlation in the chart below). This is why EUR/GBP is moving closer to my 0.90 target.

With the Fed cutting interest rates next week, the hawkish comments from the ECB will fuel further gains in the EUR/USD going into the US rate decision. There is nothing standing in the way of EUR/USD hitting 1.35 as long as the Fed continues to liberally cut interest rates and the ECB remains nimble.

Published on Fri, Dec 12 2008, 08:56 GMT

USD/JPY: At Risk of Hitting 13 Year Lows

Wed, Dec 10 2008, 17:01 GMT
by Kathy Lien

GFT

We are inching closer to a formal bailout plan for the Big 3 automakers and as previously suggested, regardless of the final outcome, the markets will cheer an end to the drawn out drama. The rally in equities this morning have driven major currencies higher against the US dollar and Japanese Yen, but it remains to be seen whether the improvement in investor sentiment will last. We are walking into a lot of potentially weak economic data on Thursday and Friday that could serve as a harsh reminder of the problems that the US economy faces. The PPI and retail sales figures should resurrect concerns that deflation and depression will hit the US.

The Treasury market is already pricing in the possibility of deflation and depression with yields in zero to negative territory for the first time since the Great Depression. Fed Fund futures are pricing in a 100 percent chance of a 75bp rate cut from the Federal Reserve next week. This would take US rates to 0.25%, making the US dollar the lowest yielding currency in the developed world. Although the greenback has remained weak against the Japanese Yen, if the Fed takes interest rates to zero, we could see the dollar fall to 13 year lows against the Japanese Yen.

Published on Wed, Dec 10 2008, 17:01 GMT

Currencies and Equities Recover as Aid is on the Way

Mon, Dec 8 2008, 15:34 GMT
by Kathy Lien

GFT

If the equity market managed to rally despite news that 533k jobs were lost from the US economy last month, then Obama's pledge to increase spending this weekend and the developments for the Big 3 automakers will only help. Risk appetite appears to be slowly returning to the markets with the low yielding US dollar and Japanese Yen losing ground to higher yielding currencies such as the Euro, Australian and New Zealand dollars.

Aid is on the Way

The market's immunity to bad news suggests that everyone is tired of hearing the obvious, which is that the US economy is in bad shape and will worsen before it improves. It appears that all of the weakness in the first half of the 2009 is priced in and instead investors are latching onto the stimulus plans for hope that they will help to trigger recovery in the second half of 2009. This weekend, President-elect Barack Obama laid out his plan to create or preserve 2.5 million jobs. His focus is on infrastructure - upgrading public buildings to make them more energy efficient, building roads and highways and modernizing school buildings. He is hitting the ground running and is expected to announce a $500B to $700B stimulus plan in the first days of his administration.

At a time when uncertainty about the US economy is at elevated levels, the prospect of a major stimulus package and a decision on aid for the Big 3 automakers is helping to improve investor sentiment. The Big 3 automakers have dominated the headlines for the past few weeks and regardless of whether GM and Chrysler will be forced into bankruptcy, the markets will be relieved that there is a resolution.

Of course, there is still plenty of reasons to be skeptical about the rally in currencies and equities. The layoffs keep coming in as Dow Chemical announces an 11 percent reduction in their workforce, which translates into 5000 jobs. Bonus cuts, salary freezes and warnings about earnings have also become the norm.

But it is important to realize that equities and currencies have become extremely oversold in the past few weeks and the lack of any major US economic data until Thursday is helping to fuel the recovery. I think that we are witnessing a bear market rally and that we have yet to hit a long term bottom.

Published on Mon, Dec 8 2008, 15:34 GMT

Currencies Setting Up for a Major Breakout − FOMC Minutes Could be Trigger

Wed, Nov 19 2008, 14:10 GMT
by Kathy Lien

GFT

US consumer prices dropped 1 percent last month, taking the annualized pace of growth to 3.7 percent, which is the lowest level since October 2007. Falling oil prices takes the credit for lower inflationary pressures with gasoline prices tracking the 50 percent decline in crude. Gas station receipts fell a whopping 14 percent and commodity prices have fallen in general, which has helped to push down transportation costs. Although the core PPI numbers accelerated, core CPI dropped 0.1 percent and we expect it to head even lower. Less price pressure will give the Federal Reserve more room to cut interest rates. We expect the Fed to cut by another 50bp in December, but it is important to note that Fed Fund futures are pricing in a tiny chance of a 75bp rate cut next month.

The housing market continues to be one of the weakest links in the US economy. Housing starts fell to a record low while building permits dropped to the lowest level in close to 50 years. When you have an environment where foreclosures are rising at a very rapid pace, there is no desire by builders to break new ground.

This afternoon, we have the minutes from the latest FOMC meeting at which the Fed cut interest rates by 50bp to 1 percent. Given the continued concern reflected in Bernanke's testimony to the House Financial Services Committee on Tuesday, the Fed is likely to support further easing.

All of the major currency pairs have been consolidating since the middle of last week and the FOMC minutes could be the trigger for a major breakout.

Published on Wed, Nov 19 2008, 14:10 GMT

US Dollar: Leaving the Mess for Obama

Tue, Nov 18 2008, 07:04 GMT
by Kathy Lien

GFT

IS THE DOLLAR RALLY OVER?

Since the summer, the US dollar has staged a remarkable rally, but with manufacturing data surprising to the upside and the US dollar giving back its gains today, everyone is wondering whether the dollar rally is over. The British pound, which has seen one of the most severe decline this month rose close to 2 percent on little to no news. For some market watchers, this may represent currencies that have become overstretched but in our opinion all signs still point to more trouble for the global economy.

Leaving the Mess for Obama

Even though the global recession is underway and the problems in the US economy continue to deepen, there are increasing signs that the Bush Administration wants to leave the clean up job to Barack Obama. According to Treasury Secretary Paulson, even though the first half of the $700 billion bailout package is being used up quickly, the Bush Administration will not be asking Congress for the remaining $350 billion. With 8 weeks to go before Bush leaves office, the current Administration is more focused on wrapping things up than starting new initiatives. Paulson said it best – "I'm going to do what we need to do to keep the system strong but I'm not going to be looking to start up new things unless they're necessary, unless they make great sense” and "I want to preserve the firepower, the flexibility we have now and those that come after us will have." This was the same spirit that Bush took at this weekend’s emergency meeting of G20 nations. The meeting was a big disappointment as the Group failed to deliver any specific solutions. Instead, they set an action plan for March 31 and another meeting for April 30th. The G20 is clearly waiting for the new Administration to take charge before putting the pedal to the medal. The only question is, will the global economy be able to wait that long.

General Motors: Biggest Risk This Month

The fate of General Motors will be the biggest event risk until the end of the month. In my opinion, the US government will not allow GM to fail. President elect Barack Obama has already pledged on numerous occasions to support the auto and retooling industry. To back off his promises so early in the game would be a reputation killer and not something the world expects from Obama. House Speaker Nancy Pelosi has also called on Congress to pass an emergency rescue package for the industry. Given that 1 in 10 jobs in America deals with the auto industry (from dealerships, auto parts etc), there is no question that the US government will extend life support to General Motors. Nonetheless the longer the US government stalls the more strain it puts on the financial markets, because investors don’t like uncertainty.

Citigroup to Cut 50k Jobs, How Do Non-Farm Payrolls Fare in Recession?

Citigroup announced today that they will be cutting more than 50,000 jobs in the “near term.” This is on top of the 23,000 jobs that they have already cut and will leave the company with approximately 300,000 employees globally. Even though non-farm payrolls dropped by more than 200k in September and October, Citigroup’s layoffs and job cuts by other companies will drive non-farm payrolls even lower. In analyzing non-farm payrolls data during recessions, we see that at the beginning of an official recession, as defined by the National Bureau of Economic Research, non-farm payrolls start to decline rapidly. However after falling between 200k and 300k, job cuts stall and then pick up once again. We saw this trend in the 1981 to 1982 recession, the 1990 to 1991 recession and during the 2001 recession. The following chart illustrates the double dip trend of non-farm payrolls during the 2001 and recession.

Stronger Industrial Production Does Not Invalidate Recessionary Conditions

Industrial production and the Empire State manufacturing survey was better than forecasts, but that does not draw away from the strong risk that the US economy will fall into a technical recession when third quarter GDP numbers are released next week. A resumption of mining after Hurricanes Gustav and Ike helped industrial production rebound last month. The Empire State manufacturing survey fell to a record low of -25.43 but that was marginally better than the market’s expectations. Given that the global recession is underway, we continue to believe that the US dollar and Japanese Yen will outperform all of the major currencies. Producer prices and the Treasury’s International Capital flow reports are due for release on Tuesday. The drop in oil prices should alleviate price pressures.

GBP/USD: UNDERVALUED CURRENCY SEES STRONG REBOUND

Since the middle of July, the British pound has fallen more than 27 percent. In past editions of the Daily Currency Focus we said that 1.55 is the approximate fair value level for the GBP/USD. With that in mind, the currency pair is now undervalued on the basis of purchasing power parity (PPP). Of course, PPP is far from accurate and as we have seen in the past, currency pairs can overshoot their fair value levels for some time. Nonetheless this helps to explain why we have seen a strong recovery in the British pound today – not only was it the day’s biggest market mover, but it was also the best performing currency. House prices continue to decline with Rightmove reporting a 2.9 percent drop this month. The UK economy is in a recession and we expect next week’s third quarter GDP numbers to confirm that. The Confederation of British Industry, the country’s biggest business lobby group expects GDP to drop by 1.7 next year, which would be the largest decline since 1980. Consumer prices are due for release tomorrow and given the drop in producer prices, CPI should ease as well.

EUR/USD CONSOLIDATES BUT PROBLEMS STILL EXIST

The euro does not seem unnerved by developments abroad and is benefiting from the fact that attention has shifted to the recession brewing in the Japanese economy and the problems in the UK economy. The fear that the Euro-zone economy will reach recession has been realized, taking some uncertainty off of the table. However the risks still exist for the Eurozone. The region reported that their Trade Balance has narrowed significantly, from -9.4B to -5.6B. The impact of a strong currency in the first half of the year is kicking in as exports take a big hit. French Business Sentiment also fell to multi-year lows. The health of the French economy is crucial as it is one of the only large EZ economies not to be in a recession. Tomorrow’s schedule includes Italian Trade Balance and Current Account, as well as EZ Construction Output.

Published on Tue, Nov 18 2008, 07:04 GMT

Dollar Hangs Tight on GM Risk

Mon, Nov 17 2008, 15:12 GMT
by Kathy Lien

GFT

Signs of stability in the US manufacturing sector has failed to turn around the market's risk appetite. Although the US dollar has weakened marginally against all of the major currencies, if US stocks continue to sell off, we could see the dollar regain strength.

Will the US government allow GM to fail?

Nonetheless the longer the US government stalls, the more strain it puts on the financial markets, because investors don't like uncertainty.

G20 Holding Out for Obama

The G20 meeting this weekend was also a big disappointment. With slightly more than 2 months to go before the US Administration changes, this was hardly a surprise because President Bush was not expected to commit his successor Barack Obama to any initiatives that he does not support. Since the group set an action plan for March 31 and another meeting for April 30, the G20 is clearly waiting for directions from Obama's new Administration before putting the pedal to the mdeal. . The only problem is, the global economy may not be able to wait that long.

Global Recession Trades

The global recession is underway and that is going to continue to weigh on all risk trades. Japan has officially hit recessionary conditions, joining the Eurozone and New Zealand. Next week, the US and the UK will be releasing their third quarter GDP numbers and I expect growth to contract in both countries, pushing them into an official recession.

I continue to believe that the US dollar and Japanese Yen will outperform all of the major currencies in a global recession as investors see the low yielders as low risk. Going forward, central banks like the ECB and the BoE will be forced to engage in more aggressive monetary easing going, which would hit the Euro and British pound. My favorite trades continue to be short USD/JPY and EUR/JPY.

Published on Mon, Nov 17 2008, 15:12 GMT

Has the US Dollar Hit a Top or is this a Mirage?

Fri, Nov 14 2008, 08:15 GMT
by Kathy Lien

GFT

n every major bear market, there are relief rallies and that is what we have seen today. The Dow Jones Industrial Average dropped more than 300 points during the US trading session before reversing violently to end the day up more than 550 points. The major turnaround in equities has forced the US dollar to give back its gains. However as much as we would love to see the global unwind come to an end, the continued weakness in US economic data suggests that this could be more of mirage than a bottom for currencies and equities.

Sharp Rise in Jobless Claims Points to Major Decline in Non-Farm Payrolls

When the labor market is in trouble, the US economy is in trouble because a rise in jobless claims has a direct correlation with consumer spending. Jobless claims rose 516k last week to the highest level since September 2001. The number of claims for unemployment benefits was only surpassed in the 2.5 weeks following 9/11. Extrapolating the jobless claims data to non-farm payrolls report and we see that non-farm payrolls could top 300k before the end of the year. In September 2001, the last time jobless claims were at current levels, non-farm payrolls dropped 244k. The next month it hit that recession cycle's low of -300k. Retail sales dropped 1.8 percent in September 2001, not far from the market’s expectations for retail sales in October. Although the NBER has yet to admit the US economy is in a full blown recession, the jobless claims data is already beyond at recessionary levels. The latest economic report from the US confirms the seismic challenges facing the US economy.

Retail Sales and G20 Meeting

Jobless claims rose 516k last week to the highest level since September 2001 and it has a direct correlation with consumer spending. Retail sales are expected to contract for the fourth consecutive month. The recent bankruptcies and profit warnings confirms that US retailers are already struggling. Both ISCS and SpendingPulse reported a sharp decline in sales while various independent studies across the nation report that consumers are cutting back. The recent drop in oil prices means that gasoline receipts will fall as well. The average price of a gallon of gasoline has fallen close to 50 percent from its summer highs. We don’t expect consumer spending to recover until well after the holiday shopping season. Just ask your neighbor and he will probably tell you that he is cutting back spending. World leaders will be gathering in Washington tomorrow for the G20 Emergency Economic Summit. Unfortunately we are skeptical of any groundbreaking announcements. Even though Gordon Brown, Prime Minister of the UK will want to push for reforms, President Bush may not want to commit Barack Obama to anything.

No V Shaped Recovery

Expectations for a V shaped recovery or sharp turnaround is unrealistic because there is still a very tough road ahead for the US economy. Nouriel Roubini, a NYU Professor who was one of the first people to forecast the recession now believes that the downturn could last well into 2009 and expects the unemployment rate to hit 9 percent. George Soros the infamous speculator that broke the Bank of England in 1992 takes things one step further by saying that we may even see a depression. Both men believe that when the US economy hits a bottom, it could stay there for some time which means that we could have more of a U or L shaped recovery. In this troubling market environment we continue to expect the US dollar and Japanese Yen to outperform, but with expectations skewed strongly in favor of disappointments from retail sales and the G20 meeting, the risk certainly lies to the upside.

EUR/USD: RECESSION IN GERMANY

The Euro rallied 2.5 percent even though Germany has become the second major developed country to fall into a technical recession. The price action in the Euro today is the classic behavior of the anti-dollar, which frequently bucks its own economic data to trade base upon the market’s appetite for US dollars. Nonetheless, the 0.5 percent contraction in growth during the third quarter spells big trouble for the Eurozone GDP report that is due for release on Friday. Growth for the region as a whole is expected to contract by 0.1 percent, which would put the Eurozone in a technical recession. Yet ECB officials continue to deny reality. Central bank governing council member Constancio said today that a recession has not been confirmed. The weak numbers should still add pressure on the European Central Bank to loosen their monetary policy. Another half point rate cut in the month of December has already been priced into the markets, but so far, the ECB has not shown the same aggressiveness that we have seen from the Bank of England. In addition to the GDP report, Eurozone consumer prices are due for release tomorrow. The decline in French CPI as well as the overall downtrend in commodity prices should drive inflation lower.

GBP/USD: WILL THE UK STEP IN TO SUPPORT THE POUND?

The British pound was one of the few currencies to weaken against the US dollar today. Since the beginning of the month, the pound has fallen close to 10 percent against both the US dollar and the Euro. It has become increasingly clear that next to New Zealand and Germany, the UK will be the next country to fall into an official recession and the Bank of England will have no choice but to respond with more interest rate cuts. On an intraday basis, the GBP/USD fell to a low of 1.4560, the weakest level since June 2006. There was no UK economic data on the calendar, which means that the price action in the pound was driven entirely by liquidation. With the risk of interest rates falling to the US’ levels of 1 percent, no one wants to be long British pounds at this time. As the currency continues to slide, the burning question on everyone’s mind is whether or not the Bank of England will step in to buy the British pound. We believe that they will not because the UK government knows that the weakness of the currency helps to support the economy.

Published on Fri, Nov 14 2008, 08:15 GMT

Global Unwind Continues − Will the UK Become the Next Japan?

Wed, Nov 12 2008, 15:13 GMT
by Kathy Lien

GFT

The global unwind continues this morning with US equities, commodities and currencies taking another beating. The US dollar and Japanese Yen continue to outperform while the British pound hit a fresh 5 year low.

The story is still the same, which is sell first and ask questions later. It is earnings season and the reports that we have seen so far are a harsh reminder of the growing problems in the US economy. Retail sales are due for release on Friday and the warnings from retailers indicates that consumer spending has slowed materially. Best Buy cut its full year forecast today, DHL is shutting down its US operations and Circuit City became the 14th retail chain to go bankrupt, joining companies like Linen N Things and Steve and Barry.

We are in a global easing cycle and the market expects central banks around the world to follow the UK's aggressive interest rate cuts.

Is the UK Becoming the Next Japan?

When the Bank of England cut interest rates by 150bp last week, I turned aggressively bullish EUR/GBP on the belief that interest rates are headed below 2%. The currency pair has now hit a record high as the market realizes that not only will UK interest rates fall below 2%, but could be headed to Japanese levels. Against the dollar, the British pound has fallen to fresh 6 year lows but the historically significant moves are in EUR/GBP.

According to the November Inflation Report, the monetary policy committee believes that inflation will fall below their 2 percent target with the potential of hitting 1 percent. With price pressures expected to ease significantly, the Bank of England sending a strong signal that interest rates will continue to come down.

There is talk that the recessionary conditions in the UK economy could turn the UK into the next Japan. Another 200bp of easing by the end of the first quarter has been priced into the markets, which would take interest rates to 1%. If the BoE chooses to overshoot monetary stimulus, UK interest rates could be at Japanese levels. Mervyn King has become quite a maverick and given his fear of deflation, we would not be surprised to see another large rate cut from the central bank.

When the dust settles, the UK's aggressive monetary stimulus should turn their economy around faster than the Eurozone or the US, but in the meantime, more rate cuts mean more weakness for the British pound.

Published on Wed, Nov 12 2008, 15:13 GMT

What Matters More, The Good or the Bad?

Wed, Nov 12 2008, 08:03 GMT
by Kathy Lien

GFT

US DOLLAR: GOOD NEWS VERSUS BAD NEWS

Every day, equities, currency and bond traders weigh the good news with the bad to determine if they want to buy or sell. Today, there were just as many positive reports that should have helped to stabilize the markets but has instead failed to stem the bleeding in equities and currencies. In a market environment where pessimism is being felt in the bones of investors, it has become increasingly difficult to shift market sentiment. The US dollar and the Japanese Yen continued to outperform as risk aversion drags nearly all of the major currency pairs lower. Even though USD/JPY has remained unchanged, the EUR/USD and GBP/USD fell more than 200 pips.

