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Tuesday October 14, 2008 - 21:44:26 GMT
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Forex Research - Are Recession Fears Driving the Dollar and Equities Lower?

Are Recession Fears Driving the Dollar and Equities Lower? Last Updated 10/14/2008 5:26:00 PM EST (GMT +5)

TODAY’S BIGGEST PERCENTAGE MOVERS

AUD/CAD ( +140 pips or +1.73%)

EUR/CAD ( +250 pips or 1.59%)

USD/CAD ( +158 pips or +1.38%)

THE STORIES IN THE CURRENCY MARKET

  • USD: ARE RECESSION FEARS DRIVING THE US DOLLAR AND EQUITIES LOWER?
  • EUR: ECB PLEDGES MORE ACTION, IF NECESSARY
  • GBP: UK EMPLOYMENT NUMBERS COULD BE SOFT
  • JPY: CARRY TRADES STRUGGLE, KEEP AN EYE ON THE VIX
  • CAD: OIL BREAKS BELOW $80, ELECTIONS
  • AUD: NEW SPENDING PLAN ANNOUNCED
  • NZD: GAINS STRENGTH AGAINST THE GREENBACK

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

ARE RECESSION FEARS DRIVING THE US DOLLAR AND EQUITIES LOWER?

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 76 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 surprising 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 become increasingly 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 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.

ECB PLEDGES MORE ACTION, IF NECESSARY

The European Central Bank has pledged to take more action if necessary. In a speech today, ECB President Trichet said that it’s time for action and not rhetoric and quick decisions are needed. The US learned the hard way that delays have consequences and the ECB does not want to make the same mistakes. Although price stability remains their top priority, Trichet willingly admitted that slower growth reduces price risks. His dovish comments are very much in line with the market’s expectations for further easing by the ECB. Interest rates are expected to fall as low as 3 percent over the next 12 months. Economic data was mixed with French consumer prices and the German ZEW survey of analyst sentiment deteriorating while Eurozone production was in line with the market’s expectations. Eurozone consumer prices are due for release tomorrow and given the drop in French data, inflation should ease. With the EUR/USD closing near the day’s lows, we could see losses in the currency pair over the next 24 hours.

UK EMPLOYMENT NUMBERS COULD BE SOFT

The British pound strengthened against the US dollar today but that strength was fleeting considering the fact that the GBP/USD closed nearly unchanged on the day after having been up more than 200 pips. UK consumer prices soared to the highest level in more than 10 years last month as the cost of gas, clothing and leisure activities increased. The strength of inflationary pressures illustrates how difficult it must have been for the Bank of England to decide to cut interest rates earlier this month. They must have believed that the problems in the UK economy and the credit markets were severe enough to warrant a rate cut that could potentially push inflation even higher. However with that in mind, the slowdown in growth should reduce inflation in the coming months, it is just interesting to see that it hasn’t yet even though oil prices peaked back in July. UK employment numbers are due for release tomorrow. Given the drop in the employment component of service and manufacturing PMI, the labor market in September should have been soft.

CARRY TRADES STRUGGLE, KEEP AN EYE ON THE VIX

When trading carry, it is always important to keep an eye on the VIX, which measures the volatility of the stock market. Although the VIX is 20 percent lower than its high on Friday, the 600 point intraday move in the Dow today should keep volatilities lifted. A compression in volatility or a drop in the VIX would be positive for carry trades, but a continued expansion in volatility will make it difficult for carry trades to recover, even if the stock market rallies. The Bank of Japan held an unscheduled policy board meeting today and announced that the Japanese government will add liquidity to the markets, suspend the sale of stocks that they have held for many years, and broaden the tools for their repo operations. This in combination with stronger economic data has failed to stop a further correction in the Japanese Yen. The trade, current account and industrial production numbers are due for release this evening.

CANADIAN DOLLAR SLIPS AS OIL PRICES DROP BELOW $80

Oil prices dropped below $80 a barrel, taking the Canadian dollar down with it. New motor vehicle sales were softer than expected, reflecting the Canadian economy’s sensitivity to US and global growth. Elections are underway in Canada right now and there is a decent chance that Stephen Harper, the current Prime Minister will be reelected. Unfortunately he heads up a minority government which makes it extremely difficult to implement any new measures which is very much needed in the current economic environment. The Australian dollar is slightly weaker on the day as well, but the New Zealand dollar is firmer. Australian Prime Minister Rudd announced an A$10.4 billion spending package to boost the economy by giving lump-sum payments to the elderly, families and first time home buyers. Aside from Australian leading indicators, there are no releases expected from these commodity producing countries

EUR/USD: Currency Pair in Play Over the Next 24 Hours

The EUR/USD will be the currency in play for the next 24-hours. Consumer prices are due for release from the Eurozone at 5:00am ET or 9:00 GMT while US producer prices and retail sales will be released at 8:30am ET or 12:30 GMT.

Despite a strong rally earlier this morning, the EUR/USD has closed near its lows and is trading within our “sell zone,” which is determined using Bollinger Bands. As long as the currency pair does not trade above Tuesday’s high of 1.3770, there is a strong chance that we could see further losses. However those losses could very well be limited to 1.3330, which is a significant support level as both the 200-week SMA and the 61.8 percent Fibonacci retracement of 2006-2008 rally that took the currency pair from 1.1640 to 1.6038 converges at that price level.

 

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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