Dollar Still Bearish

July - 25 - 2010 Author: Christine Allen Respond

The European stress tests are behind us and now it feels like we could be entering the dog days of summer. Many Senior FX traders in Europe take the entire month of August off for summer holidays which suggests that position squaring could be their top priority this week. However with the euro taking another stab at the 1.30 level, the Australian dollar trading at a 2 month high and the New Zealand dollar reaching a 6 month high today, it is hard categorize the price action as boring. Stronger U.S. economic data, a more optimistic outlook from FedEx Corp and relief that the stress tests in Europe are over has helped to promote additional risk appetite in the financial markets. As a result, the dollar traded lower against every major currency.

The Weakness of USD/JPY

However despite the improvement in risk appetite, the weakness of USD/JPY is telling us that investors are still very bearish dollars. Last week, we said that we are in a transitional point in the global recovery and the U.S. economy where the dollar will one day trade on risk and another on fundamentals. This continues to be the dynamic in the currency market but at the end of the day, it is important to remember that the Federal Reserve has no plans to raise interest rates before the end of the year. This explains why the dollar has underperformed the Yen (because the price action of USD/JPY best reflects the market’s sentiment towards dollars) and why Aussie and Kiwi have hit new highs against the greenback. New Zealand is expected to raise interest rates this week while the Australians are anticipating a key piece of data that will determine whether a rate hike in August is necessary. There is a great deal of U.S. economic data scheduled for release and despite the improvement in new home sales, we are still anticipating softer numbers.

Manufacturing vs. Housing

Even though new home sales surprised to the upside, there continues to be weakness in other parts of the economy. New home sales received the most attention today but there were also reports that manufacturing activity in the Chicago and Dallas regions have slowed. As a result, Richmond will likely report softer activity tomorrow. Consumer confidence will be also released on Tuesday and given the deterioration in the University of Michigan survey and IBD Consumer confidence surveys, we would be surprised if the Conference Board did not report weaker results. New home sales rose by 23.6 percent in the month of June, the strongest percentage gain in 30 years. Compared to the market’s forecast for a gain of only 3.3 percent, the pickup in sales implies that the housing market may not be as weak as the existing home sales data suggests. However investors should not mistake the rebound for a full blow recovery in housing because new home sales fell to a record low in May. The data has to be put into context and in absolute terms, the number of units sold is still at very depressed levels. The median price of a home sold also declined for the third month in a row. Yet the data provides hope that new home sales bottomed in May.

EUR: Third Time the Charm?

For the third time in a row this month, the euro has broken above the psychologically and technically important 1.30 level on an intraday basis, but once again, it failed to rise enough to call the move a sustained break. It is often said that the third time is the charm and we believe this should be the case for the euro. Although some people view the EU stress tests as worthless, at least it did not kill the rally in the financial markets and what doesn’t hurt you only makes you stronger. Credit default swaps which are the cost of insuring against a default on a bond or loan has fallen which confirms that the stress test results did not heighten risk aversion. European Policymakers were out in force today talking up the stress tests. ECB member Orphanides, Paramo and Ordonez all said they were satisfied with the stress tests results which show the stability and robustness of the banking industry. Even European Central Bank President Trichet added his two cents by saying the tests were an important exercise in transparency that is appreciated by the ECB. The Basel Committee on Banking Supervision has been hard at work on developing a global standard of capital requirements for banks. This morning, they have reached a broad agreement on the overall design of the rules which are expected to apply a 3 percent leverage ratio that will be tested from 2013 to 2017. The banks would be required to publish their individual leverage results starting in 2015. More regulation seems to be the only thing that policymakers around the world can agree on and unfortunately banks are screaming that this is the reason why they have been reluctant to lend. No European economic data was released today, but German consumer confidence and import prices are scheduled for release tomorrow. Confidence is expected to hold steady while price pressures are expected to grow mildly. Meanwhile the Swiss Franc traded lower against the euro for the third consecutive trading day. The UBS consumption indicator is scheduled for release tomorrow and after hitting the highest level since 2008 in May, a dip would not be out of the question particularly after imports and exports fell in the month of June.