The Good News: US Government Accelerates Efforts to Minimize Foreclosures

As investors remain nervous about the outlook for the global economy, good news has failed to have a positive impact on risk appetite. Today officials from the Treasury and the Federal Housing Finance Agency said that through Fannie Mae and Freddie Mac they plan on accelerating efforts to help homeowners that are facing foreclosures. This includes reducing interest rate and extending loan terms, which should have been perceived as a step in the right direction. More specifically, the mortgage servicers will help borrowers who are more than 90 days delinquent bring their monthly payments down to 38% of their gross income, which is now considered the threshold of affordability. For an American that earns $75,000 a year, affordable means monthly payments of $2375 or under. In addition after falling to a record low, IBD/TIPP reported a material improvement in economic optimism.

The Bad News: Fears of GM Bankruptcy

However the market has completely shrugged off the positive developments and has instead chosen to focus on the fears that General Motors will be forced into bankruptcy. The White House has indicated that they are open to accelerating the loans previously approved for the auto industry while House Speaker Nancy Pelosi called on Congress to pass an emergency rescue package for the industry. $25B loans were originally allocated to the automakers for developing more fuel-efficient vehicles, but the legislation could be changed to divert the money towards more urgent initiatives such as helping the automakers fend off bankruptcy. Given President-elect Barack Obama's pledge to help the auto industry last week, official support is inevitable. However if the government does not act fast, the market could push the automaker into bankruptcy. On Monday, analysts issued price targets of zero for GM's stock. With 263k workers under their umbrella, General Motors could be too big to fail.

Oil Prices Fall to 21 Month Low

The other big story was the sell-off in oil prices. The price of crude dropped to a 21 month low of $58.86 a barrel. For the currency market, the decline in oil prices is bullish for the US Dollar, and Japanese Yen but bearish for the Euro and Canadian dollar. Since the beginning of the year, there has been a 70 percent positive correlation between the EUR/USD and the price of oil. With the fear of weakening global demand keeping oil prices under pressure, OPEC nations are starting to realize that production cuts may not be the answer. The strong rise in commodity prices that we have seen throughout 2006 and into the summer of 2008 was driven by the frothy expectations that the global economy will continue to expand at a healthy pace. That of course has been proven false. Now that oil prices have dropped more than 50% since the summer and have refused to recover, oil exporters have resorted to hedging their oil exports at sub-$100 levels. The front page story in the Financial Times today talks about how Mexico, the world’s sixth largest oil producer is hedging nearly all of next year’s oil exports. This is a clear sign that they fear oil prices will remain below $70 a barrel in 2009. Even though the report only talks about Mexico, we doubt that they are the only oil producing country to be hedging against a further decline in crude prices. In order to hedge against a drop in oil prices, oil producers need to enter into derivative contracts that sell oil forward.

EUR/USD: PRESSURED BY PROBLEMS IN BANKING SECTOR

Despite a surprising improvement in analyst sentiment, the Euro came under heavy selling pressure on disappointing earnings reports from European banks, pessimistic commentary from ECB and EU officials and overall risk aversion. A number of Eurozone financial institutions will be reporting earnings this week and we believe that their reports will echo the problems being felt by Intesa Sanpaolo SpA, Italy’s largest bank who was forced to scrap its cash dividend after a 54 percent drop in profit. There is no reason to believe that European banks will be able to avoid some of the major losses reported by US banks. According to the comments from ECB member Bini-Smaghi, the high level of money market rates should encourage more rate cuts from the central bank. German investor confidence improved this month with the economic sentiment index rising from -63 to -53.5, but it still remains well below the historical average of 27.1. Eurozone industrial production is due for release tomorrow morning. Given the sharp decline in the German, French and Italian reports, we expect a deep contraction in September’s manufacturing activity.

GBP/USD: COULD THE UK BECOME THE NEXT ICELAND?

Now that the British pound has fallen below 1.55 against the US dollar, the next level of support in the currency pair’s is not until its 6 year low of 1.5267. UK economic data was stronger than the market expected with the trade deficit narrowing and the annualized declining in house prices improving. However the positive reports have not relieved the market’s fear that the UK could become the next Iceland. That of course is a bit far-fetched, but it does illustrate the market’s concern about the UK economy. Gordon Brown announced this morning that he plans on cutting taxes in order to bolster demand and help pull the UK economy out of a recession. Employment data is due for release on Wednesday. The employment component of service sector ISM decreased, but edged marginally higher in manufacturing. We expect the number of people claiming employment benefits to rise, pushing the jobless rate higher.

RISK AVERSION DRIVES DOWN AUSTRALIAN NEW ZEALAND AND CANADIAN DOLLARS

Risk aversion continued to drive the Australian, New Zealand and Canadian dollars lower. Australian economic data has been weak with the NAB business confidence index hitting a record low despite steady employment numbers. According to comments made by Australian Finance Minister Tanner this afternoon, China’s stimulus package should help the country avoid a recession, but that is assuming further rate cuts. Consumer confidence is due for release this evening and we expect consumers to share the same pessimism as Australian businesses. There was no economic data released from New Zealand but central bank governor Bollard believes that the country’s banks will be able to weather a recession. The Canadian dollar traded mostly off of oil prices, which slipped to a 21 month low of $58.86 a barrel.

Published on Wed, Nov 12 2008, 08:03 GMT

EUR/USD Slips as Oil and Stocks Head Lower

Tue, Nov 11 2008, 14:38 GMT
by Kathy Lien

GFT

Even though the lack of meaningful US economic data has kept the US dollar in flux, there is one commodity that is continuing to grind lower. Oil prices fell to the lowest level in 20 months as exporters wake up to reality that crude prices may stay at current levels for some time. For the currency market, the decline in oil prices is bullish for the US Dollar, and Japanese Yen but bearish for the Euro and Canadian dollar. The weakness of US stocks will also add pressure on high yielding currencies Since the beginning of the year, there has been a 70 percent positive correlation between the EUR/USD and the price of oil.

With the fear of weakening global demand keeping oil prices under pressure, OPEC nations are starting to realize that production cuts may not be the answer. The strong rise in commodity prices that we have seen throughout 2006 and into the summer of 2008 was driven by the frothy expectations that the global economy will continue to expand at a healthy pace. That of course has been proved to be false.

Now that oil prices have dropped more than 50% since the summer and have refused to recover, oil exporters have resorted to hedging their oil exports at sub-$100 levels. The front page story in the Financial Times today talks about how Mexico, the world's sixth largest oil producer is hedging nearly all of next year's oil exports. This is a clear sign that they fear oil prices will remain below $70 a barrel in 2009. Even though the report only talks about Mexico, we doubt that they are the only oil producing country to start hedging. In order to hedge against a drop in oil prices, oil producers need to enter into derivative contracts that basically involve selling oil prices forward.

Published on Tue, Nov 11 2008, 14:38 GMT

US Dollar: Recession Trades Still On

Tue, Nov 11 2008, 08:07 GMT
by Kathy Lien

GFT

US equity traders realize that everyone is pinning too much hope on China. The big story in the financial markets today is the 4 trillion Yuan or $586 billion stimulus plan announced by China on Sunday. Equities in Asia rallied strongly overnight, taking risky assets like carry trades up with it. The US dollar started the NY session weaker but has recovered all of its losses. The Japanese Yen and the US dollar, which are the two lowest yielding G7 currencies continue to hold onto their gains as investors come to grips with the reality that the stimulus plan announced by China will not save the global financial and economic crisis. Instead, the only thing that is assured is that at one fifth of 2007 GDP, China will have less money to spend on financing the US’ current account deficit.

China: Not the Answer to Everyone’s Problems

Every country is doing their best at stimulating domestic growth and that is exactly what China is focused on right now. Their priorities are at home and not abroad and their plans to invest in low-rent housing, infrastructure, rebuilding programs and tax breaks on capital spending are aimed at helping their economy cool at a more manageable pace. However it is not a bailout for the financial market and will not be enough to stimulate global growth. Some foreign manufacturing and construction companies will benefit from China’s investment in infrastructure, but the bottom line is that like the rest of the plans announced by developed governments, it shifts and not creates wealth. We also don’t think that it is a coincidence that China made its announcement ahead of a busy data week that will surely confirm the continued weakness in the Chinese economy. With a need to focus domestically, Chinese demand for dollar denominated investments will decrease, especially after some particularly nasty losses incurred at the Sovereign Wealth Fund.

Will there be Fireworks at the November 15 Meeting?

World leaders will be headed to Washington for the Economic Summit on November 14 and 15. The hope is that we will see more detailed proposals on dealing with the economic crisis. Unfortunately as the date nears, investors are starting to realize that no substantial changes may come out of the meeting. With a little more than 2 months before the leadership changes in the US, the current administration may not want to commit to any major policy changes. But if they do, that is exactly what can turn the financial markets around (US President-elect Barack Obama has announced that he will not be attending the financial Summit). Although G20 finance ministers and central bankers pledged to jointly tackle the global financial crisis at this weekend’s G20 meeting, the disagreement between more or less state controls are becoming increasingly clear. It remains to be seen whether there will be fireworks at this weekend’s emergency summit.

Recession Trades Still On

As long as US economic data continues to head towards multi-decade lows and concerns about earnings plague the financial markets, recession trades are still on. This includes short USD/JPY and short EUR/JPY, which refuse to rally. Earnings forecasts have been cut for the 3 Gs - Google, Goldman Sachs and General Motors. With some analysts issuing a price forecast of zero for GM, the US economy and the financial markets are in for more trouble. Coming back to haunt us is AIG - the US government has been forced to hike its bailout of the insurance giant from the $85 billion in September to $150 billion. We wonder who else will be asking the US government for more money. With no meaningful US economic data on the calendar tomorrow and banks closed for Veterans Day, risk aversion could continue to send currency traders into the safety of the US dollar and Japanese Yen.

Published on Tue, Nov 11 2008, 08:07 GMT

US Dollar: Another Failed Attempt at Stabilization

Tue, Oct 28 2008, 08:09 GMT
by Kathy Lien

GFT

After the sharp volatility in the currency and equity markets during the Asian and European trading sessions, the US session was relatively quiet up until the last 10 minutes of trading. For most of the US session, stocks oscillated between positive and negative territory, giving traders hope that we may be finally seeing some stabilization. The last hour of trading has been wrought with surprises and today was no different. The Dow tumbled more than 200 points 10 minutes before the market closed, driving all of the major currency pairs down with it. As we have seen throughout the past week, the US dollar and the Japanese Yen have been the biggest beneficiaries of equity market weakness. In this nervous market environment, investors do not need a reason to sell. With no buyers in the market, we have seen a low volume late day liquidation. Going into the Asian trading session, this should lead to more weakness for the EUR/USD and USD/JPY.

Pressure on the Fed to Cut Interest Rates

As the dollar continues to strengthen, the pressure on the Federal Reserve to make a larger interest rate cut has grown. Since the last interest rate cut by the central bank on October 8th, the dollar has rallied more than 8 percent and the Dow Jones Industrial Average has fallen by more than 10 percent. Going into the FOMC meeting, economists can’t seem to agree on how much the Federal Reserve will cut interest rates. Of the 64 economists surveyed by Bloomberg, 53 percent expect a 50bp rate cut, 26.5 percent expect a 25bp cut. Fed Funds traders appear to be more optimistic as they have already priced in 50bp of easing for Wednesday with a 32 percent chance of a 75bp rate cut. The only problem is that the next interest rate cut by the Fed will not be their last. The economy is expected to get worse before it gets better and the Federal Reserve will not want to back themselves into a corner quite yet; a larger rate cut on Wednesday would give them less room to cut interest rates in December.

Dollar Rally May Not End After Presidential Elections

If history can be a guide, the dollar rally may not end after the November 4th elections. In 6 out of the last 7 elections, regardless of whether Democrats or Republicans win, the US dollar has rallied in the 6 months following the election. With this in mind, central banks will have to take more aggressive monetary measures if they want to combat this historical trend.

Housing: Have We Hit a Bottom?

Both new and existing home sales bounced in the month of September, suggesting that the housing market may have bottomed. Although the data is certainly encouraging, it is important to realize that the increase is coming off of very low levels. The sale of inventory has also been driven by price cuts as home owners and developers become more desperate. The median price of a new home saw negative annualized price growth for the 5th month in a row. It will be interesting to see how the numbers fare in October because credit has been almost unattainable this month. Tomorrow we will receive the S&P/Case-Shiller Home Price Index, which can shed more light on the housing market. However it is important to realize that the data will be for the month of August and a lot has changed since then to make these numbers of little value in indicating a bottoming housing market. Consumer Confidence and the Richmond Fed Manufacturing Index are also due for release. The turmoil in the financial markets and the erosion of retirement accounts should weigh heavily on consumer sentiment.

ECB LOOKING TO CUT INTEREST RATES AGAIN

European Central Bank President Trichet has always been one to hate surprises. In the past, he has frequently forewarned the market before a rate hike and has even openly admitted that the words strong vigilance is synonymous with a rate hike projection for the following month. However in a complete U turn from the central bank’s prior monetary policy biases, Trichet is now projecting a rate cut. In his most candor comment this new rate cutting cycle, Trichet said this morning that he is looking to cut interest rates at their monetary policy meeting next week. With interest rates at 3.75 percent, the ECB has plenty of room to ease monetary policy. We believe that the best option by the ECB would be to cut interest rates alongside the US on Wednesday. Since they already have the intention to cut interest rates next week, there is no reason to delay it if a coordinated rate cut would send a more powerful message and have a better chance of stabilizing the financial markets. Eurozone M3 money supply came in slightly above expectations, while the German IFO business sentiment index reaffirmed recessionary concerns. While the IFO Current Assessment was slightly stronger than expected, Expectations and Business Climate were seen to the down-side. Tomorrow’s schedule is packed with German and French Consumer Confidence numbers.

G7 STATEMENT IS ALL TALK AND NO ACTION

The Japanese are becoming increasingly frustrated with the appreciation of the Japanese Yen and their G7 counterparts are doing the minimum needed to appease them. The G7 released a statement on the Japanese Yen this morning, but it was all talk and no action which suggests that the Japanese are having a very hard time convincing their US and European counterparts to join in on any physical intervention to sell the Yen. It is certainly not in the US’ best interest to engineer further strength in the dollar and for the ECB to intervene and buy Euros would completely contradict the dovish comments made by Trichet this morning. The Japanese will have to act alone if they plan on engaging in any physical intervention because the ECB and the US know that a weak USD/JPY and EUR/JPY is good for exports. The strength of the Yen has become a major hindrance for the export-driven economy and part of the reason why the Nikkei has fallen to 2 decade lows. Japanese Corporate Service Prices were seen down by 0.1% compared to a report of 1.4% reported last September. Retail Trade figures will be released later today. Tomorrow, we will see Vehicle Production and Industrial Production figures. YoY vehicle production will gives us some insight into the strength of Japan’s two strongest automakers (Toyota and Honda) and how they have been able to cope with faltering international economies.

Published on Tue, Oct 28 2008, 08:09 GMT

US Dollar Hits 2 Yr High, Growing Risk of Coordinated Rate Cuts

Mon, Oct 27 2008, 13:57 GMT
by Kathy Lien

GFT

The US dollar is on steroids this morning as the sell-off in global equities sends the dollar to a 2 year high against the Euro. The EUR/USD is within 3 percent of its fair value of 1.20 while the GBP/USD and USD/JPY are now undervalued on a purchasing power parity basis. However PPPs matter little in a market environment that is driven by fear. The currencies have overshot their PPP levels for years and there no is reason why they can't undershoot them as well. We still believe that we are nearing a bottom but bear market sell-offs can last far longer than what may be logical.

Central banks are having a very tough time dealing with the sharp moves in both the equity and currency markets. Investors continue to bail out of the funding currencies of high risk investments like carry trades, stocks, bonds, real estate, emerging markets and commodities.

Risk of G7 Intervention

The G7 released a statement on the Japanese Yen this morning, but it was all talk and no action which suggests that the Japanese are having a hard time convincing their US and European counterparts to join in on any physical intervention to sell the Yen. It is certainly not in the US' best interest to engineer further strength in the dollar. The Japanese will have to act alone if they plan on engaging in physical intervention because the ECB will not back Yen intervention either as a weak EUR/JPY is good for exports.

Coordinated Rate Cuts

A higher probability scenario is another round of coordinated interest rate cuts by major central banks. The strength of the US dollar and Japanese Yen have been driven entirely by the weakness in global equities. Another coordinated rate cut could stabilize stocks which would help to take some of the steam out of the US dollar and Japanese Yen.

At minimum, the latest rally in the US dollar will give the Federal Reserve a stronger reason to cut interest rates by 50 instead of 25bp. Fed fund futures are currently pricing in a 68% chance of a half point rate cut and 32% of a 75bp rate cut. A quarter point rate cut has been completey discounted by the markets. To deliver anything less than a half point cut would be a big disappointment.

Published on Mon, Oct 27 2008, 13:57 GMT

USD: Stabilization?

Fri, Oct 24 2008, 07:12 GMT
by Kathy Lien

GFT

In the face of today’s 200 point positive and negative swings in the Dow, it could be argued that the US dollar has been relatively stable if you only look at the daily change of the 3 major currency pairs. The EUR/USD rallied 100 pips, the GBP/USD was unchanged while USD/JPY fell 75 pips. This compares to multi hundred pip moves for all 3 currency pairs on Wednesday. Even the largest market movers had a far milder move today than yesterday. On a percentage basis, the largest market mover was AUD/JPY which dropped 1.09% while it was CAD/JPY yesterday which dropped five times that amount. These moves however masks the volatility that we are still seeing on an intraday basis; the EUR/USD hit a new 20 month low while the GBP/USD fell to a fresh 5 year low. Although it may be very tempting to say that the dollar has hit a top, especially against the Euro, in order for this EUR/USD rally to be real and for investors to be convinced to stop selling higher yielding currencies, we need to see stabilization in the financial markets and a return of confidence.

Keep an Eye on Job Losses

Even though the non-farm payrolls report is not due for another 2 weeks, all signs point to serious job losses and for that reason we are still concerned about the outlook for the US economy and by extension we are also wary of today’s rally in US equities. According to the Financial Times, more than 78,000 people could be laid off from Wall Street. For the world outside of finance, massive job cuts have also been announced by companies like Yahoo, Merck and General Motors. Although we will not get to the double digit unemployment rates that we saw during the Great depression, we do expect the current unemployment rate to climb to a new 5 year high. Since consumer spending is the backbone of the US economy, a weak labor market will depress spending, which should in turn lead to softer growth. Therefore even though buyers have returned to the equity markets, there will be plenty of reasons for them to bail once again.

Emerging Markets to Welcome any Dollar Correction

Any correction in the US dollar will be cheered by the emerging market nations who have had to take drastic measures to combat the dollar’s strength against their own currencies. The rally in the greenback has taken a big toll on the Brazilian Real, South African Rand, Hungarian Forint, Turkish Lira and Polish Zloty. In order to avoid a mass exodus out of their local currencies, central banks of some of these countries have been forced to raise interest rates. Since the strength of the dollar has been the primary catalyst for the sharp decline in these currencies, a correction would be welcomed by all of these nations because it would help stabilize their currencies and make their jobs a lot easier.

Oil Prices Could Bottom on OPEC Production Cuts

US existing home sales are due for release tomorrow but the biggest event risk is undoubtedly the emergency meeting by OPEC. Oil prices have firmed up today on the expectation of a 1 million to 1.5 million production cut from the oil producing nations. The price of crude has fallen more than 50 percent since its July highs, giving the OPEC nations a valid reason to cut interest rates. However since 2000, whenever oil prices have fallen by more than 20 percent on a rolling 6 month basis, production cuts have marked major turning points for oil prices. There is a decent chance that we have seen the bottom in oil prices and for the currency market that could fuel a rebound in the Euro and Canadian dollar.

