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Forex Research - Dow Breaks 9k, Where Are the Losses in Currencies

Dow Breaks 9k, Where Are the Losses in Currencies Last Updated 10/9/2008 5:43:07 PM EST (GMT +5)

TODAY’S BIGGEST PERCENTAGE MOVERS

AUD/CAD (+268 pips or +3.56%)

USD/CAD ( +223 pips or +1.98%)

EUR/AUD ( -367 pips or -1.81%)

THE STORIES IN THE CURRENCY MARKET

  • USD: DOW BREAKS 9K, WHERE ARE THE LOSSES IN CURRENCIES
  • EUR: EURO MAY BE AT A NEAR TERM BOTTOM
  • GBP: BRITISH POUND CONTINUES TO SELL OFF, HOW LOW WILL THE BOE TAKE RATES
  • JPY: CARRY TRADES WILL CONTINUE TO STRUGGLE
  • CAD: USD/CAD HITS 1 YEAR HIGH
  • AUD: EMPLOYMENT RATE HITS 4.3%
  • NZD: PRONE TO MORE LOSSES

EXPECTATIONS FOR UPCOMING FED MEETINGS

 

** PERCENTAGES MAY NOT ADD UP TO 100% BECAUSE OF THE PROBABILITY OF LARGER OR SMALLER MOVES BEYOND THOSE SHOWN ON THIS TABLE

DOW BREAKS 9K, WHERE ARE THE LOSSES IN CURRENCIES

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. CNBC is even talking about the Fed possibly buying equity futures, but ultimately none of these solutions 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.

BRITISH POUND CONTINUES TO SELL OFF, HOW LOW WILL THE BOE TAKE INTEREST RATES?

Despite a ground sweeping bailout plan with components that the US eventually adopted (taking equity stakes in banks), the British pound continued to weaken. The credit markets remain frozen with LIBOR rates hitting all time highs. Like the US, the UK government will be forced to explore further options. Interest rates are currently at 4.5 percent and economists are looking for a move all the down to 2.5 to 3.5 percent. The UK trade balance was weaker than the market expected, adding pressure on the British pound. The meltdown in the US markets has a direct effect on the UK markets since London is one of the world’s leading financial centers. Expect the UK to feel the same pain as the US but with a lag. As long as growth continues to slow, the UK will have to lower interest rates which should drag the British pound down with it. Given the proximity of the 1.70 price level, there is a decent chance that British pound traders will want to test that level.

EURO MAY BE AT A NEAR TERM BOTTOM

There has been a tremendous amount of volatility in the currency markets over the past few trading sessions, but the EUR/USD was left out of the party. ECB officials were out in force today reassuring investors that they are focused on restoring trust and stability in the financial markets. Like the Federal Reserve, the ECB has now been forced to put the markets and growth ahead of inflation. Life will not be easy in the Eurozone as monetary policy member Stark forecasts several quarters of weak growth. Given that the central bank has pledged to do what is necessary “at anytime,” we know that they have fully shifted to a dovish monetary policy bias – in other words, more interest rate cuts could be right around the corner. With the ECB and the Federal Reserve expected to cut interest rates at the same time and by the same amounts over the next few months, the volatility of the EUR/USD could begin to compress. Only after the Federal Reserve signals that their rates cuts are coming to end and the market’s find the ECB still easing could the Euro see another meaningful leg lower. In the meantime, it is unlikely for the Eurozone as a whole to make a similar announcement as the UK and the US has about taking equity stakes in banks. The ECB only manages monetary policy which means the decision of capitalizing banks is left the governments of the individual countries that participate in the European Monetary Union. Meanwhile the German trade surplus narrowed in the month of August as export demand turned negative. This is yet another piece of evidence that confirms the slowdown in the Eurozone.

CARRY TRADES WILL CONTINUE TO STRUGGLE

Even though many of the Japanese Yen crosses have ended the US trading session higher, there is a decent chance that we will see further selling in the Asian and early European trading sessions. Many of the Asian markets stabilized last night, but 678 point drop in the Dow will lead to another burst of risk aversion. As we have argued in past editions of the Daily Currency Focus, the further the Dow drops the more weakness we expect in USD/JPY. One percent interest rates is becoming a growing reality for the US and if that happens, USD/JPY could fall to 95. Don’t expect Japanese authorities to step into the markets and stop the decline. They understand that the problems stem from the US and intervening to buy dollars and sell Yen at this point would be counterproductive. Therefore we expect carry trades to continue to struggle given the volatility in the financial markets.

USD/CAD HITS 1 YEAR HIGH

The biggest story for the commodity currencies today is the strength of USD/CAD. Over the past 9 trading days, the US dollar has strengthened more than 11 percent against its Canadian counterpart, hitting a 1 year high in the process. The fear in Canada is that not only will growth slow, but there could even be a bank failure in Canada. The government has denied it vehemently, but judging from the price action of the loonie, traders do not think that Canada will be spared. Canadian employment numbers are due for release tomorrow. We expect the number to be weak given the drop in the employment component of the IVEY PMI report. Meanwhile, the US dollar lost ground against the Australian and New Zealand dollars. Australian employment change was stronger than the market expected, but the unemployment rate ticked up from 4.1 to 4.3 percent.

CAD/JPY: Currency in Play Over the Next 24 Hours

CAD/JPY will be our currency pair in play for the next 24-hours. Canadian employment numbers are due for release at 7:00AM ET or 11:00 GMT. We are picking CAD/JPY instead of USD/CAD because the sharp weakness in US equities will make the Yen crosses particularly volatile over the next 24 hours.

CAD/JPY is trading firmly in the sell zone, which we determine using Bollinger Bands. Given that the currency pair is trading at 3 year lows, we need to look to the weekly charts for any meaningful support level. CAD/JPY has broken many significant support levels, cementing the currency pair’s downtrend. The 85 price could provide some psychological support but below that, there is no major support until 83, which represents the 2005 low. As for resistance, 90.45 is the 100-month SMA and the 61.8 percent Fibonacci retracement of the 1999-2007 rally. Only if that price level is broken could we see a more meaningful bounce.

 

About The Author

Lien has extensive knowledge within the interbank market, particularly in trading spot FX and options. She has written for numerous publications, is frequently quoted on financial media outlets, and is the author of several books, including Millionaire Traders. Read more >>

DISCLAIMER: This forum and the information provided here should not be relied upon as a substitute for extensive independent research before making your investment decisions. Global Forex Trading is merely providing this column for your general information. This forum and its information does not take into account any particular individual’s investment objectives, financial situation, or needs. All investors should obtain advice based on their unique situation before making any investment decision based upon this forum or any information contained within. In addition, any projections or views of the market provided by the author may not prove to be accurate. Global Forex Trading and Kathy will not be responsible for any losses incurred on investments made by readers and clients as a result of any information contained in this column. Global Forex Trading and Kathy do not render investment, legal, accounting, tax or other professional advice. If such advice is sought, or other expert assistance is required, the services of a competent professional should be sought.



 

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