GBP: Still Reeling from GDP Report

After sharp gains on Friday, the British pound climbed to a 3 month high against the U.S. dollar. It fell against the euro but gave back less than half of Friday’s gains. The FTSE 100 Index also rose 0.72 percent but despite the gain, the pound has found it difficult to break the key 1.55 resistance mark, hitting its highest point since April 24 th when GBP/USD also tested the 1.55 resistance point. The sterling’s strength can attributed to two key events; the Preliminary GDP release, which showed the UK economy growing almost twice as much as economists expected in the second quarter and the fact that none of the 7 banks that failed the stress tests came from the UK. Amidst the good stress test results the BoE took additional measures to support financial institutions and limit systemic risk, as the UK government unveiled its plans for a new BoE Financial Policy Committee (FPC) to oversee the financial sector, with BoE Governor Mervyn Allister King as its chairman. The UK also plans to create an independent Consumer Protection and Markets Authority (CPMA) to police the financial market and fine banks for abuse, by regulating interbank exchanges and monitoring the sale of financial products. These two new macro watchdogs are part of an continuous effort by the UK to separate itself from the European Union by showing that it is fully capable of handling its domestic affairs, while also trying to boost consumer confidence at home which continues to dwindle after the massive changes instituted as part of the UK June 22 austerity budget. With no major economic releases in the next couple of days, market watchers should look ahead to Thursday’s Mortgage Approvals and the GfK Consumer Confidence Survey, which will indicate to investors how hard UK consumers are being hit as a result of the newly implemented taxes and public sector cuts, all of which could also stunt the already weak UK housing sector.

AUD: Surprise Downtick in PPI

The Australian, New Zealand and Canadian dollars extended their gains against the greenback thanks to tighter monetary policies and stronger risk appetite. No data was released from New Zealand or Canada but the positive streak of economic releases out of Australia hit a road bump with a surprise to the downside in producer prices. Australia’s second quarter PPI release showed a less than expected rise of 0.3 percent, compared to the 0.8 percent forecasted, perhaps slowing the currency down a bit and holding back the pressure on the RBA to hike up its target cash rate. With fears regarding Europe’s financial systems lessening after the stress tests, more attention can be paid and more action taken to address strong domestic data, as positive trade and job growth in Australia heighten concerns about inflation. More will be known with CPI data to be released on Wednesday, for which an increase above the expected 1.00 percent forecast will give justification for-if not force-the RBA to raise rates during its meeting next week, as inflation in Australia is already above the RBA’s targets. If Consumer Prices does beat market expectations, the AUD/USD is likely to break through the 0.9000 figure and as investors become certain about the strength of the commodity currency, which thus far has managed to weather the still prominent global recession.

JPY: Trade Surplus Grows Despite Growing Yen

The improvement in risk appetite drove the Japanese Yen lower against most of the major currencies. Trade Balance figures released Sunday by the Ministry of Finance indicates that Japanese exports beat forecasts and that the nation’s trade surplus increased. The positive data supports recent comments made by the Bank of Japan that the economy continues to recover at a “moderate” pace and reduces concern about the impact of a strong yen. Although exports have increased every month this year, the pace of export growth slowed for the fourth consecutive month. In addition, the Yen’s recent strength has eroded exporters’ profits and may significantly impact export growth in coming months. Bank of Japan officials have commented recently that the currency’s strength “could hurt the economy” and that they “want to avoid excessive gains in the Yen.” Adding to such comments from Japanese officials, Yoshimi Watanabe, the leader of “Your Party,” a minor opposition party that gained ten seats in the July 11 th elections, stated today “what’s needed to beat deflation is easier monetary policy, aggressive fiscal policy and policy that promotes a weaker Yen.” He added “As long as we leave the fight against deflation to bureaucrats, we cannot get away from debilitating deflation and Japan will eventually become a third-rate country.” Also today, a cabinet committee backed a plan to set aside approximately 1 Trillion Yen for stimulus growth measures as opposed to the 2 Trillion Yen requested by the Democratic Party of Japan. Finance Minister Yoshihiko Noda stated last week that he is considering a plan for a spending cut for government ministries of 10 percent across the board on policy-related measures with the exclusion of social security expenses and that the Cabinet plans to finalize budget guidelines by the end of August. Chief Cabinet Secretary Yoshito Sengoku told reporters today of a plan to survey the Japanese public for their input on which policies the government should pursue using the stimulus measures. Over the next 24 hours, Japan is set to release its Corporate Services Price Index.

USD/JPY: Currency in Play for Next 24 Hours

USD/JPY will be the currency pair in play for the next 24 hours. In the U.S., the S&P/CaseShiller Composite Home Price Index for May is expected at 9:00 ET or 13:00 GMT, followed by the Richmond Federal Reserve’s July Manufacturing Survey and Consumer Confidence at 10:00 ET or 14:00 GMT. Japan is set to release its Corporate Services Price Index figure at 7:50 ET or 23:50 GMT.

After breaking into the Range-Trading Zone yesterday, USD/JPY is back trading within the Sell-Zone, which we determined using Bollinger Bands. After reaching its lowest point since November last week, the pair has been consolidating between the 86.50 and 87.50 levels. The pair has repeatedly failed in its efforts at fighting a much larger downtrend which began in May. Near-term support lies at the 86.50 level, which proved sturdy the past week and coincides with the 10-Day Simple Moving Average. If this level is broken, the next support level would be at the psychologically important 85.00 level, which supported the pair back in December. The closest level of resistance is at the 87.50 level, which held the pair down the past week and provided strong support in late 2008 and early 2009. If this level is crossed, the pair could see further resistance at the 88.80 level, which proved strong two weeks ago.

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