Published on Fri, Oct 24 2008, 07:12 GMT

Dollar Continues to Rally: What is Behind the Move?

Thu, Oct 23 2008, 07:18 GMT
by Kathy Lien

GFT

Dollar bulls continue to take the markets by the horns, driving the British pound to a 5 year low and the Euro below 1.28. Deleveraging and risk aversion have been the primary catalysts for the strength in the low yielders (US dollar and Japanese Yen) but currency bets gone wrong, repatriation and the fears of weak growth in Europe have also fueled the rally.

Although earnings from US banks has been everyone's main focus, European banks who will also be reporting earnings soon and they could face some serious losses as well, especially the ones that have recently received assistance from their local governments. Liquidity problems are usually synonymous with major balance sheet problems for banks. In the corporate sector, Citic Pacific and Latin American companies will not be the only ones to suffer losses due to currency bets gone wrong as they try their hands in the FX markets. The outlook for the European economies is very grim and when combined with risk aversion in the financial markets, it translates into severe weakness for the Euro and British pound against the US dollar.

The Dollar Could Rise Another 5 Percent

After injecting a massive amount of liquidity into the financial markets, central banks are finally seeing their desired reaction as LIBOR rates fall and lending becomes more fluid. In the long run, this should help to stabilize the financial markets and restore confidence, but in the short term, there could be further dollar strength. Given that the Purchasing Power Parity levels for the EUR/USD and GBP/USD are approximately 1.15 and 1.56 respectively, the dollar could rally another 5 percent before the dust settles. Furthermore, the Fed has made another announcement in an attempt to stabilize the financial markets. They changed the interest rate that they are paying on excess reserves from 75bp below the Fed funds rate to 35bp. The announcement itself was not a big surprise, but the timing was. They have could have made this announcement next week when they cut interest rates, but their decision to do so now rather than later suggests that they may be preparing for a smaller rate cut next week. Unless the Federal Reserve wants to take interest rates to zero percent, each quarter point rate cut from here on forward may need to be rationed. The market is still pricing in a greater chance of a 50bp rate cut, but the Fed will not be alone in feeling the need to be conservative; the Bank of Canada certainly felt this way when they cut interest rates by only 25bp this week.

How Much Will Dollar Strength Hurt Exporters?

On a trade weighted basis, the US dollar has appreciated more than 18 percent since July. The typical notion is that dollar weakness helps US exporters while dollar strength hurts them but globalization has actually changed this dynamic with some exporters now benefitting from dollar strength. The key is in their expenses because if they manufacturer abroad, dollar strength reduces their foreign expenses. A perfect example is Caterpillar Inc, the world’s largest manufacturer of construction and mining equipment. In the third quarter, they actually recorded an exchange rate gain because the strength of the dollar reduced their net liability position in Europe. Google on the other hand took a big hit from dollar strength. Although the company does not export anything, more than 50 percent of their revenues come from outside of the United States. As the dollar appreciates, it reduces the value of their foreign earnings. The same is true for Yahoo. Therefore just because a US company is export driven does not mean that the dollar’s recent strength will be a drag on earnings. At the same time, a multinational service oriented firm is just as vulnerable to currency fluctuations.

Global Economic Summit Scheduled for November 15

The Global Economic Summit will be held on November 15 in Washington. The continual weakness in the equity markets and heightened risk aversion will pressure world leaders to come up with new ways to deal with the global economic crisis. Whether the leaders deliver remain to be seen, but the original goal of the meeting is to put more regulation and surveillance in place to prevent a repeat of the crippling financial crisis. Gordon Brown of the UK is in favor of strengthening the surveillance role of the International Monetary Fund (IMF) and giving them the power to coordinate global responses. Large and radical change are expected leading some people to call this meeting Bretton Woods 2. For those who are unfamiliar with Bretton Woods, 44 Allied nations gathered in Bretton Woods, New Hampshire to set up a system of rules, institutions and procedures to regulate the international monetary system towards the end of World War 2. The core of the Bretton Woods system centered around the obligation of each country to fix their currency to the US dollar, which was fixed to gold. Although the major nations of the world may not be looking to bring back those pegs, they do want to return to the discipline that governed the markets in the first Bretton Woods.

Published on Thu, Oct 23 2008, 07:18 GMT

Dollar Rally Could be Short Lived

Wed, Oct 22 2008, 07:19 GMT
by Kathy Lien

GFT

With the exception of the Japanese Yen, the US dollar has rallied against every major currency. The settlement of the Lehman CDS auction, the new Money Market Investor Funding Facility, the drop in oil prices and the sell-off in equities have all contributed to the impressive strength in the greenback. However the dollar’s rally may be short-lived as the credit market continues to thaw. Although the VIX and individual currency volatilities have increased over the past 24 hours, the 3 month LIBOR and TED spreads have fallen. This suggests that lending conditions are continuing to improve, which should help to stabilize the financial markets. Since the US dollar and the Japanese Yen have benefitted significantly from market instability, calmer times should help higher yielding currency pairs recover.

Fed Introduces New $600B Money Market Investor Funding Facility

The Federal Reserve also announced a new facility aimed at relieving pressure on money market mutual funds. Over the past few months, redemptions by individual investors and hedge funds have skyrocketed. Despite prior steps to restore stability, money market investors continue to head for exits. Through JPMorgan Chase, the Fed has announced a new backstop for these funds whereby they will be buying up to $540B of certificates of deposits, bank notes and commercial papers with a remaining maturity of 90 days or less. The remaining $60B in this facility will be coming from commercial paper issued by the special purpose vehicles set up by JPMorgan. They have called this their Money Market Investor Funding Facility. Although there has been no immediate market reaction, this should help free up credit in the financial markets and restore stability in the long run.

EURO FALLS TO THE LOWEST LEVEL SINCE FEB 2007

The Euro dropped to the lowest level against the US dollar since February 2007. The combination of weaker oil prices and dollar repatriation has weighed heavily on the currency pair. It is becoming increasingly apparent that the Eurozone financial sector is in just as bad shape as the US. According to the Financial Times’ economic forecasts for all European countries, neither Germany, France, Spain or Italy are expected to grow by more than 0.5 percent in 2009. Perhaps they are lucky not to suffer from the negative 2009 GDP growth that is forecasted for the UK. Tough times are ahead for the Eurozone which should lead to a test of the 1.30 level in the EUR/USD. There was no meaningful Eurozone data released over the past 24 hours and nothing of consequence is expected on Wednesday. Switzerland on the other hand reported a stable trade balance as exports and imports decline.

BRITISH POUND CLOSES IN ON 5 YEAR LOW ON RECESSIONARY COMMENTS FROM KING

The British pound fell to the lowest level against the US dollar since November 2003 as Bank of England Governor King suggests that the UK is in a recession. The prospect of a prolonged slowdown in consumer demand and further housing market weakness should thrust the country into its first recession in 16 years. He also added that a larger, faster trade and FX adjustment may be necessary. With such a dour economic outlook, the UK needs a weak currency to attract whatever export demand that may still be remaining. Prime Minister Gordon Brown also said this morning that more borrowing will be needed. Public finances are in horrible shape and is likely to get worse with the expected drop in tax revenue. The Bank of England minutes are due for release on Wednesday. The data will shed light on how close the UK is to another interest rate cut.

Published on Wed, Oct 22 2008, 07:19 GMT

Why is the Euro and British Pound Not Participating in the Rally?

Mon, Oct 20 2008, 17:11 GMT
by Kathy Lien

GFT

With the lack of any major US economic data on the calendar this week, the big event risk for the stock market and the US dollar is the Lehman Brothers' Credit Default Swap settlement on October 21. The fear that European banks may be forced to pay out on the default protection has prevented the Euro and British pound from rallying despite the recovery in US stocks. The estimated payout on the CDS could be as high as $365 billion, more than half of the US government's $700B bailout plan. The settlement should be most if not all in US dollars, which is why there has been a strong demand for dollars against the next 2 most actively traded currencies. If the CDS settlement triggers no bankruptcies, then the stability that we are beginning to see in the financial markets may last.

The sheer relief that there has been no negative news this weekend has helped the stock market and high yielding currencies recover. The liquidity that central banks have pumped into the financial markets are also finally having an effect on the credit markets. As indicated by the table below, everything from 3 month LIBOR spreads to the TED spread and currency volatilities have fallen since Friday and most of these indexes are down sharply from last Monday. This shift indicates that banks and other counterparties are becoming less risk averse and more willing to lend to each other which is helping equities and carry trades rally.

Is $700B Not Enough?

In Bernanke's testimony on the budget before the House today, he talked about the need for another stimulus plan given the strong possibility of a deeper slowdown in the US economy. He said that the additional stimulus should be decided by elected officials and should come at a time when the economy is the weakest. The pros and cons of more government spending could be argued extensively and the White House has already indicated that they are open to the idea.

However for the currency market, Bernanke's comments about a second stimulus plan reflects his continued concerns about the US economy. Going into next week's interest rate decision, this suggests that the Fed will be looking to bring interest rates down to as low as 1 percent.

Published on Mon, Oct 20 2008, 17:11 GMT

DJIA: Does the Panic of 1907 Offer Hope?

Thu, Oct 16 2008, 08:26 GMT
by Kathy Lien

GFT

FX MARKET HIT BY WEAK DATA, PRESSURE GROWS ON FED TO CUT INTEREST RATES

The currency and equity markets were hit by another wave of liquidation as weak economic data and a pessimistic Beige Book report highlighted the need for further interest rate cuts by the Federal Reserve. The biggest beneficiaries of the sell-off in equities continue to be the two lowest yielding G7 currencies which are the US dollar and Japanese Yen. Low yielding currencies tend to do well in times of slowing growth and volatility while high yielding currencies perform terribly. The equity market is having a very difficult time rallying as investors shift their focus from one problem to the next. Last week, it was the frozen credit markets and now that credit is thawing, the focus has turned to the potential severity of the US recession.

Expect Third Quarter GDP to Turn Negative

The definition of a recession is two consecutive quarters of negative GDP growth and so far we have only seen one quarter of negative growth which was then followed by a 2.8 percent increase in GDP in the second quarter. However the recent trend of consumer spending, which constitutes 70 percent of GDP suggests that there is a strong chance third quarter growth will be negative, putting the US halfway to qualifying for the technical definition of a recession. Retail sales fell by the largest amount since August 2005 as consumers cut spending on cars, furniture, electronics, clothing and sporting goods. Americans are eating out less and only spending on the necessities like health care and gas. Consumer spending has now declined every single month in the third quarter. The Empire State manufacturing survey fell to the lowest level since July 2001 while business inventories grew by a tepid 0.3 percent. According to the Beige Book report, all 12 Fed Districts saw slower growth last month with consumers cutting back and capital spending plans put on hold in light of the economic uncertainty. As for inflation, core producer prices increased but headline prices declined. The headline numbers have become just as important as the core numbers which means that the data today will pressure the Federal Reserve to continue cutting interest rates.

Bernanke: Signaling More Rate Cuts?

In a prepared speech to the Economic Club of New York, Fed Chairman Ben Bernanke said that the credit markets will take time to freeze and that an economic recovery will not happen immediately. He also indicated that the turmoil in the financial markets pose significant threats to growth. He has pledged to continue fighting the crisis and indicated that the TARP is not a “total solution.” Bernanke may be hinting to us that further rate cuts are needed, making 1 percent interest rates a growing possibility. Fed fund futures are pricing in an 85 percent chance that interest rates will be slashed to 1 percent before the end of the year.

DJIA: Does the Panic of 1907 Offer Hope?

After the horrid US data released this morning, there are plenty of reasons to believe that the equity markets including the Dow Jones Industrial Average are headed lower. However in every battle there are reasons for hope. According to a very interesting study published by Barclays Capital this morning, the current equity market movements are strikingly similar to that of the “Panic of 1907.” Back then, there were 5 waves in the equity market sell-off; a decline of 17%, followed by a 13% rise, another 22% decline, a 12% recovery and then the final push lower that drove equities down 37 percent between the second and fourth quarter of 1907. Taking a look back at the Dow’s move between 2007 to present, the numbers are eerily similar. Starting in Oct 2007, the Dow first slipped 18%, then rallied 13%, declined another 18%, recovered 10% and the latest decline from the August high to of 11,867 to the October low of 7,882 has been approximately 34%. This suggests that there could be one final push lower below 8000 before a long term bottom. When the rally does happen, it could be as much as 20 percent and after that, expect a long phase of consolidation. Back in 1907, there was a 15 year consolidation before the stock market picked up once again taking us into the Roaring 20s.

Consumer Prices, Jobless Claim, TIC and Industrial Production

The US economic calendar continues to be very busy tomorrow with consumer prices, jobless claims, industrial production and the Treasury’s International Capital flow report due for release. We expect most of the data to be dollar negative, but the one that we are most interested in is the TIC report. Although the data is for the month of August, which was before the meltdown in stocks, it will be interesting to see if there has massive repatriation of assets by foreign investors as the credit crisis escalates.

Published on Thu, Oct 16 2008, 08:26 GMT

Are Recession Fears Driving the US Dollar and Equities Lower?

Wed, Oct 15 2008, 07:18 GMT
by Kathy Lien

GFT

The feel good factor in the markets was relatively short-lived with the 400 point rally in the Dow this morning turning into a more than 75 point decline by the end of the US trading session. The US dollar weakened against every major currency but the reversal in the Dow has caused the greenback to recover some of those losses. Given that the Dow saw its largest point gain ever on Monday, a correction would be natural. However, in this fickle and unsteady market environment where investors are not sure how hard they should be pushing the buy button, any significant correction will leave investors extremely insecure about being long stocks. The currencies that will be impacted the most are the US dollar and the Japanese Yen because continued weakness in equities has been helping the dollar but hurting the Yen.

Is Earnings Season Bringing Back Recession Fears?

With the third quarter earnings season in full swing, the latest correction in the stock market is partially attributed to the fears of a recession. Former US Fed Chairman Paul Volcker said on Tuesday that there is a risk of a considerable recession in the US and Europe. We find the debate of a recession quite interesting because talking about whether a recession is here or not is just a matter of semantics. Everyone from individuals to corporations large and small is already acting like a recession is here. In fact, not many people would argue that the US economy is in the worst shape since the Great Depression. Over the past 50 years, there have been 6 times that the US economy has fallen into a recession and to be compared to the Depression at a time when we have yet to see two consecutive months of negative GDP growth indicates the potential of addition weakness for the US economy. So far, third quarter earnings have been soft, forcing many companies like Pepsi to cut jobs. In the second quarter, many multinational US corporations benefitted from positive currency translations. The dollar’s weakness boosted their overseas earnings helping to contribute to the company’s profitability in the second quarter. However the 15 percent rally in the US dollar over the past 3 months will erase any positive currency contributions, increasing the chances of earnings reports missing expectations. This is part of the reason why rating downgrades by Standard and Poors has hit a 6 year high. Taking a step back, it would be surprisingly if the credit crisis and the meltdown in stocks did not lead to a major slowdown in the global economy. With retirement accounts falling as much as 40 percent in value over the past month, individual and corporations will increasingly become more frugal especially going into this holiday shopping season which could lead to more troubling times for the US economy. Recessions fears are real and will remain for some time.

Details on the US’ Recapitalization Plan

The price action in the equity markets today may continue to be the classic “buy the rumor, sell the news” reaction to the Treasury’s Recapitalization plan. This morning, Treasury Secretary Paulson announced a $250B program that would inject half of that amount into 8 of the country’s largest financial institutions and leave the other available to any bank or bank holding company that needs it. The US government has taken an equity stake in the banks and will be privy to dividend payments on their preferred stock. Based upon the tone of Paulson’s press conference, he was extremely reluctant to resort to this option but unfortunately, he felt that to not do so would leave US citizens and businesses “without access to financing,” which is “totally unacceptable.” The FDIC announced that they were guaranteeing all deposits regardless of size in non-interest bearing accounts through 2009. This means that all checking accounts that do not pay interest are covered in case the bank fails but there is still a $250k limit on interest bearing or savings accounts. In taking these actions, the US government has basically pledged to prevent another major bankruptcy and even if a bank of any size fails, consumers are protected as long as their money is held in a non-interest bearing account.

Watch Out for Retail Sales

A number of important US data are due for release tomorrow including retail sales, producer prices, Empire manufacturing, business inventories and the Fed’s Beige Book report. Both ICSC and SpendingPulse have reported a decline in consumer spending so we expect the retail sales to be weak. Import prices also took a big tumble, which should lead to softer producer prices. Overall we expect most of the economic data to be dollar bearish. The same is true for the Fed’s Beige Book report as the US economy weakens and inflation eases.

Published on Wed, Oct 15 2008, 07:18 GMT

What Triggered the Major volatility in carry trades and equities?

Mon, Oct 13 2008, 07:09 GMT
by Kathy Lien

GFT

The price action in the equity markets today was nothing short of impressive. We literally had a W shaped trading day where stocks opened down 600 points, rallied back into positive territory, sold off again by another 600 points before recovering most of its losses by the end day. The volatility that we have seen in the currency market is only an extension of the movements in equities. On an intraday basis, the Dow saw a 1000 point swing, with stocks up as much as 300 points in the last hour of trading. Two very different factors drove the sharp reversal in the markets - no one wanted to be short carry trades going into the G7 meeting and the money from the Lehman credit default swap is coming back into the markets.

The Case for a Bounce Next Week

Even though the economy could still be in for more trouble over the coming months, there is a case for a major bounce next week. Many people are arguing that this week’s sell-off in stocks is tied to the need to raise cash to settle the Lehman Brothers’ credit default swaps. For those who bought protection against a bankruptcy on Lehman brothers, they are set to get 91.375 cents on the dollar. The sellers of the protection will now have to make cash payments of more than $270 billion to the buyers. As the money changes hands, those who have bought protection could now put their payments to work in the equity markets which could pave the way for a serious bounce.

Will the G7 Come Up With a Grand Plan?

There is big hope for this weekend’s G7 and G20 meetings. Unfortunately with expectations running very high, there is a chance that the G7 could disappoint. Unlike the weekend meetings in the US that led to the AIG bailout and the creation of the TARP program, the world’s largest economies are getting together to come up with a plan that could stabilize the financial markets. This could be the most significant G7 meeting since the 1985 Plaza Accord. The crisis has now gone global and a global response is needed. Unfortunately, investors have become increasingly desensitized to the groundbreaking measures introduced domestically and internationally, so it could take a lot to convince banks to start lending to each other. Grand plans are hard to come by and the G7 may just insist on tailoring solutions to their own countries which could be a big disappointment to the equity and currency markets. Italy has already said that the G7 draft is weak and needs to strengthen which confirms the possibility there could be a disappointment. In that case, there could be weakness for equities, USD/JPY and other Japanese Yen crosses. The EUR/USD and GBP/USD could come under pressure if there is aggressive selling in EUR/JPY and GBP/JPY just as we have seen today. If the G7 manages to come up with a grand plan, there is case a for a major relief rally in USD/JPY and other carry trades. Some ideas being floated around include bank recapitalization, equity or FX intervention and unsecured lending by central banks. Ultimately, it will be up to the market to decide if enough is enough with the aggressive selling because the flush that we have seen in the past week is no longer driven by economic fundamentals.

A Look at P/E Ratios: Are Stocks Becoming Good Values?

