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Daily Currency Market Focus

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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, 08:05 GMT