The Dow Jones Industrial Average has fallen more than 40 percent over the past year, leaving many investors wondering whether stocks have finally become cheap. Price to Earnings or P/E ratios has fallen to the lowest level in 23 years. With the S&P 500 trading at 860, the estimated P/E ratio according to the NY Times was just below 12. Over the past century, the average P/E ratio was approximately 15.5. According to a study by Yale Economics Professor Robert Shiller, the P/E ratios in the UK and Germany have fallen to levels that have only been seen 4 or 5 times in 150 years. From that perspective, P/E levels have fallen significantly but it is important to remember that earnings are expected to decline and P/E ratios always fall below the average in recessions. If economic conditions are as bad as the stagflationary period of the 1970s, then P/E levels could still fall to single digits. USD/JPY is due for a bounce, but in the long run, the prospect of further rate cuts from the US should continue to drive the currency pair lower. In addition to the G7 meeting, we are expecting US producer prices, consumer prices, retail sales, manufacturing and housing market reports next week.

Published on Mon, Oct 13 2008, 07:09 GMT

Dow Breaks 9k, More Losses in FX, Waiting for the Fix that Finally Works

Fri, Oct 10 2008, 07:08 GMT
by Kathy Lien

GFT

Another day, another plan from the US government that has failed to impress the markets. This morning, the Treasury said that they will be injecting capital directly into banks by taking an equity stake. In theory this announcement should give banks the peace of mind to start lending as a direct capital injection from the US government should reduce the risk of counterparty failure. More specifically, Bank A would be less worried about Bank B running out of money to meet their daily obligations which would hopefully make Bank A more willing to lend to Bank B. This was the smartest option announced by the US government to date and the one that leading economists have been calling for. Unfortunately, timing continues to be the Achilles heel of the Bush Administration. The Treasury would not start taking equity stakes until the end of the month while the $700B bailout plan has yet to be up and running. The market wants a fix now and not 3 weeks later. Between now and the end of the month, liquidity could evaporate. We saw that with AIG who quickly ate into their nearly all of their $85B loan from the federal government and are now asking for more money. For the US dollar, this means more weakness against the Japanese Yen as the market waits for the fix that finally works.

The Fix that Finally Works

The question is – what will that fix be? Unfortunately there are little answers to this all important question. Some economists are calling for another round of coordinated rate cuts while others are calling for stimulus checks and direct loans to small businesses, but this still does not solve the crisis of confidence in the banking sector. So far, the plans announced by the US government have been reactive, which means that they are in response to the hemorrhaging in the stock market and the widening of credit spreads. What really needs to happen is for banks to just buckle down and start lending. They are in the business of taking risk and it is time that they take on some risk in the interest of unfreezing the credit markets.

G7 Meeting – Most Significant Since 1985 Plaza Accord

The next hope is the G7 meeting. Interestingly enough Treasury Secretary Paulson is calling for an emergency G20 meeting to discuss the financial crisis. The G20 is the 20 largest economies in the world which includes Australia, China, Russia and some countries in the Middle East. This acknowledges the shift in wealth over the past decade and the need to get those countries involved. The G7 meeting is happening on Friday while the G20 meeting is scheduled for the weekend. This will be the most significant G7 / G20 meeting since the 1985 Plaza Accord which marked a major turning point for the US dollar. At that time the 5 nations attending the event agreed to intervene in the currency markets and to sell US dollars to reduce the US current account deficit and to pull the US economy out of a serious recession. FX intervention is still on the table, but it remains to be seen whether even that step will enough to surprise the markets.

How Low Can Stocks Go?

The Dow Jones Industrial Average has fallen to the lowest level in 5 years. Since its peak in October 2007, the Dow has fallen close to 40 percent. The worst financial crisis prior to the current one was the Wall Street Crash of 1929, which led to the Great Depression. Stocks started selling off in October 1929 with the big crash happening on October 29th of that year. Equities did not bottom out until July 1932, after the Dow lost 89 percent of its value. These are scary figures but it provides a perspective on how bad things have gotten in the past. We sincerely hope that this doesn’t happen, but the lower equities fall, the greater the decline in USD/JPY and carry trades.

Published on Fri, Oct 10 2008, 07:08 GMT

USD: What is the Fed Waiting For?

Wed, Oct 8 2008, 07:47 GMT
by Kathy Lien

GFT

Before the US stock markets opened this morning, the Federal Reserve announced a plan to buy commercial paper directly from issuers in yet another attempt to unfreeze the credit markets. Although this led to a rally in US stocks, USD/JPY and other carry trades, the rally was short-lived. Having been up as much as 165 points intraday, the Dow Jones Industrial Average ended the US trading session down 508 points. For the Federal Reserve and the US economy, the new commercial paper funding facility is a step in the right direction because it lends directly to business sector. However what the Fed ceases to realize is that the lack of liquidity comes from the lack of confidence and so far, their approaches have been too conservative to warrant a recovery in confidence. We have been calling for coordinated easing by central banks around the world, but the Reserve Bank of Australia has now raised the bar by cutting interest rates 100bp. In response to the turn in equity markets, Fed Chairman Ben Bernanke has finally buckled when he said that the Federal Reserve is ready to cut interest rates. Unfortunately a quarter point rate cut at this point is not enough, especially when compared to Australia’s full percentage point cut. If the Fed had surprised the markets with a 25bp rate cut last week after the House’s approval of the bailout plan, that one-two punch to the credit crisis may have done the trick, but now the Fed needs to do more if they want to put an end to the hemorrhaging that we have seen across the financial markets.

Is the Fed Waiting for the G7 Meeting?

One possible reason why the Federal Reserve has yet to cut interest rates may be because they are saving ammo for Friday’s G7 meeting. According to the comments by ECB member Quaden this morning, the Federal Reserve’s counterparts in Europe are also ready to cut interest rates. As we have seen by the Fed’s commercial paper announcement, the Bank of England’s plan to inject capital into as much as GBP 45B into banks and Spain’s EUR 50B bank rescue fund, fractured responses are not working. A signal of solidarity and coordinated interest rate cuts by central banks around the world is the minimum that the markets need in order to reverse the current trend. US stocks continue to sell off with the Dow Jones Industrial Average falling to the lowest level in 5 years. Bernanke’s comment about possibility cutting interest rates has not helped the US dollar or US equities because Investors want less talk and more action.

What to Expect for the US Dollar

The US dollar continues to behave very differently against the Japanese Yen and every other major currency. Although the dollar weakened against the Yen, it has soared the Euro, British pound and Australian dollar. In fact, year to date, the only currency that has outperformed the US dollar is the Japanese Yen. The reason for this divergence is because interest rate expectations are once again the primary drivers of currency prices. The US is expected to cut interest rates aggressively over the next 12 months, but the verdict is out on whether rates would fall as low as 1 percent. For the Eurozone, 100bp of easing has already been priced into the markets while traders are expecting 150bp of easing from the Bank of England by next October. Even the Reserve Bank of Australia is expected to cut another full percentage point. The Federal Reserve has been cutting interest rates since last August so they only have a limited amount of room to ease whereas the last move made by the European Central Bank in July was an interest rate hike. Therefore we expect the dollar to continue to fall against the Japanese Yen but strengthen against the Euro, British pound and Australian dollars.

Why Commercial Paper

For our readers who may be confused by the Fed’s action in commercial paper, it is important to understand that the commercial paper market is where companies go to raise short term money to buy inventory, meet payroll obligations and pay bills. In recent weeks the commercial paper market has been under a lot of stress due to the lack of buyers for the commercial paper, making it difficult for companies to meet their day to day obligations. The Fed’s hope is their willingness to be the buyer of last resort will help to tie these companies over and prevent bankruptcies, making investors more confident in the process. Meanwhile the FOMC minutes revealed that the Fed was considering cutting interest rates last month. The world has changed quite a bit since September 16 and even if the minutes were hawkish, the Fed has no choice but to cut interest rates – it is not a matter of if, but a matter of when.

BAILOUT PACKAGE EXPECTED FROM THE UK

The spotlight will be on the United Kingdom tomorrow as the Bank of England is expected to unveil a large bank rescue plan before their markets open tomorrow morning. The talk on the street is that the plan could be as much as GBP 45B or $78B dollars. The UK government and the Bank of England have learned quickly that increasing their guarantee for bank deposits and nationalizing a few banks is not enough in this type of market. A bailout plan is the next logical step for the UK government followed by an interest rate cut on Thursday. Given the continual sell-off in the equity markets and the rise in risk aversion, it is realistic to expect a 50bp rate cut from the Bank of England. This could come as a one shot deal on Thursday or 25bp on Thursday followed by 25bp on Friday if there is coordinated action by the G7. The UK has been reluctant to agree to an EU bailout package that commits their tax payer dollars to a program that they have no control over. Instead, they have been big proponents of individual actions by the member states which is exactly what we will be seeing tomorrow. Monetary policy on the hand may be easier to agree on and even if the BoE cuts rates on Thursday, they could cut again alongside their international counterparts.

Published on Wed, Oct 8 2008, 07:47 GMT

Dollar sells off as traders question if bailout plan is the right prescription

Mon, Oct 6 2008, 08:18 GMT
by Kathy Lien

GFT

The wait is over - the House of Representatives have finally passed the $700B bailout plan but the markets remain unconvinced that this is the right prescription for the credit crunch. The goal of Congress was to find a way to bolster confidence and unfortunately the fact that the stock market went from being up more than 200 points to down more than 150 points by the end of day indicates that the crisis of confidence has not been resolved. Although USD/JPY has trailed the stock market lower, the greenback’s weakness against the Euro and British pound illustrates the market’s belief that the Federal Reserve is gearing up for an interest rate cut. We have previously said that if the bailout plan fails to do the trick of materially unfreezing the credit markets and so far it hasn’t, investors will be looking to Bernanke for help. With the big disappointment in non-farm payrolls and the lack of celebratory fireworks in reaction to the bailout plan, there is little doubt that the Federal Reserve will cut interest rates by the end of this month.

$10 Trillion in Debt and Counting

However for the time being, the problem of a weak economy still exists and it may be a while before the average American reaps any benefits from the bailout package. The national debt has exceeded $10 Trillion this week and this does even not include the costs of the bailout. The more liquidity initiatives that the Federal Reserve takes, the more destruction is done to the US balance sheet. The US government is bailing out Wall Street, but will foreign investors continue to bailout out the US government? Herein lies the critical question that will determine the fate of the US dollar. The weakness in the US economy and the global slowdown may cause foreign central banks and sovereign wealth funds to fold their arms when it comes to recapitalizing the US financial system. This is one of the main reasons why we believe that the US dollar will continue to weaken against the Japanese Yen. The second reason is the prospect of US interest rates falling to 1.50 percent by the end of the year.

Ninth Consecutive Month of Job Losses, Largest Decline in Payrolls Since March 2003

Non-farm payrolls dropped 159k last month, 50 percent more than the market expected. This marks the ninth consecutive month of job losses in the US economy and the largest decline in payrolls since March 2003. It is difficult to argue that the labor market is in anything but bad shape and we expect conditions to worsen. Unfortunately, there was no silver lining in the details of the employment report. The unemployment rate remained at a 5 year high of 6.1 percent while average hourly earnings and weekly hours slipped. This indicates that not only are Americans having difficulty finding jobs but they are making less as well. Although the job report was not bad enough to warrant a 50bp rate cut, it is still worrisome enough for the Fed to cut interest rates by 25bp at the end of this month.

Bailout Plan Has Less than 4 Weeks to Prove Itself

With the Federal Reserve’s interest rate decision scheduled for October 29, the bailout plan has less than 4 weeks to prove itself. Outside of the minutes from the most recent FOMC meeting, pending home sales and the trade balance, there are no significantly numbers on the US economic calendar next week. This means that traders will be focusing on digesting the implications of the drop in non-farm payrolls and the impact of the bailout plan on Wall Street and Main Street. These 2 factors should be the primary drivers of the dollar’s price action in the coming week.

Published on Mon, Oct 6 2008, 08:18 GMT

Dow falls 300 points, What's in store for the US dollar ahead of Payrolls?

Fri, Oct 3 2008, 12:23 GMT
by Kathy Lien

GFT

Even though the Senate has approved the newly revived bailout plan for the financial markets, equity traders are not convinced that the plan will be enough to rescue the US economy. In Wednesday’s edition of the Daily Currency Focus, we talked about how “on Monday when the markets opened, investors were not convinced that the $700B bailout plan would do the trick. Both US stocks and USD/JPY were sold long before the market caught whiff of the House’s rejection. Therefore it still remains to be seen whether the markets will have a positive reaction to the new bailout plan.” Our concern is that the US economy remains very weak and the crisis of confidence that has frozen the credit markets may not be solved by a plan that focuses on recapitalizing banks and not creating jobs. This has put the Dow within an arm’s reach of 10,000 as few hundred point swings have become the norm. For USD/JPY this also means renewed selling and a chance of slipping to 104.00.

What to Expect for Non-Farm Payrolls

This morning’s US economic releases continue to be weak with jobless claims rising to the highest level since 2001 and factory orders falling to a 2 year low. Recession fears are back and credited for today’s sharp slide in stocks, oil prices and the Japanese Yen crosses. Non-farm payrolls for the month of September are due for release tomorrow and now more than ever, the degree of job loss will determine where the dollar is headed next.

For the first time in this cycle, the market is looking for non-farm payrolls to fall by more than 100k. This would mark the ninth consecutive month of job losses. We believe that non-farm payrolls could fall as much as 130 to 150k. The 4 week average of jobless claims and continuing claims remain at 5 year highs. Claims are usually not subject to significant revision and are therefore very reliable leading indicators for NFP. Also, we have not heard the last of the layoff announcements. With market caps taking a bit hit and lending difficult to attain, US companies are tightening their belts and cutting back. With that in mind however, arguments can be made for an improvement in payrolls. Despite the turmoil in the financial markets, consumer confidence has improved, but the survey was closed before Monday’s 777 point drop in the Dow. The Monster.com employment index and the ADP report also points to a smaller drop in payrolls, but the reliability of ADP is in question and unfortunately the most reliable leading indicator for non-farm payrolls, which is service sector ISM will not be released until after the NFP report (Read our full NFP Preview).

How Non-Farm Payrolls Will Impact the Fed’s Decision and the EUR/USD

This time around, non-farm payrolls can determine 2 things – how much the Federal Reserve will cut interest rates and whether the EUR/USD will hit bottom. Here are the possible scenarios:

Payrolls Drop By 75k or Less: If payrolls drop by less than 75k, the Federal Reserve may postpone their interest rate cut or the best that we will get out of the Fed will be a quarter point rate cut accompanied by neutral comments. This would drive the EUR/USD towards 1.35 and help USD/JPY recover.

Payrolls Between -76k to -125k: If payrolls are anywhere between -76k and -100k, the Federal Reserve will probably cut interest rates by 25bp and hint that more easing may be necessary. This would keep the dollar under pressure against the Japanese Yen but it may not stop the EUR/USD from falling.

Payrolls Drop by More -125k: If payrolls drop more than -125k, there would be a strong case for either an intermeeting rate cut by the Federal Reserve or a 50bp cut at their scheduled meeting on October 29. As of 11:30am ET today, Fed Fund futures are pricing in a 90 percent chance of a 50bp rate cut in October and 10 percent chance of a quarter point cut (Fed fund futures can be very volatile). This would mean a bottom for the EUR/USD and further losses in USD/JPY.

The recent improvement in inflationary pressures makes it easier for the Federal Reserve to cut interest rates. The dovish comments by European Central Bank President Trichet suggests that if the expected approval of the bailout plan the House fails to stabilize the markets, there could be coordinated easing by the ECB and the Federal Reserve, which would be first in 7 years.

EURO HITS 1 YEAR LOW ON THE POSSIBILITY OF A NOVEMBER RATE CUT

The Euro fell to a one year low against the US dollar after ECB President Trichet buckled under the weight of bank failures, recessions and slower global growth. The central bank left interest rates unchanged at 4.25 percent, but for the first time in 5 years, there is a realistic chance that the ECB could cut interest rates in November if not sooner. Given the deterioration in economic data, bank failures and slower global growth, it was only a matter of time before ECB President Trichet would have acknowledged the slowdown and the need for easing. Today, he talked about the increase to downside risks and the reduction of upside price risks. Interestingly enough, in addition to his usual press conference and Q&A session, Trichet held individual interviews with reporters. This indicates that he is serious about getting his message across. He also wanted the citizens and the financial sector to realize that they can rely on the central bank to deliver stability. Trichet is not a fan of surprises and his actions today certainly suggests that he is preparing the market for an interest rate cut. At the meeting, only 2 options were discussed, leaving interest rates unchanged or cutting them - raising interest rates was out of the question. The market is currently pricing in 100bp of easing over the next 12 months.

Will an EU Bailout Plan Happen?

Meanwhile there has also been a lot of talk about an EU version of the TARP. As this is a crisis of confidence, it is important for the members of the European Union to signal that they will support the banking sector if another major failure occurs. However, if you think politics are a stumbling block in the US, it is even more so in Europe. The French have been calling for an EU bailout plan but the British and the Germans believe that each country should figure out its own solution. Earlier this week, Ireland announced that they were guaranteeing nearly all bank deposits and this morning, Greece followed suit. An agreement on banking regulations and individual solutions will be far more likely that an EU bailout plan.

Published on Fri, Oct 3 2008, 12:23 GMT

Quarter End Flows Drives US Dollar Higher

Wed, Oct 1 2008, 09:20 GMT
by Kathy Lien

GFT

It is the end of the third quarter and demand for US dollars has been exceptionally strong. This is related to repatriation flows and profit taking following yesterday’s big moves. On the bailout front, since Congress is on recess for the Jewish holidays, there have been no significant developments. As a result, to credit today’s rally on the hope for a new bailout plan may be a bit of a stretch since the Senators haven’t even sat down to discuss potential changes. Therefore we still believe that yesterday’s sell-off is the market’s true sentiment towards the US dollar and US stocks and so far, there aren’t any concrete reasons to believe otherwise.

How Higher LIBOR Rates Impact Average Americans

Despite today’s recovery, there is evidence that investors and banks are still nervous. The overnight LIBOR rate which is the rate at which banks lend to each other hit an all-time high of 6.88 percent intraday. The 3 month LIBOR rate is also above 4 percent, the highest level since January. For the average American, overnight lending rates or the 3 month LIBOR have little significance until they realize that many home equity loans, lines of credit, student loans, small business loans and credit card rates uses LIBOR as an index. Therefore the rise in borrowing costs will surely be felt on Main Street as lenders charge higher interest rates on loans. For the average American, this adds further strain to their ever-thinning pocketbooks. Lending between banks is frozen as counterparty risk remains the number one problem in the financial markets. Volatility continues to remain high and we do not see any reason for that to change either. Yesterday, the S&P500 fell by the largest amount in 20 years and today, the index rose 5 percent. This schizophrenic behavior of the markets is sure to turn many investors gun shy.

Will An Interest Rate Cut Help?

In order to restore confidence at this stage of the game, the Bush Administration needs to shock the markets. One way of doing so could be through a rate cut by the Federal Reserve. As one of the most powerful psychological tools in the government’s arsenal, Bernanke may want to save it until there is evidence that the new bailout plan has failed to stabilize the markets. Fed fund futures have already priced in a quarter point rate cut between now and the October 29 monetary policy meeting. However the futures contracts have been wrong in the past and should the new bailout package prove to be stronger than the one proposed on Monday, the futures contracts will price in a smaller chance of a rate cut. For the Federal Reserve, after pumping a huge amount of liquidity into the financial system, inflation has become a very big concern. Therefore Bernanke will not readily agree to cut interest rates unless he has no other choice. Furthermore, a measly 25bp rate cut from the Fed may not do the trick. Risk aversion is so severe that the only things that can stabilize the markets may be a 50bp one shot rate cut or a coordinated easing by central banks around the world, but Bernanke will have a tough time convincing his Eurozone counterpart, Trichet.

Raising the FDIC Limit

In the latest development of the bailout drama, the most popular and likely proposal is to raise the FDIC insurance from $100,000 to $250,000. This bribe to Main Street offers a jolt of confidence and peace of mind. For the government no initial outlay is needed to increase the FDIC limit. The 3 big banks that are left on Wall Street - Bank of America, J.P. Morgan Chase and Citigroup will still be here when the dust settles. According to today’s WSJ, the Big 3 holds approximately 75 percent of all US deposits. Therefore even if other commercial banks fail, the FDIC only has to fork up a limited amount of money and even if they have to fork up more than that, it is the confidence booster that Americans need.

Consumer Confidence Improves but Still Near 16 Year Lows

Interestingly enough, despite the problems in the US financial markets, consumer confidence actually improved in the month of September from 58.5 to 59.8. However the index still remains near its 16 year lows and is half of what it was a year ago. It is important to note that the survey was closed on September 23, which was before the 777 point slide in the Dow on Monday. The Chicago PMI index also beat expectations even though manufacturing activity in the Chicago region slowed this month. There were no silver linings in the house price report, which dropped 16.3 percent in the month of July, the fastest pace on record. On Wednesday we are expecting our first leading indicators for Friday’s non-farm payrolls report. This includes the ADP employment change, the Challenger layoffs report, and manufacturing ISM. The numbers will shed more light on the weakness of the US labor market.

Published on Wed, Oct 1 2008, 09:20 GMT

House Kills the Bailout Plan and the US Dollar

Tue, Sep 30 2008, 07:43 GMT
by Kathy Lien

GFT

The rejection of the $700B bailout plan by the House of Representatives came completely out of the left field, driving a knife through both US equities and the US dollar. For the Bush Administration, it certainly feels like they are moving one step forward and taking two steps back but the severity of the financial crisis makes it absolutely necessary for Washington to put economics ahead of politics. Although traders were initially dissatisfied with Congress’ approval of Paulson’s plan, they were counting on a bailout. The combination of a huge liquidity injection by the Federal Reserve today and the hope that the bailout plan would move forward kept stocks from falling further. However those efforts and the sleepless weekend of debates turned out to be futile after the House rejected the bailout bill. For fairness, there was no was guarantee that Paulson’s plan would have helped average Americans, but at least it could have brought some stability to the financial markets. Unfortunately it is now back to the drawing board for Paulson who has to meet with Bush, Bernanke and Congress to discuss their next steps. Volatility in the financial markets benefits no one especially as more than $1 Trillion in market value has been wiped out from US stocks today. The VIX, which measures equity market volatility shot to the highest level in 6 years while gold prices jumped 3.8 percent. LIBOR rates have also skyrocketed while the TED spread continued to widen indicating that as a result of the House’s rejection of the bill, investors both domestically and internationally have become more risk averse. For those that are willing to part with their cash, they are demanding a high premium.

Dow 10,000 Could Mean 100 USD/JPY

The Dow Jones Industrial Average closed down more than 650 points while the S&P500 dropped more than 7.6 percent, which is the largest percentage decline in 20 years. We have long argued that if the Dow hit 10,000, USD/JPY could fall to 100. That correlation remains intact today as the plunge in US equities drags USD/JPY towards 104.00. In the September 19th edition of the Daily Currency Focus, we argued that the US dollar could fall by another 5 percent. At that time, USD/JPY was trading at 107.40 and to many people a 5 percent move lower, which is the equivalent of 530 pips seemed like a farfetched possibility. However since then the dollar has already fallen close more than 300 pips, making a move towards 102 within reach. With the US stock market plunging and the US government looking to raise the national debt, in addition to hammering out the bailout plan, the Bush Administration will have to work extra hard to reassure foreign investors.

Gold Becomes a Hedge for Inflation and the US Economy

Now more than ever, the US needs to rely on foreign funding. If Central Banks and Sovereign Wealth Funds around the world start to lose confidence in the US financial markets or the US government, we could be looking at a complete freeze in lending that expands beyond the banking sector. According to an article in the Wall Street Journal, central banks are already loading up on gold as European central banks cut their sales to the lowest level in almost 10 years. Gold prices are up more than $35 an ounce today as a hedge for inflation and a hedge for the US economy. Everyone is starting to realize that commodities are the only assets that have no counterparty or credit risk. Gold prices first jumped on inflation fears after the Federal Reserve’s liquidity injections this morning. Having more than doubled their swap limits from $290B to $620B, the Fed is trying to tell the market that they are serious about providing liquidity and given today’s sharp volatility, they will continue to do aggressively in the coming days.

TARP Drama Gets More Dramatic - Time to Play Defensive

For everyone from traders, investors, banks and the average American, the latest development in the TARP soap opera means one thing – which is that it is time to become more defensive. The Treasury has failed to restore confidence in the financial markets and it could be some time before there is stabilization. This is the new age of conservatism which means tighter terms for loans on credit cards, cars and homes as well as more penny pinching by US consumers. Expect this to lead to more layoffs and less expansion efforts by US companies. In fact, the longer the US government takes to agree on a plan, the greater the recessionary risks. Looking ahead, we still expect more weakness for the US dollar, particularly against the Japanese Yen.

Published on Tue, Sep 30 2008, 07:43 GMT

Bailout Plan Fails to Impress, Traders Worried More About Dominoes Effect

Mon, Sep 29 2008, 14:49 GMT
by Kathy Lien

GFT

The Congressional agreement of the $700 Billion bailout plan has proved to be anti-climatic for the stock and currency markets. There was a relief rally in the US dollar Sunday evening, but it lasted for no more than a blink of an eye as more problems came knocking on the door for financial institutions. Investors quickly moved onto the latest problems with a string of bank bailouts announced in Europe and the practical failure of Wachovia. Being sold at $1 a share is almost the same as filing for bankruptcy.

THE DOMINOES EFFECT

The US dollar has weakened against the Japanese Yen, but its strength against the Euro and British pound indicate that the concerns for those currency pairs now shift to the prospect of further bank failures in Europe. In the Eurozone, Fortis was bailed out by Belgium, the Netherlands and the Luxembourg governments while the Hypo Real Estate group was bailed out by the German government. In the UK, Bradford and Bingley was nationalized by the UK government. If the US banking sector is a good model, then we know that this is just the beginning of bank failures as the dominoes effect triggers more losses. With the ECB interest rate decision scheduled for Thursday, the problems in the banking sector could pressure the European Central Bank to consider easing monetary policy.

On the heels of the bailout plan, the Federal Reserve has injected a tremendous amount liquidity into the global money markets by increasing their swap lines. This is driving gold prices through the roof as inflation fears soar and money flocks out of US dollars and into gold as the safe haven play. Nonetheless, the Fed is trying to tell the market that they are serious about providing liquidity with the size of today's liquidity injection - they more than doubled their swap limits from $290B to $620B.

US COMPANIES PLAYING DEFENSE COULD BOOST RECESSION RISKS

So far, the Treasury's plan has failed to restore confidence in the financial markets. Not only are we expecting more layoffs across the board due to slower global growth but US banks and other financial institutions will also be looking to play defense over the next few months. This means tighter terms for home loans, car loans, and credit card loans which could strain the expansion efforts of US companies and the spending ability of US consumers. The Treasury's plan has failed to reduce recessionary risks and that may be part of the reason why US stocks continue to fall and the US dollar is at risk of breaking 105 against the Japanese Yen.

MORE WEAKNESS FOR THE US DOLLAR

Looking ahead, I still expect the dollar to weaken against the Yen, but the troubles in Europe could lead to more erratic trading for the US dollar against the Euro and British pound.

Published on Mon, Sep 29 2008, 14:49 GMT

US Dollar Consolidates as Traders Wonder if TARP = TRAP

Thu, Sep 25 2008, 08:18 GMT
by Kathy Lien

GFT

For the second day in a row, Federal Reserve Chairman Ben Bernanke and US Treasury Secretary Paulson pleaded to the power players of Washington to pass their request for $700 Billion to implement their Troubled Asset Relief Program (TARP). However if we move the letters around a bit, TARP becomes TRAP and that is exactly how many investment managers, economists, politicians and average Americans view the plan. They are afraid that this is a trap for US taxpayers because they may be paying for a bailout that benefits the private and not public sector. Bernanke argues that a failure of the private sector would have “grave” consequences for the public sector, which is true and Paulson has finally agreed to accept limits on executive pay under the bailout plan. Yet, today’s price action in US stocks and the US dollar suggest that some investors are holding out the hope that Paulson’s TARP does not become the trap that keeps Americans still paying for bailout many years to come.

LIBOR Rates Jump, TED Spread Widens

Other investors on the other hand are more skeptical. Three month LIBOR rates jumped 26 basis points to 3.47 percent, which is the highest level since January. The TED spread, which measures the difference between the interest rates of the 3 month LIBOR and the 3 month Treasury bill hit an intraday high of 311 basis points. Not only is this only the second time in 2 decades that the TED spread has gone above 300bp, but the premium is far above its pre-credit crunch levels of 20 to 30 basis points. The greater the TED spread, the greater the degree of risk aversion and the fear of default in the market. Therefore the jump in the LIBOR and the widening of the TED spread suggests that investors are still hoarding their cash and they are skeptical of whether the government’s efforts will actually restore stability in the financial markets and improve risk appetite.

Paulson’s Plan Could be a Lose-Lose for the US Dollar

Paulson’s plan is ultimately a lose-lose situation for the US dollar. If it is approved, it would cause a destruction of the US balance sheet by increasing the nation’s debt ceiling by 6.6 percent to $11.315 trillion. If it is not approved or if Paulson and Bernanke only get a trimmed down version of the plan, they would have to go back to the drawing board to come up with other solutions to unclog the mess. If we end up being between rescue plans, the uncertainty would weigh on the US dollar. Therefore I still believe that the US dollar could fall another 5 percent over the next few months.

Home Sales, Durable Goods and President Bush

Existing home sales dropped by 2.2 percent last month while mortgage applications plunged by 10.6 percent, the largest decline since July. The ongoing turmoil in the financial markets has made it increasingly difficult for even people with money to buy a home to secure loans. House prices continue to fall with the median price declining 9.5 percent from last August, causing more homeowners to pull their houses off market. The inventory of unsold homes dropped 7 percent, which was the largest decline since December 2006. In times of strong growth, a reduction of inventory may be good because it could suggest that demand is strong, but in times of weak growth, it suggests instead that homeowners are giving up on selling their homes now. Durable goods, jobless claims and new home sales are due for release Thursday morning. We continue to expect economic data to confirm that the US economy is weakening. President Bush will also be giving a nationally televised address on the financial crisis on tonight. Although we do not expect any groundbreaking announcements, his comments could nonetheless be somewhat market moving for the US dollar.

Published on Thu, Sep 25 2008, 08:18 GMT

Dollar Could Fall Another 5 Percent

Tue, Sep 23 2008, 07:25 GMT
by Kathy Lien

GFT

DOLLAR FALLS BY MOST SINCE 1999, PAULSON’S BAILOUT PLAN FAILS TO PLEASE THE MARKETS

The last thing that US Treasury Secretary Paulson probably hoped for when announcing his $700 Billion bailout plan was the price action that we saw across the financial markets today. Rather than stabilizing or calming the markets, the destruction of the US balance sheet has triggered the largest drop in the US dollar against the Euro since its inception in 1999 and the largest single day rise in oil prices since 1984. The Dow Jones Industrial Average closed down 372 points, indicating that no one is satisfied with Paulson’s bailout plan. With the details of the plan yet to be hashed out, the one thing that is certain is that US taxpayers will have to foot the bill, which is ultimately negative for the US economy. The US is surrendering free-market capitalism which is very unattractive to foreign investors.

Flight to Quality into Commodities and Out of the US Dollar

As the US fiscal position deteriorates, the only trade that has been benefitting is long commodities. In addition to the sharp rise in oil prices, gold prices are now trading above $900 an ounce. Less than 2 weeks ago, they were trading below $750 an ounce. For central banks and sovereign wealth funds, the bargain basement prices of commodities have made oil and gold extremely attractive investments, especially at a time when investments anywhere else have become far less certain. For a country like China that is continuing to modernize, their energy needs are expected to grow. Therefore no time is better than now to stock up on commodities that have some real value. Although their pockets are deep, they have certainly taken a hit in their US financial sector investments. Three state owned banks invested as much as $350 million into Lehman Brothers over the past year and that investment is now worth zero. The only true haven for safety is in gold because there is no counterparty or credit risk.

US Dollar Could Fall Another 5 Percent

Unfortunately this is not the first time that the US government has paid “Cash for Trash” as Paul Krugman writes in today’s NY Times. However a more recent example of a government buying up bad debt was Japan in 1996. They created the Resolution and Collection Corporation which is similar to a Resolution Trust Corp in that they would acquire and then dispose of troubled paper that belong to failed institutions in an orderly manner. Although the Japanese Yen rallied briefly after the announcement, it proceeded to fall 12 percent over the next 12 months. Against the euro, the dollar has fallen 6 percent over the two weeks while the dollar index has fallen 5.5 percent. This suggests that if the dollar were to follow in the Yen’s path, we could see another 5 percent decline before the currency hits a bottom.

Watch Out for Paulson, Bernanke and G7 Meeting

Even dollar bears have to be careful in the current market environment because the only thing that is assured is volatility. Paulson and Bernanke will be testifying on the credit turmoil at the Senate Panel tomorrow morning - they will try again to calm the markets which could lead to a relief rally in the US dollar and in US stocks. This morning, the G7 pledged to act if necessary. With the next meeting of finance ministers scheduled for October 10, the Group of Seven may be signaling some sort of coordinated action if all else fails. If the move is in currencies, their would want to talk up the dollar because it adds pressure on commodity prices, giving relief to consumers globally.

Published on Tue, Sep 23 2008, 07:25 GMT

USD: Don't Expect a V−Shaped Economic Recovery, Maybe a W or L

Mon, Sep 22 2008, 07:34 GMT
by Kathy Lien

GFT

US DOLLAR: WILL THE BI-POLAR MARKETS CONTINUE?

The volatility that we have seen in the currency, stock and bond markets this past week has not been for the faint of heart. The Dow Jones Industrial Average fell 500 points on Monday, but instead of continuing lower over the course of the week, it staged the biggest 2 day rally in 5 years. Three to four hundred point swings in the stock market have become the norm this week as surprises and disappointments from the US government keeps traders on their toes. The current Administration has thrown everything but the kitchen sink at the markets and based upon the recovery that we have seen over the past 2 trading sessions, something has worked. The most powerful of which is probably the Securities and Exchange Commission’s temporary ban on short selling and the hope that Paulson and Bernanke will deliver a new groundbreaking rescue plan that will include a bail-out fund that sops up all of the troubled paper. This has forced a massive short squeeze that drove stocks up more than 750 points in 2 days. Although there could have also been some genuine buying, the rise in gold prices suggests that some investors are still nervous. With no details disclosed at his press conference on Friday, it will certainly be another long weekend for US Treasury Secretary Paulson.

Don’t Expect a V-Shaped Economic Recovery, Maybe a W or L

The main take away from the recent developments is that we will not see a V shaped economic recovery. According to the data released this past week, the housing market and the manufacturing sector are still in trouble. Durable goods, the final numbers for second quarter GDP, new and existing home sales are due for release in this coming week and we expect the data to confirm the weakness of the US economy. Layoffs will rise, consumer spending will slow and corporate profitability will decline for at least the next 3 to 6 months. A recovery usually comes in one of four forms – U, V, W or L. We believe that in the current case of the US economy, we will probably see a recovery that looks more like a W or an L.

Investment Banks: 3 Down, 2 to Go

Of the top 5 investments banks on Wall Street, 3 have disappeared this year – Merrill Lynch, Lehman Brothers and Bear Stearns. The last ones standing are Morgan Stanley and Goldman Sachs (Citigroup and JPMorgan are considered universal banks since they have commercial banking divisions). With Morgan in merger talks, there could end up only being one independent player left in the market. For banks to consolidate is not a surprise but their consolidationnow is more of an act of desperation than anything else. However the pain is probably not over with more write-downs expected over the next few months. Barrons estimates that there will be another $150B of write-downs before we are done. This will stress the markets as well as central bankers and put a full fledged recovery in both the economy and financial markets at risk.

How Does this Impact the US Dollar?

The US government’s destruction of its balance sheet is ultimately negative for the US dollar especially as the budget deficit continues to grow but on a shorter term basis, we are seeing a very non-uniform performance in the US dollar. On Friday for example, the greenback strengthened against the Japanese Yen but weakened significantly against many of the other major currencies. We continue to believe that the outlook for the US dollar has changed because commodities are rebounding and the greenback has lost its safe haven status and therefore we have probably seen a top in the US dollar. Unless the European Central Bank agrees to global easing, we should see the EUR/USD revert to a period of range trading, although that range will probably be an extremely wide one characterized by sharp intraday swings. Expect more surprises and volatility in the new week if Paulson unveils his new plan.

EUR/USD: 1.45 POSSIBLE, 1.50 UNLIKELY

After hitting a low of 1.3882, the EUR/USD has seen a material recovery this past week. The dynamics that were pressuring the EUR/USD lower have changed which means that fundamentals and technicals now support a turn. Although the Federal Reserve is sterilizing their liquidity injections, which means that they are not printing money, currency traders are selling the US dollar as if the printing presses have come on. Oil prices are trading back above $100 a barrel, gold prices continue to rise and the Federal Reserve is moving closer to cutting interest rates. These macro developments are diametrically opposite from the factors that drove the dollar higher between the middle of July and the first 2 weeks of September. The Eurozone economy will no doubt be impacted by the US banking crisis, but the members of the ECB continue to warn investors that they are not relaxing their focus on inflation. Until Trichet gives in and agrees to global easing, the bottom in the EUR/USD’s latest sell-off may not be challenged. However at the same time, we do not expect the EUR/USD to break 1.50. In the week ahead, the big releases in the Eurozone are the German IFO report, manufacturing and service sector PMI. Meanwhile, the Swiss National Bank kept interest rates unchanged at 2.75 percent. The uncertainty in the financial markets leaves their bias neutral.

Published on Mon, Sep 22 2008, 07:34 GMT

Markets reverse on talk of resolution trust corp − What is it and will it help

Fri, Sep 19 2008, 07:38 GMT
by Kathy Lien

GFT

MARKETS REVERSE ON TALK OF RESOLUTION TRUST CORP – WHAT IS IT AND WILL IT HELP?

Over the past few days, the markets have shrugged off the government’s bailout of AIG and a flush of liquidity from central banks around the world. No matter what the Federal Reserve or the US Treasury tried to do, they failed to please the markets. However in the last few hours of trading today, a possible resurrection of the Resolution Trust Corp (RTC) sent the stock market surging and gold prices plunging. New traders may wonder what the RTC is and how it can help the markets. The RTC is essential a government owned asset management company that is tasked with taking over and eventually liquidating faulty assets. It was first created as a result of the Savings and Loans crisis of the 1980s. For the readers of the Wall Street Journal, former Fed Governor Paul Volcker, former US Treasury Secretary Brady and former US Comptroller Ludwig wrote an opinion piece on Wednesday calling for the current Administration to resurrect the RTC. The idea was then floated around by current US Treasury Secretary Paulson this afternoon, triggering the sharp reversal across the financial markets. USD/JPY traded as low as 104.00 just a few hours before talk of the RTC hit the newswires and afterwards, it rallied up to 105.78. However the more important question to ask is whether or not an RTC will help. The problem in the financial markets right now is not with lending but with letting money go. No one is willing to take on risk, but if the RTC is willing to do so and keep it in house for a months or even years before liquidating so as not to flood the markets with bad assets, it can help. According to the opinion letter in the WSJ, if the RTC buys the bad debts, it accomplishes the following:

1. Restores Liquidity
2. Orderly Liquidation of Troubled Paper
3. Reduces Foreclosures because the Agency Would Manage Mortgage
4. Can Help to Revive Banks Stuck with Troubled Paper

Is the US at Risk of Losing its AAA Rating?

However the big danger of inundating the US government with bad debt at a time when they have spent a tremendous amount of public funds to bailout companies like AIG is the risk of the US losing its AAA credit rating. On Wednesday, S&P said that “there’s no God-given gift of a AAA rating, and the US has to earn it like everyone else.” Although the S&P followed that statement up by saying that they are not at risk of losing their rating, we certainly believe that with the US, they will be more reactive than proactive of downgrading the government’s debt if needed. The consequences would be catastrophic if the US gets downgraded, but Americans cannot have their cake and eat it too. Not only will US tax payers have to pay for this eventually, but 15 years down the line, Medicare obligations will balloon and if the US government doesn’t get its balance sheet into shape by then, the consequences could be even more severe.

Fire up the Printing Presses?

This is perhaps the reason why the Federal Reserve may consider firing up the printing presses. Along with major central banks from around the world, the Fed has added $247B in a coordinated liquidity injection this morning. To pay for this, they are selling an additional $100B in short term debt, which in essence sterilizes their efforts. If that doesn’t work in stabilizing liquidity, the Federal Reserve can always print money. Printing money has its problems as well, since accelerates inflationary pressures and with inflation just beginning to trickle lower, the Fed may not want to take this gamble yet.

US Household Net Worth Dwindling

The US dollar has recovered against the Japanese Yen, but the outlook for the US economy is still grim. For the third quarter in a row, household net worth has declined. Jobless claims surged last week to 455k, but that was largely tied to disruptions from Hurricane Gustav. As the problem in the underlying US economy grows, so does the prospect of an interest rate cut from the Federal Reserve. According to our tables, the market is starting to price in a tiny chance of a 50bp rate cut at the October FOMC meeting.

EUR/USD: B ACK TO RANGE TRADING

Over the past few editions of the Daily Currency Focus, we have made a case for the EUR/USD to start range trading. On Monday, we talked about how the year to date range of the EUR/USD is near its 40 year high and on Tuesday, we outlined the reasons why the bottom in the EUR/USD may be real. Unless the European Central Bank agrees to global easing, the EUR/USD may have a tough time breaking its prior low of 1.3882. Right now, they refuse to do so because of inflationary pressures (vis a vis wage negotiations in Germany). However like the Federal Reserve, the ECB has injected a tremendous amount of liquidity into the financial system. Although the US has been hit the hardest by the financial crisis, the Eurozone is not spared and because of that, the ECB is committed to fighting the crisis and helping to restore stability. If the RTC announcement by the US fails to calm the markets and bring down the LIBOR rate and TED spread, which has widened to the highest level since 1984 earlier today, the ECB may have to succumb to global easing. German producer prices are due for release on Friday and we expect the data to be Euro negative, but with macro factors so dominant, the impact on the EUR/USD may be minimal.

FSA BANS SHORT SALES, UK RETAIL SALES BLOW AWAY EXPECTATIONS

The British pound soared as retail sales blew away the market’s expectations. Despite financial sector turmoil, falling house prices and a weakening labor market, UK shoppers continued to spend. Even though discounts and promotions helped to fuel sales, the resilience of UK consumers is impressive. The pound was also helped by news that Lloyds TSB will be buying HBOS for $22 Billion. They have helped to rescue a troubled bank and preventing the UK financial markets from having deal with a Lehman style failure. On top of these two big announcements, the Financial Services Authority imposed a temporary ban on short selling. Like the US, the UK is in over their heads with the latest financial crisis and we expected continued vigilance by all central bankers.

STOCKS SEE STRONGEST RALLY SINCE 2002, RISK ON?

For the Japanese Yen crosses, the story is always risk on or off. Equities have been week since the beginning of the month and we are finally relieved to report that the S&P 500 saw their strongest one day rally since October 15, 2002 while the Dow Jones Industrial Average which is up 410 points, saw its biggest one day gain since March 2003. As happy as we are about the market’s recovery, we are skeptical about whether it will last. Volatility has been elevated across the financial markets – especially for currencies on an intraday basis. Today’s rally has been fueled by nothing more than the hope that a new proposal by the US government will restore stability. The proposal has not been approved or finalized which means that the markets could remain nervous. Therefore it is of utmost importance for currency traders to exercise caution in the current market environment.

Published on Fri, Sep 19 2008, 07:38 GMT

Gold Challenges the US Dollar as Currency of Choice

Thu, Sep 18 2008, 07:23 GMT
by Kathy Lien

GFT

GOLD CHALLENGES THE US DOLLAR AS CURRENCY OF CHOICE

The biggest stories in the financial markets today was the government bailout of AIG, the 450 point drop in the Dow and the 10 percent rise in gold prices (+$80), which the largest since September 1999. As we have been warning in prior reports, if global fears persist, there would come a point where repatriation of US dollars would be overshadowed by foreign investors liquidating their dollar denominated investments. We saw that in today’s price action with the greenback selling off across the board as gold, the ultimate form of safe haven becomes the currency of choice. In the eyes of Sovereign Wealth Funds and central banks, commodities including oil may be the safest bet. Supply and demand dynamics for oil have not changed dramatically so $95 oil may be seen as a bargain. Amidst all of the volatility in the financial markets, the one overriding theme is risk aversion. For that reason, we continue to believe that USD/JPY is the clearest trade in the currency market as continued uncertainty drags the currency pair lower.

Government Pulls Out All the Stops, No One is Convinced that it is Enough

The US government has pulled out all of the stops but the market is not convinced that the storm has passed. The price action in everything from stocks, bonds, the US dollar and gold indicates that every new rescue is having less of an impact. In addition to spending $85B to bailout AIG, the SEC has also issued new short selling rules that prohibit naked short selling in all US equities. Their goal is to reduce volatility and based upon today’s price action, it hasn't worked.

Investors from around the world are nervous and not willing to take on counterparty risk as trust becomes a commodity these days. LIBOR rates increased by the most in 9 years indicating that banks have become extremely cautious about lending. The rates of US Treasury 3 month bills fell to the lowest amount in 54 years, while the 2 year swap rate hit a record high. Gold prices surged more than $85 an ounce. The TED spread, which is the difference between what banks and the Treasury pay to borrow ballooned to a wider level than Black Monday in October 1987. The degree of these moves proves that there is still a significant amount of risk aversion in the markets which is bearish for USD/JPY.

Weak Housing Data Doesn’t Help Either

Adding further uncertainty to the outlook for the US economy is the current account and housing market data. The deficit widened from $175B to $183B in the second quarter, while housing starts fell 6.2 percent to a 17 year low. Building permits, which is frequently perceived as a leading indicator for the housing market dropped more than 8 percent. With the number of layoffs expected to rise, this holiday shopping season could be particularly grim for retailers. Looking ahead, jobless claims, the Philadelphia Fed index and leading indicators are scheduled for release. Even though we expect dollar bearish numbers, economic data have become nothing more than an afterthought these days.

EUR/USD: INTEREST RATE EXPANSION COULD MEAN A BOTTOM

Since last Friday, the Euro has rallied close to 500 pips, leading many people to wonder whether this a real bottom for the EUR/USD. In order to answer this question, we have to first look at what drove the EUR/USD down 10 percent in 2 months, which was oil, interest rates and flight to quality. Between the middle of July and the first week in September, oil prices dropped close to 40 percent, a possible rate hike by the Federal Reserve was the talk of town and the US dollar benefitted significantly from safe haven flows. However now the market is pricing in a 100 percent chance of a quarter point rate cut at the October FOMC meeting (see table of Fed interest rate expectations), oil prices have hit a bottom and are trending higher while the US dollar is no longer a safe haven play. If the Federal Reserve cuts interest rates over the next 2 months while the ECB refuses to follow suit, interest rate compression will be replaced by interest rate expansion in the Euro’s favor. For these reasons, this could be a true bottom in the EUR/USD at least until slower global growth forces a more aggressive hand by the ECB. However this does not mean that we expect the EUR/USD to surge to 1.50. Instead, range trading is the more likely course for the currency pair. The offsetting factors of US investors liquidating their foreign holdings to raise cash and foreign investors dumping their US investments in lieu of safer assets should keep the EUR/USD and GBP/USD range bound. Meanwhile the Swiss National Bank will be making a monetary policy announcement tomorrow. Interest rates are expected to remain unchanged and any comments from the SNB should lean towards easier monetary policy.

Published on Thu, Sep 18 2008, 07:23 GMT

Euro: How does the Volatility Stack Up Historically?

Wed, Sep 17 2008, 10:48 GMT
by Kathy Lien

GFT

EURO: HOW DOES THE VOLATLITY STACK UP HISTORICALLY?

Since the beginning of the year, the EUR/USD has had a trading range of 21 big figures or 2100 pips. The high of 1.6038 was set back in July and while the low (so far) of 1.3882 was hit last Friday. With an average annual range of 1900 pips since the Euro’s inception, the move may seem unprecedented to many traders. However that is not true, in 2003, the EUR/USD had a 2300 pip range and in 2002, the range was approximately 2200 pips. On a percentage basis, the range that we have seen thus far pales in comparison to the move that we saw in 2003. Nonetheless, EUR/USD 1 month volatilities continue to be at the highest level since 2001. For currency traders, the latest move in the EUR/USD compared to its move historically suggests that 1.3882 is not far from the bottom in the EUR/USD and it should just be a matter of time that the dust settles and the volatility and trading range of the EUR/USD starts to contract. However keep in mind, that this “time” could still be a month away. Meanwhile surprisingly enough, the German ZEW survey of analyst sentiment improved last month while consumer prices dropped by less than expected. The Eurozone trade balance is due for release on Wednesday and the deficit is expected to grow considering the slowdown in German exports.

FED LEAVES RATES AT 2%, BUT STOCKS SOAR ON HOPE FOR AIG

The Federal Reserve left interest rates unchanged at 2 percent, which given the market’s grossly skewed expectations for a rate cut, should haven bearish for the US stock market and it was, for about 15 minutes. The Fed’s decision to hold rates steady sent the Dow Jones Industrial Average to a 2 year low intraday before equities reversed violently higher to end the US trading session up 140 points. Although today’s Fed meeting was probably one of the most important in months, speculation about what could happen to AIG has dominated trading. The waiting game is underway and the stakes have increased after the Federal Reserve failed to cut interest rates. This morning, a government bailout seemed out of the question, but as the day unfolded, there was news that the Federal Reserve could be reconsidering its stance on AIG. If this true, it may be the Fed’s compromise. In order for today’s move to be a bottom for US stocks, AIG needs a bridge loan from the Fed, the private sector or Sovereign Wealth Funds. Hank Greenberg, the former CEO of AIG is already talking about stepping in to help and some people are floating around the idea of conservatorship.

Fed is Holding on to its Ammunition

Going into the meeting, everyone thought that the Fed was backed into a corner and would have no choice but to cut interest rates by 25 and possibly even 50bp. Although the tone of the FOMC statement was relatively cautious, the action or more specifically, the lack of action by the Federal Reserve indicates that they are not willing to bend to the market’s pressure. The statement expressed concern about growth, but the outlook for inflation was still uncertain. Therefore one of 2 things probably compelled the Federal Reserve to hold back today - with liquidity injections and 325bp of easing since August 2007, they probably believe that they have done enough. Or they have injected so much liquidity into the financial system today that they want to give the markets an opportunity to respond. If things get worse they can always cut interest rates in October or between monetary policy meetings.

Fed Fund Futures See 60-40 Chance of Rate Cut by Christmas

Fed Fund futures completely miscalculated the central bank’s move today, but even so, it does reflect the market’s expectations. Yesterday, Fed fund futures was pricing in a 92 percent chance that interest rates would be at 1.75 percent or lower by the end of the year with a 50 percent of rates falling even further to 1.50 percent. These expectations have changed dramatically since today’s announcement. The futures contracts are now pricing in approximately a 60 percent chance that we will see a 25bp rate cut by the end of the year.

What Does this Mean for the US Dollar?

For the US dollar, this should be good news because the recent correction was primarily triggered by the readjustment of interest rate expectations. Now that the Fed has failed to deliver, dollar bulls have a reason to jump back into the markets, especially with oil prices at $91 a barrel. We expect the downtrend in the EUR/USD and GBP/USD to resume but USD/JPY should also trickle lower as US equities sell off, but of course that is all contingent upon AIG at this point.

US Economic Data: An Afterthought

The surprises and disappointments of US economic data are nothing more of than an afterthought these days. Consumer prices were weaker than expected while foreign purchases of US securities grew at the slowest pace in 11 months. Looking ahead, housing market data and the second quarter current account balance are due for release on Wednesday.

Published on Wed, Sep 17 2008, 10:48 GMT

Will a Fed Rate Cut be Enough of a Lifeline to Save the Market?

Tue, Sep 16 2008, 08:13 GMT
by Kathy Lien

GFT

FED MEETING: 64% CHANCE OF RATE CUT, WILL THIS LIFELINE SAVE THE MARKET?

Since the beginning of the year, we have lost 3 of the largest investment banks on Wall Street and such unprecedented developments have called for unprecedented actions by US government and Wall Street officials. Since the announcement of Lehman Brothers filing for bankruptcy and Bank of America taking over Merrill Lynch, AIG has been given special permission by US authorities to tap into $20bln of its own capital to prevent a liquidity crisis and credit downgrades. The Federal Reserve is also holding a special meeting to discuss possible remedies to AIG’s problems. The ECB and the Bank of England have pumped more liquidity into the financial system while the Federal Reserve made an unusual intervention to drive Fed funds lower.

Why Did Fed Funds Soar to 6 Percent when Futures are Pricing in a Rate Cut?

Fed fund futures are pricing in a 64 percent chance of a 25bp rate cut tomorrow by the Federal Reserve. This is a big change from last week, when the only thing that the market was thinking about was a rate hike. However despite this sharp shift in expectations, Fed funds surged to a high of 6 percent, 400bp above the Fed’s target rate of 2 percent intraday. This jump in the overnight lending rate between banks indicates that no one wants to take on risk. Trust is a commodity these days as the move in Fed fund futures suggests that no one knows if their counterparty will be here to survive another day. Fund funds gave back all of its gains by the end of the US trading session, but that does not mean that risk appetite has returned – quite the contrary. AIG is in big trouble, Washington Mutual is still on our watch list with their bonds now cut to junk status by Moody’s and the worries now turn to Goldman Sachs and Morgan Stanley who will be releasing earnings this week. Large write downs could drive a nail in the coffin for the US stock market and USD/JPY. Of all the pairs in the currency major, USD/JPY and other carry trades will be hit the worst. Over the past 3 years, there has been a 68 percent correlation between the VIX and USD/JPY - higher volatility means trouble for the currency pair. Although consolidation in the banking sector was something many people expected, no one thought that the consolidation would occur because of Chapter 11 filings.

Will a Fed Rate Cut be Enough to Shore Up Confidence and Trigger a Reversal in the US Dollar?

So far, the efforts of the US government have failed to bring any stability to the financial markets. Stocks dropped more than 400 points today, 2 year bond yields plunged a jaw dropping 40bp while the repatriation has lifted the dollar against everything except for the low yielders. Traders are now turning to the Federal Reserve for help, but a rate cut, may not be enough to shore up confidence. In addition to balancing growth with inflation, the Federal Reserve is also responsible for maintaining stability in the banking sector and right now, they need to step up to the plate because judging from the price action in the markets today, expanding lending facilities and adding $70 billion of temporary reserves to the banking system is not enough. With oil prices below $100 a barrel, the economy deteriorating, the financial markets in disarray and the Dow Jones Industrial Average down more than 15 percent year to date, there is no reason for the Federal Reserve not to cut interest rates. However, the more important question is whether or not a rate cut will be enough to put an end to the volatility. In our opinion, it is not enough. Even if the Fed cuts interest rates, that may not reduce the true cost of borrowing and relax terms of credit. Default risk is the market’s biggest problem and is the primary reason why reducing risk, dumping exposure and repatriation is the one cohesive theme that we are seeing across the financial markets.

This dynamic continues to drive the dollar higher despite the systemic risk and why it’s performance against the low yielders (yen and Swiss franc) is dramatically worse than its performance against the other majors. However, if the problems exacerbate, Sovereign Wealth Funds may start dumping their US investments, which would start turning the systemic risks from dollar positive to dollar negative

Published on Tue, Sep 16 2008, 08:13 GMT

Lehman's Latest Developments Spell Big Trouble for Carry Trades and US Dollar

Mon, Sep 15 2008, 07:46 GMT
by Kathy Lien

GFT

The US dollar dropped like a rock at the open of the Asian trading session on Sunday. It has been a long weekend for US government officials and the leaders of Wall Street Banks. Bank of America and Barclays pulled out talks to buy Lehman Brothers as the government refused to provide sufficient funding. The events of this past weekend is the same as last Sunday - only the names have changed with the GSEs swapped out for Lehman. It is very possible that Barclays and Bank of America wanted more government funding than JPMorgan received for Bear Stearns given their negotiating power and market risk. There is still hope for Lehman as talks with Merrill Lynch are underway, but what is assured is volatility. Government bailouts can become a slippery slope and Paulson may not want to open the flood gates.

Dollar Collapses as Traders Prepare for Bankruptcy, Watch Out for Further Carry Trade Losses

The dollar collapsed against the Japanese Yen, Euro and British pound on Sunday evening as traders prepare for a possible Lehman bankruptcy. The ISDA (International Swaps and Derivatives Association) extended the hours of an emergency trading session between Wall Street dealers and Lehman Brothers so that they can net out or cancel transactions that offset each other with Lehman. No one knows what will happen with Lehman and what the credit quality of their assets are - all they know is that the right thing to do now is to reduce Lehman exposure. Counterparty risk is huge at this point and that spells big trouble for carry trades and the US dollar.

FOMC Statement Could be Dollar Bearish

The big event this week is the FOMC meeting. With the troubles in the financial sector, the last thing that the Federal Reserve wants to do is to talk about the possibly of raising interest rates. In fact, expect Lehman's troubles to drive up expectations for a rate cut over the next 12 months. Economic data has taken a turn for the worse and the troubles in financial sector are growing. The Fed will keep interest rates unchanged at 2.00 percent but the FOMC statement could actually be dovish. Consumer confidence improved for the month of September but we are particularly worried about the sharp drop in retail sales and the softer PPI numbers.

Published on Mon, Sep 15 2008, 07:46 GMT

Euro Breaks 1.40 Following RBNZ Decision

Thu, Sep 11 2008, 09:10 GMT
by Kathy Lien

GFT

TODAY’S BIGGEST PERCENTAGE MOVERS

AUD/NZD (+190 pips or +1.61%)
NZD/USD (-115 pips or -1.70%)
USD/CHF (+104 pips or +0.95%)

THE STORIES IN THE CURRENCY MARKET

EUR: BREAKS 1.40, HOW MUCH FURTHER CAN IT FALL?
USD: FLIGHT TO QUALITY
GBP: SET TO BREAK 1.75
CAD: WATCH FOR A DROP IN TRADE
AUD: BREAKS 80 CENTS
NZD: NEW ZEALAND CUTS RATES, OUTLOOK REMAINS DOVISH
JPY: STILL VULNERABLE

EURO BREAKS 1.40 HOW MUCH FURTHER CAN IT FALL?

The Euro broke 1.40 following the Reserve Bank of New Zealand interest rate decision as traders realized that the European Central Bank could cut interest rates over the next few months. Despite the hawkishness of ECB President Trichet, it should just be a matter of time before he gives in and cuts interest rates as well. For some investors like central banks who have deep pockets, EUR/USD at 1.39 may be a value play. But even if we see a relief rally in the EUR/USD, don't expect it to last because the break of 1.40 could trigger a flush down to 1.39. On a purchasing power parity basis, the EUR/USD could fall as low as 1.15.

3 Factors Driving the EUR/USD Lower

1. Oil Prices Fall Despite OPEC Cut: There is a 70% Correlation between EUR/USD and Oil YTD
2. European Commission Slashes Eurozone Growth Estimates, Rate Cuts Anticipated
3. Risk Aversion: 1 Month ATM EUR/USD Volatility Hits Highest Level Since September 2001

Since the beginning of the year, there has been a 70 percent correlation between the price of oil and the EUR/USD. With crude prices edging lower despite a production cut by OPEC, the correlation with oil is a big reason why the Euro has broken 1.40. The European Commission also downgraded the Eurozone's GDP forecast. The sharp drop in German exports suggests that the country could fall into a technical recession next quarter. Despite the problems, the growth story still favors the US over the Eurozone.

Volatility at 7 Yr High - One month at the money EUR/USD volatilities also hit the highest level in 7 years. Volatility peaked at 14.55 in the EUR/USD days after the 9/11 attack. We are faced with sharp volatilities once again with ATM 1 month vols at 12.63. High volatility tells us that the currency markets are still nervous but periods of high volatility usually precede periods of lower volatility. Back in 2001, after volatility peaked, the trading range in the EUR/USD contracted by 50% - that range lasted for 8 months.

Eurozone Needs a Weak Euro - The weakness of the Euro should be comforting for the European Central Bank because it is the answer to many of their problems. As an export dependent region, the slide in the Euro will help to support the economy, just like the weakness of the US dollar has contributed to corporate profitability. The Eurozone can also handle a weaker currency at this time because oil prices have fallen materially. Therefore don't expect the ECB to stem the currency's fall. We still believe that there will be further losses in the EUR/USD but not beyond 1.35.

US DOLLAR: FLIGHT TO QUALITY

A flight to quality continues to drive the US dollar higher. The big story in the financial markets today was the largest loss on record for Lehman Brothers, their big write down and plans to raise capital by selling their Neuberger stake and spinning off their real estate investments. That was not the only trouble in the financial sector. Shares of Washington Mutual plunged as capital concerns surface and on top of this, legendary investor Warren Buffett also told one of the companies that he has invested in, the Kansas Bankers Surety Co. that they should stop insuring bank deposits above the federal government’s guarantee. As we have seen in the past, there is never just one cockroach in the closet. Goldman Sachs will announce earnings next week and they are expected to report more write downs.

Despite the lack of US economic data, we continue to have big moves in the currency markets. The trade weighted dollar index hit a 1 year high as the EUR/USD broke 1.40 and the Australian dollar broke 80 cents. The US trade balance is due for release on Thursday. The drop in the export component of the manufacturing ISM index suggests that the trade deficit increased in July.

NEW ZEALAND CUTS RATES, OUTLOOK REMAINS DOVISH

The Reserve Bank of New Zealand cut interest rates by 25bp to 7.75 percent. Since January, the New Zealand dollar has plunged 13 percent, reflecting slower growth and the market’s expectations for further rate cuts. The market is looking for another 100bp of easing by the RBNZ over the next 12 months and for that reason, we still expect the NZD/USD to break 65 cents. The terms of trade in New Zealand was better than expected, but a persistent drought has caused exports to suffer while high interest rates and a weak housing market has pushed New Zealand into its first recession in 10 years. According to RBNZ Governor Bollard, there could be more rate cuts. Although that would depend on inflation and the price action of the New Zealand dollar, he expects monetary policy to be less restrictive going forward and for the economy to contract in the third quarter.

Even though the Australian dollar ended the US session positive against the greenback, it is well off its highs. Like New Zealand, the outlook for the Australian economy is gloomy. Despite an improvement in business confidence, consumer confidence has deteriorated. The combination of weaker economic data and lower gold prices drove the Australian dollar below 80 cents. Employment numbers are due for release this evening. The improvements in the employment component of service. manufacturing and construction sector PMI all point to a stronger release. The Canadian dollar on the other hand held its own against the greenback despite weaker labor productivity in the third quarter and lower oil prices. The international trade balance is due for release on Thursday and we believe that the data should be negative for the Canadian dollar given the drop in the IVEY PMI index.

BRITISH POUND BREAKS 1.75

The British pound quietly trended lower today and broke 1.75 following the RBNZ rate decision. UK economic data continues to spell trouble for the pound with the GDP estimate coming in at -0.2 percent for the month of August and the visible trade balance widening more than expected. Like the ECB, the Bank of England is probably enjoying the benefits of a weaker currency. Without having to worry about rising oil prices, the sell-off in the British pound should help to support the UK economy. However despite any contribution, we continue to believe that the UK economy is headed for a recession and as a result, the Bank of England will cut interest rates by 50 to 75bp next year. Problems in the US financial sector have led to a reduction of risk around the world. As one of the largest financial centers UK investments will certainly be affected.

USD/JPY: STILL VULNERABLE

The Japanese Yen crosses rallied today, but we do not believe that the recovery will last. Stocks are off their highs and the sharp rise in volatility indicates that investors are still risk averse. In times of uncertainty, we tend to see the low yielders outperform and in this case that would be the Japanese Yen and Swiss franc. Year to date, the Japanese Yen has strengthened against all of the G10 currencies with the most predominant strength seen against the New Zealand dollar. Japanese economic data was mixed with the corporate goods price index falling, the trade surplus narrowing but leading indicators improving. Since the CGPI index is a measure of inflation, the drop indicates that relief is also coming to Japan with prices easing. Machine orders are due for release this evening and they are expected to drop for the second month in a row.

CAD/JPY: CURRENCY PAIR IN PLAY OVER THE NEXT 24 HOURS

The Canadian international merchandise trade balance is due for release at 8:30AM on Thursday. We believe that trade will be weak, which should weigh on the Canadian dollar. Technically, CAD/JPY remains within our “sell zone,” which is established by Bollinger Bands. As long as the currency pair holds below 101.25, which is key Fibonacci resistance, we could see a move back below 100 towards Friday’s low of 98.60.

EXPECTATIONS FOR UPCOMING FED MEETINGS (NEW FORMAT)
CURRENT US INTEREST RATE: 2.00%
.	9/16 Meeting	10/29 Meeting	12/16 Meeting
NO CHANGE	93.0%	79.3%	37.5%
RAISE 25BP	2.5%	9.1%	28.7%
RAISE 50BP	0.0%	0.0%	0.0%
CUT 25BP	4.5%	8.0%	25.2%

Download the full report

Published on Thu, Sep 11 2008, 09:10 GMT

What are the Pros and Cons of Dollar Strength

Wed, Sep 10 2008, 15:09 GMT
by Kathy Lien

GFT

TODAY’S BIGGEST PERCENTAGE MOVERS

AUD/JPY (-235 pips or -2.50%)
AUD/USD (-130 pips or -1.60%)
EUR/AUD (+575 pips or +1.54%)

THE STORIES IN THE CURRENCY MARKET

USD: WHAT ARE THE PROS AND CONS OF DOLLAR STRENGTH?
EUR: GERMANY COULD SEE A TECHNICAL RECESSION
GBP: WEAK DATA FAILS TO STIFLE THE CURRENCY’S RECOVERY
CAD: HIT BY FALLING OIL PRICES
AUD: FRESH 12 MONTH LOW
NZD: RBNZ EXPECTED TO CUT INTEREST RATES
JPY: CARRY TRADES COULD FACE MORE LOSSES

WHAT ARE THE PROS AND CONS OF DOLLAR STRENGTH?

To the frustration of US Treasury Secretary Paulson, the market’s optimism following the government’s takeover of Fannie Mae and Freddie Mac was relatively short-lived. The Dow Jones Industrial Average plunged close to 280 points today, giving back nearly all of Monday’s gains. The US dollar weakened against every major currency with the exception of the Australian dollar. There were fresh concerns about the viability of Lehman Brothers following news that their talks about a capital infusion with Korea Development Bank has failed. Despite the GSE bailout, investors are starting realize that even though the Treasury’s announcement was monumental from many perspectives, it alleviates but does not solve the banking sector’s problems. More writedowns could be announced especially as Goldman Sachs reports earnings next week. As a reflection of risk aversion returning, carry trades have resumed their decline with AUD/JPY leading the pack.

There were no big surprises in today’s US economic reports. Pending home sales were worse than expected in the month of July, but sales in June were revised higher. Wholesale inventories rose 1.4 percent compared to the market’s 0.6 percent forecast.

In yesterday’s Daily Currency Focus we promised to talk about the pros and cons of dollar strength. The weakness of the US dollar has been instrumental in preventing a more serious downturn in the US economy. It encouraged foreign investment, helped to reduce the trade deficit and boosted the foreign earnings of US corporations. Say good bye to these 3 benefits with the dollar now strengthening. The 10 percent rally in the dollar will no longer help to boost exports and in fact could lead to disappointments in corporate earnings going forward. We are also seeing more M&A flow at the expense of the dollar. Earlier this week we reported about the ConocoPhillips (US) and Origin Energy (AUD) deal. This morning, there were widespread rumors that Pfizer (US) is considering a bid for Bayer (EUR). From a currency valuation standpoint, overseas firms are becoming a steal. The strength of dollar also brings with it one big benefit – lower inflationary pressures. Since rising prices has been one of the primary strains on the US economy, the combination of a stronger dollar and falling energy prices will bring down inflation at a faster pace, reducing the Federal Reserve’s urgency to raise interest rates.

GERMANY COULD SEE A TECHNICAL RECESSION

The Euro fell to a fresh 11 month low against the US dollar at the beginning of the Asian trading session and attempted to test that level once again at the beginning of the US session. Both times, the 1.4050 level held as Euro traders scooped in to take the currency pair back towards 1.4200. Trading the Euro today has been like riding a rollercoaster as the US dollar’s rally begins to peeter out. We continue to believe that the market has not seen the end of dollar strength, but from here on forward, the sell-off in the EUR/USD will slow and recoveries are likely. The latest drop in oil prices however should keep a lid on any significant EUR/USD recovery.

Don’t expect much help from Eurozone economic data either. Germany’s current account and trade surpluses shrank in the month of July as imports surged and exports plummeted. The Eurozone’s largest member is suffering from slower global growth and many analysts argue that the sharp drop in exports could lead to a technical recession in Germany, which is defined by two consecutive quarters of negative GDP growth. Second quarter GDP dropped by 0.5 percent, the slowest pace of quarterly growth in 10 years. French industrial production is due for release tomorrow, but the expected recovery should have a limited impact on the Euro.

WEAK DATA FAILS TO STIFLE THE GBP RECOVERY

As the sell-off in the British pound deepened, we upgraded our warnings about a potential recovery. A bounce was imminent and that is exactly what we saw today. The latest economic data from the UK continues to be disappointing with retail sales slowing, house prices falling to the lowest level in 30 years and industrial production declining for the third month in a row. According to the RICS, home sales are at a record low, reflecting difficult times in the UK economy. There is talk that UK Chancellor Alistar Darling will follow in the footsteps of US Treasury Secretary Henry Paulson by intervening in the mortgage market. This would not be a first for the UK government in this economic cycle. In February, the UK government took control of Northern Rock. The earliest that another intervention could occur would be at the end of this month, after Darling receives a key report on the mortgage market. This reminds us of the events leading up to the takeover of Fannie Mae and Freddie Mac. According to the Wall Street Journal, the Treasury hired Morgan Stanley to perform a similar analysis of their potential options in dealing with Fannie and Freddie back in August. The preliminary findings were delivered on August 18 and the official decision or announcement was not made until this past weekend.

The UK trade balance is due for release tomorrow morning. The rise in new and export orders suggest that we could actually see an improvement in the trade deficit.

AUSTRALIAN, NEW ZEALAND AND CANADIAN DOLLARS PLUMMET

The worst performing currency today was the Australian dollar, which fell more than 1 percent against the US dollar and 2 percent against the Japanese Yen. Despite an improvement in business confidence and a rise in retail sales, plunging gold prices and rising risk aversion drove the Aussie dollar to the lowest level in a year. The AUD/USD is now trading within a whisker of 80 cents and we believe that with the Reserve Bank looking to continue to cut interest rates, it should only be a matter of time before that level is broken. Canadian housing starts were also stronger than expected, but that has failed to help the Canadian dollar which trended lower on the $4 drop in oil prices. Australian consumer confidence and Canadian productivity are the only numbers due for release from Australia and Canada tomorrow.

New Zealand has an interest rate decision on Wednesday at 5pm Eastern time. Slowing growth is expected to drive the Reserve Bank to cut interest rates for the second time this year by 25bp, bringing their yield down to 7.75 percent. It will not take much for the New Zealand dollar to break below 65 cents – just dovish comments from the RBNZ about more rate cuts to come.

CARRY TRADES FACE FURTHER LOSSES

In yesterday’s Currency Focus, we warned that the USD/JPY rally may not last and today, we are already seeing risk aversion return. USD/JPY fell to an intraday low of 106.83 as fears about more problems in the banking sector plague the market. We continue to believe that the Japanese Yen crosses are headed for further losses. The most vulnerable currency could be EUR/JPY as the low yielders outperform while the Euro weakens on softer economic data and broad dollar strength. There are a lot of economic releases expected from Japan this evening including the corporate goods price index, the trade balance, the current balance and leading indicators. The current account surplus is expected to improve, but the trade balance, inflation report and leading indicators should weaken.

NZD/USD: CURRENCY PAIR IN PLAY OVER THE NEXT 24 HOURS

The Reserve Bank of New Zealand’s interest rate decision is scheduled for 5pm ET on Wednesday afternoon (21:00 GMT). The NZD/USD is currently trading within our sell zone on both the daily and weekly charts. The 0.6800 level represents key Fibonacci resistance while 0.6600 is near term support. The RBNZ decision could determine whether or the currency pair breaks 0.6500.

Published on Wed, Sep 10 2008, 15:09 GMT

Dollar shrugs off Non−Farm Payrolls as traders look beyond Q3

Mon, Sep 8 2008, 09:42 GMT
by Kathy Lien

GFT

TODAY’S BIGGEST PERCENTAGE MOVERS

CAD/JPY (217 pips or 2.15%)
NZD/JPY (127 pips or 1.75%)
USD/JPY (125 pips or 1.18%)

THE STORIES IN THE CURRENCY MARKET

USD: DOLLAR SHRUGS OFF NFP AS TRADERS LOOK BEYOND Q3
EUR: STILL HEADED FOR 1.40?
GBP: A PAUSE OR A BOTTOM?
CAD: COULD SEE MORE WEAKNESS
AUD: BIG WEEK AHEAD
NZD: EXPECTED TO CUT INTEREST RATES
JPY: SEASONALITY COULD DRIVE USD/JPY LOWER

DOLLAR SHRUGS OFF NON-FARM PAYROLLS AS TRADERS LOOK BEYOND Q3

Non-farm payrolls were worse than expected, the dollar sold off but the weakness did not last. Currency traders have become accustomed to disappointing US economic data, particularly from the labor market. Oil prices continue to be the single biggest driver of the US dollar. Crude prices hit an intraday low of $105.13 a barrel, giving traders the hope that beyond the third quarter, the US economy will get better. Although we are skeptical about a recovery, we know that weaker economic data has not stopped the dollar from rallying in the past.

Non-farm payrolls fell by -84k last month, driving the unemployment rate to a 5 year high of 6.1 percent. The most pessimistic components of the report were the unemployment rate, the big drop in manufacturing payrolls and the revisions. The US government said that 9k more jobs were lost in August than previously expected and 38k more jobs was lost in June. Even though we did not get the -100k print that we had expected last month, payrolls in June were revised to -100k. Since the beginning of the year a total of 605k jobs have been cut and we expect at least another 2 or 3 months of negative job growth before the labor market hits a bottom. Over the past 30 years, the US economy has gone through 3 recessions and in each of those 3 recessions, there was a string of job losses that lasted for a minimum of 11 months.

The Federal Reserve’s next interest rate decision is in 2 weeks which means that traders will be looking at next week’s economic data to determine whether or not the US central bank will raise interest rates over the next 12 months. Fed fund futures are still pricing in 25bp of tightening, but today’s non-farm payroll figures have resurrected talk of a rate cut. In the table above, we have added the expectations for a 50bp rate cut. Retail sales and producer prices are the big US releases in the week ahead, but we are also expecting consumer confidence and trade.

EURO: STILL HEADED FOR 1.40?

The sell-off in the Euro accelerated significantly this week with the single currency dropping more than 500 pips to an intraday low of 1.4196. Although the ECB left interest rates unchanged at 4.25 percent, foreign exchange traders dumped Euros on the fear that the higher haircuts on collateral announced by the ECB yesterday would reduce the amount funds provided by the ECB. Following yesterday’s sharp reaction in the Euro, ECB officials were out in force trying to calm the markets by saying that the refinement of the collateral rules was not a mini rate hike.

Regardless of whether this is true, it certainly adds further strain on the Eurozone economy and their banking sector. Some banks would be subject to margin calls, which would force them to liquidate positions. The ECB is still more likely to cut interest rates than to raise them and that is one of the main reasons why the EUR/USD could continue to fall and hit support at 1.40.

The economic calendar is light next week but there are many ECB officials scheduled to speak. Given the velocity of the Euro’s move and the market’s reaction to the collateral changes, ECB President Trichet’s speech on Wednesday could be particularly market moving. Besides that, the more important numbers that we expect include Eurozone industrial production and the German trade balance.

BRITISH POUND: A PAUSE OR A BOTTOM?

For the past few weeks, we have been calling for the British pound to fall to 1.75 against the US dollar. The currency came close to doing so last night when it dropped to an intraday low of 1.7538. After falling for eight days straight, we have finally seen some stabilization in the British pound. Given that the currency pair is still overvalued, we would not be surprised to see a move towards 1.65.

Although we have seen improvements in with all three of the purchasing managers’ indexes (services, manufacturing and construction), the UK economy is still in trouble. There is a good chance that the UK could fall into a recession, forcing the Bank of England to cut interest rates by anywhere between 50 to 100bp next year. The market is currently pricing in 75bp of easing. The recent weakness in the British pound should help to bolster exports but slower Eurozone growth could limit any major contribution.

It should be a busy week for the British pound with producer prices, BRC retail sales, industrial production, the GDP estimate and the trade balance due for release. We do not expect any major improvements in the data.

AUSTRALIA CUTS INTEREST RATES, NEW ZEALAND TO FOLLOW

It has been a very tough week for the Australian and New Zealand dollars, both of which fell more than 4 percent against the greenback and 5 percent against the Japanese Yen. The Reserve Bank of Australia cut interest rates for the first time since 2001 and the Reserve Bank of New Zealand is expected to follow with their own rate cut next week. This would be the second bout of easing by the RBNZ this year and it would bring interest rates down to 7.75 percent. Given the deterioration in the New Zealand economy and the dovish comments from the RBNZ, their next rate cut should not be their last. As a result, we still believe that the New Zealand dollar should not only hit but also break 65 cents. Aside from the RBNZ rate decision, retail sales and business PMI are due for release, which means that it could be a very volatile week for the kiwi. We also expect some key numbers from Australia. The employment report is due for release on Wednesday while RBA Governor Stevens will be delivering his half yearly testimony on Sunday evening (Eastern).

Meanwhile even though oil prices have fallen significantly, the Canadian dollar ends the week virtually unchanged against the greenback. The IVEY PMI index dropped significantly, reflecting slower manufacturing activity, but stronger employment numbers for the month of August helped to drive the Canadian dollar higher. Unlike Australia and New Zealand, other than trade data, there are no major releases on the Canadian economic calendar.

SEASONALITY COULD DRIVE USD/JPY LOWER

In past editions of the Daily Currency Focus, we have talked extensively about why carry trades could continue to suffer. The current market environment of high volatility, interest rate compression and risk aversion has caused carry trades to underperform significantly. Volatility in the GBP/USD for example has reached at least a 5 year high while the volatility in the EUR/USD hit a 1 year high. However one of the other reasons why the dollar’s performance against the Japanese Yen could diverge from its performance against the other majors is seasonality. There is no significant seasonality in USD/JPY during the month of September, but there is a strong seasonality for US stocks. According to a study of 50 years worth of monthly returns for the Dow Jones Industrial Average, the results indicate that September is the month when stocks see the lowest average return (-1.02 percent). Given the current tick for tick correlation between USD/JPY and US stocks, a further decline in equities this month could lead to additional weakness in USD/JPY. There will a lot of economic data from Japan next week including the Eco Watchers Survey, CGPI, leading indicators, industrial production, trade and GDP.

GBP/CHF: CURRENCY PAIR IN PLAY OVER THE NEXT 24 HOURS

The UK and Switzerland have important numbers scheduled for release on Monday. Swiss employment data is coming out at 1:45 AM ET or 4:45AM GMT while UK Producer Prices are coming out at 4:30 AM ET or 8:30 GMT.

GBP/CHF has been trading within our sell zone for the past 3 weeks. Unless the currency pair closes above 1.9875, the downtrend remains intact. Whether or not Friday’s recovery is a hiccup within the downtrend will depend upon Swiss employment and UK PPI. The levels that we are watching are 1.9875 for resistance and 1.9495 for support.

EXPECTATIONS FOR THE NEXT FED MEETING (9/16/08)
CURRENT US INTEREST RATE: 2.00%
.	CURRENT	1 WEEK AGO	1 MONTH AGO
NO CHANGE	81.3%	78.8%	62.1%
RAISE 25BP	13.3%	11.6%	21.9%
CUT 25BP	5.4%	4.7%	4.6%
CUT 50BP	0.0%	1.7%	1.5%

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Published on Mon, Sep 8 2008, 09:42 GMT

Dollar hits YTD highs, stocks plunge: What happened?

Fri, Sep 5 2008, 10:23 GMT
by Kathy Lien

GFT

TODAY’S BIGGEST PERCENTAGE MOVERS

NZD/JPY (330 pips or -4.47%)
AUD/JPY (360 pips or -4.00%)
EUR/JPY (500 pips or -3.23%)

THE STORIES IN THE CURRENCY MARKET

USD: HITS YTD HIGHS, STOCKS PLUNGE: WHAT HAPPENED?
EUR: A WEAK CURRENCY COULD BE THE ANSWER TO THE ECB’S PROBLEMS
GBP: HEADED FOR 1.75
CAD: LEAVES INTEREST RATES UNCHANGED, NO HINTS ABOUT EASING
AUD: HIT BY SOFTER GDP GROWTH
NZD: DROPS MORE THAN 2.5%
JPY: RISK AVERSION HITS YEN CROSSES

DOLLAR HITS YTD HIGHS, STOCKS PLUNGE: WHAT HAPPENED?

Volatility has ripped through the financial markets with the Dow Jones Industrial Average plunging 344 points and the US dollar surging to a year to date high against the Euro. With the exception of the dollar’s performance against the Japanese Yen, the greenback’s strength has been universal. In yesterday’s Daily Currency Focus, we said that the dollar could see a near term reversal. That happened briefly with the EUR/USD hitting an intraday high of 1.4545, but once the US stock market started falling, the dollar resumed its rise. Given the drop in equities and bond yields, the only explanation for the divergent move in the currency market is risk aversion. The dollar has once again received a flight to safety boost. The sharp sell-off in carry trades including USD/JPY provides further evidence that risk aversion is behind today’s move.

Service sector ISM was stronger than expected, but the leading indicators for non-farm payrolls point to an ugly NFP number. Payroll provider ADP reported more private sector job losses, continuing claims hit a 5 year high while the employment component of service sector ISM sank deeper into contractionary territory. In our Non-Farm Payrolls Preview, we show the correlation between NFP and ISM and talk about why payrolls could have fallen by more than 100k in the month of August. Comments from Federal Reserve officials also gave stock traders further reasons to liquidate. San Francisco Fed President Yellen expects growth to be “subpar” and sluggish in the second half of the year while Dallas Fed President Fisher warned about the government’s potential problems in paying retirees their Social Security and Medicare as the biggest threat to the US economy. If the US government does have problems making these payments, then Fisher is absolutely right and the US could be dealing with slower growth for longer than anticipated.

The market is currently expecting non-farm payrolls to drop by -75k and the unemployment rate to remain unchanged at 5.7 percent. Of the 76 economists surveyed by Bloomberg, only 11 expect non-farm payrolls to crack the -100k mark. For traders, this means that -100k is the make it or break it point for the US dollar. If less than -100k jobs were lost last month, the dollar could continue to rise. If more than -100k jobs were lost, expect a reversal in the US dollar.

WEAK EURO COULD BE THE ANSWER TO THE ECB’S PROBLEMS

A lot can change very quickly, especially in the currency market. Less than 2 months ago, the EUR/USD hit a record high above 1.60 and now the currency is trading at a 10 month low against the US dollar. Since mid July, the currency pair has fallen 10.9 percent. For the ECB, this could be the answer to their prayers. In the past, they did not do anything to stem the Euro’s rise because they knew that a strong currency would help to offset skyrocketing oil prices. However now that oil prices have fallen more than 25 percent, they no longer need a strong currency. In fact, they could use a weaker currency to prevent a major slowdown in growth. There is trouble in the Eurozone economy as factory orders dropped for the eighth month in a row.

As the market expected, ECB President Trichet kept interest rates unchanged at 4.25 percent. His lack of commitment towards future monetary policy was a big disappointment to currency traders. Although Trichet explicitly said that he has "no bias," based upon the number of times that he used the words "price stability” in his Introductory Statement, he is still hawkish. Compared to last month's statement, Trichet used price stability two more times this month. Although he acknowledged that growth is slowing, he reminded Euro traders that inflation is still their top priority. Oil prices have fallen significantly since July but Trichet has been very adamant about inflationary pressures because of wage negotiations. The ECB's greatest fear is that unions in Germany would use inflationary pressures as an excuse to hike wages.

However even if the dollar sells off on weak non-farm payrolls tomorrow, don’t expect that to be a top. We have argued in the past that the dollar can rally even if the US economy continues to weaken. On a purchasing parity basis, the US dollar is still undervalued against the Euro and British pound. With the markets waiting for the Federal Reserve to deliver their first rate hike in 2 years and the European Central Bank to cut interest rates for the first time in 5 years, the expectations for completely diametric monetary policy is exactly what could drive the EUR/USD to 1.40 over the next few months or even weeks.

BRITISH POUND HEADED FOR 1.75

For the eighth trading day in a row the British pound lost ground to the US Dollar. The GBP/USD is now in striking distance of 1.75, our near term target. Despite an 11 percent decline, based upon purchasing power parity, the British pound is still overvalued. The currency would need to fall below 1.65 against the US dollar to become closer to fair value. The Bank of England left interest rates unchanged at 5.00 percent which was right in line with the market’s expectations. Although no statement was released, the British pound did rally following the monetary policy decision as traders looking for a surprise rate cut reversed their positions. There is no UK data due for release tomorrow. Further strength or weakness for the British pound will be largely contingent upon the fluctuations in the US dollar.

BIG EVENT RISKS FOR CANADA

The Australian and New Zealand dollars dropped more than 2 percent against the US dollar and close to 4 percent against the Japanese Yen on risk aversion and falling commodity prices. The Canadian dollar also lost ground, but not by the same magnitude as the Aussie and Kiwi. The Australian trade balance was much weaker than expected with the surplus turning into a deficit as rising oil prices drive up the value of imports. Exports were also hit by an explosion in Western Australia. Although construction sector PMI from Australia is due for release tonight, the big market mover will be Canadian economic data. The employment report and IVEY PMI are due for release. The market is looking for employment to improve and the manufacturing index to deteriorate, but the data is a tough call this month because IVEY, which is typically a leading indicator for the employment number comes out after payrolls. Either way, it should be a volatile day for the Canadian dollar.

RISK AVERSION HITS YEN CROSSES

Yesterday, we said that we are still bearish carry trades but we did not expect the sell-off in the Japanese Yen crosses to be this rapid and severe. All of the Yen crosses were hit by risk aversion with NZD/JPY losing as much as 4.0 percent or approximately 330 pips. EUR/JPY dropped more than 500 pips after the NY session. There was no economic data from Japan, but problems still abound in the financial sector. In order to reduce exposure, National City Bank has now resorted to offering cash to customers willing to close their home equity lines. Bill Gross, the legendary bond fund manager for PIMCO appealed to the US government to start buying assets to prevent a “financial tsunami.” Everyone from banks to hedge funds to sovereign wealth funds are reducing risk and Gross believes that the US Government needs to be the buyer of last resort. We continue to call for more weakness in carry trades with a move below 105 very likely for USD/JPY.

USD/CAD: CURRENCY PAIR IN PLAY OVER THE NEXT 24 HOURS

Canada and the US have employment reports due for release tomorrow. The Canadian Employment Report is due for release at 7:00AM ET (11:00 GMT) while the US Employment Report is due at 8:30AM ET (12:30 GMT).

USD/CAD entered our Buy Zone today (established by Bollinger Bands). This suggests that there could be further gains in USD/CAD, which contradicts with the weak NFP call. The levels to watch are 1.0777 on the topside and 1.0645 on the downside. A close above 1.0777, the 12 month high opens the door for a move to 1.10. A break below 1.0645, leaves support at 1.05.

EXPECTATIONS FOR THE NEXT FED MEETING (9/16/08)
CURRENT US INTEREST RATE: 2.00%
.	CURRENT	1 WEEK AGO	1 MONTH AGO
NO CHANGE	81.4%	81.0%	62.8%
RAISE 25BP	9.0%	9.6%	19.8%
RAISE 50BP	2.9%	3.3%	7.2%
CUT 25BP	6.7%	6.1%	7.7%

Published on Fri, Sep 5 2008, 10:23 GMT

US Dollar: Is it time for a reversal?

Thu, Sep 4 2008, 15:42 GMT
by Kathy Lien

GFT

TODAY’S BIGGEST PERCENTAGE MOVERS

GBP/JPY (127 pips or -0.67%)
NZD/JPY (41pips or -0.59%)
AUD/CAD (48 pips or -0.55%)

THE STORIES IN THE CURRENCY MARKET

USD: IS IT TIME FOR A REVERSAL?
EUR: WHAT IS THE RISK FOR THE ECB?
GBP: BOE TO LEAVE RATES UNCHANGED, UK FIRMS ON FIRE SALE
CAD: LEAVES INTEREST RATES UNCHANGED, NO HINTS ABOUT EASING
AUD: HIT BY SOFTER GDP GROWTH
NZD: FRESH 1 YEAR LOW
JPY: STILL BEARISH CARRY TRADES

US DOLLAR: IS IT TIME FOR A REVERSAL?

Over the past 6 weeks, the US dollar has had an incredible run. This morning, the greenback rose to a fresh 7 month high against the Euro, a 1 year high against the New Zealand dollar and a 2 year high against the British pound. These milestones represent the strength of the trend in the US dollar, but most of those moves happened in the beginning of the European trading session and since then, the US dollar has gradually given back its gains. Sharp intraday reversals can be seen in many of the dollar pairs with the greenback even losing ground against some currencies such as the Japanese Yen and Canadian dollars. The long “wicks” that we are seeing across the charts and the overextension of the dollar rally leads many traders to wonder if it is time for a reversal.

On a purchasing parity basis, the Euro and the British are still overvalued but the stars are lining up for a possible near term reversal in the US dollar. Despite the more pessimistic tone of the Fed’s Beige Book report and the continual rise in layoffs according to Challenger, Gray & Christmas, the dollar is trading on macro and not micro factors. Oil prices continued to fall, but the degree of the sell-off has tempered. If crude starts to stabilize, there could be a correction in the US dollar. So far, the leading indicators for non-farm payrolls such as the employment component of manufacturing ISM, the Challenger layoff report and the increase in strike activity point to more job losses. Tomorrow’s ADP report and service sector ISM will complete our outlook for NFP.

Yesterday, we learned that 3 out of the 10 Fed districts favored a hike of the discount rate, but a lot has changed over the past month and the Federal Reserve may no longer be in as much of a rush to raise interest rates. According to the Beige Book report, economic activity is slowing as high prices take a toll on growth - but these same price pressures are beginning to ease. As oil prices continue to fall, so is the probability of a rate hike in the first half of 2009. A week ago, the market was pricing in a 52 percent chance of a quarter rate point hike in January, but today that probability has fallen to 40 percent.

WHAT IS THE RISK FOR THE ECB?

In yesterday’s Daily Currency Focus, we said that the 1.45 level was significant support in the EUR/USD. A break below that level would have opened the door for a move down to 1.42. Even though the EUR/USD did take out the support to hit an intraday low of 1.4385, what was more impressive was the currency pair’s reversal. The close back near today’s high reflects strength rather than weakness.

The European Central Bank interest rate decision is the wildcard tomorrow. The recent decline in the Euro suggests that the market is expecting the ECB to be dovish despite their clearly hawkish rhetoric. Traders are looking at the price of oil and the recent Eurozone economic data and drawing the conclusion that the ECB can no longer be stubbornly hawkish. Second quarter growth and retail sales were both weaker than expect. Although service sector PMI was revised higher, it still remains in contractionary territory.

Keeping interest rates on hold at 4.25 percent is a given, but Euro bears may be disappointed by Trichet’s press conference. If the ECB is dovish, it would be in line with the recent price action in the Euro, so the risk is hawkishness. The ECB is not a central bank to fade – their job is to stabilize the economy and not to induce volatility. If they say that they are hawkish, there is no reason to doubt them. Recent comments from members of the Governing Council indicate that even though economic growth is slowing, the ECB expects activity to pick up next year. With a strict inflation mandate, they are much more worried about inflation feeding into wage and price setting behavior. Before shifting their stance, they may want to see oil prices remain at current levels for at least another month.

BOE TO LEAVE RATES UNCHANGED, UK FIRMS ON FIRE SALE

The British pound continued to sell off despite an improvement in service sector PMI. The UK economy is weak, but it is encouraging that manufacturing, construction and service sector PMI all improved in the month of August. This suggests that even though growth is continuing to contract, the pace of deterioration may be slowing. Consumer confidence remains at a 4 year low, but the recent decline in the British pound and the drop in oil prices should help to boost growth. The 12 percent decline in the British pound has put UK firms on a fire sale. We expect M&A activity to pick up, which could help to temporarily stabilize the currency.

The Bank of England is expected to leave interest rates unchanged at 5.00 percent. With the economy slowing and inflationary pressures easing, the next move by the central bank should be a rate cut. The market is currently pricing in 75bp of easing over the next 12 months and because of that, we still expect the GBP/USD to break 1.75. Usually when the BoE leaves rates unchanged, no statement is released, which mean that the action should be in the EUR/USD tomorrow on the heels of Trichet’s press conference.

BANK OF CANADA LEAVES RATES UNCHANGED, NO HINTS ABOUT EASING

The Bank of Canada left interest rates unchanged at 3.00 percent and gave no hints about possible easing. The statement was fairly neutral with a tinge of dovishness. According to the central bank, economic activity was slower than they expected in June while commodity prices are posing less of a risk on inflation but ultimately Mark Carney’s team still believes that the economy is growing near potential. Instead of falling, the Canadian dollar rallied 200 pips against the US dollar following the BoC rate decision. Even though no one expected the BoC to cut interest rates today most traders expected the central bank to pave the way for a rate cut before the end of the year. Futures traders had priced in 25bp of easing before December but instead, the Bank left them with the line that monetary policy is “appropriately accommodative.”

Disappointments also came out of Australia with second quarter GDP growth and service sector PMI deteriorating. The government is still upbeat about the outlook for the economy even though growth was the weakest in 3 years. The recent rate cut should help bolster growth, but the combination of weaker economic data, a dovish monetary policy bias and lower gold prices will continue to weigh on the Australian dollar. We believe that there is a decent chance that the AUD/USD will test 80 cents in the near future. The trade balance is due for release tomorrow – this Tier 2 economic data should have a limited impact on the currency. Meanwhile the New Zealand dollar continues to hit fresh 1 year lows. With the RBA cutting interest rates, the RBNZ may follow suit.

STILL BEARISH CARRY TRADES

We have been bearish carry trades for some time now and we continue to believe that the Japanese Yen crosses could face further losses. Even though oil is the number one story right now, the health of the financial sector is still a concern. Ospraie Management, one of the US’ largest hedge funds shut down their flagship fund which had about $2.8 billion under management at the beginning of April. Having lost 26 percent last month and 38 percent year to date, anticipated redemptions have forced them to close shop. Expect more hedge funds to follow in the footsteps of Osparie, which was at its peak, one of the leading commodity funds. Foreign investors around the world are starting to become gun shy about investing in US assets. Chinese banks have already cut their holdings of Fannie and Freddie debt and are probably reevaluating all of their US exposure. Carry trades only perform well when central banks are raising interest rates, the markets are stable and investors are optimistic. The fact that all 3 of these conditions do not hold suggests more trouble for the Yen crosses.

EUR/USD: CURRENCY PAIR IN PLAY OVER THE NEXT 24 HOURS

The European Central Bank interest rate decision is scheduled for 7:45am Eastern Time or 11:45 GMT. ECB President Trichet begins his press conference at 8:30am ET / 12:30 GMT.

The EUR/USD entered our sell zone on Monday and has lost 200 pips on an intraday basis since then. However the today’s long wick signals a potential reversal. The levels that we are watching are 1.4600 on the upside and 1.4385 on the downside. If the EUR/USD clears 1.46, we could see a move to 1.48. If 1.4385 is broken, our target is still the 100 SMA on the weekly chart which sits at 1.4200.

EXPECTATIONS FOR THE NEXT FED MEETING (9/16/08)
CURRENT US INTEREST RATE: 2.00%
.	CURRENT	1 WEEK AGO	1 MONTH AGO
NO CHANGE	79.0%	78.9%	62.8%
RAISE 25BP	12.3%	12.3%	19.8%
RAISE 50BP	2.1%	2.2%	7.2%
CUT 25BP	6.6%	6.6%	7.7%

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Published on Thu, Sep 4 2008, 15:42 GMT

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