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Forex Research - Currency Rallies May Be Limited as Schizophrenic Markets Leaves Panic in the Air

Currency Rallies May Be Limited as Schizophrenic Markets Leaves Panic in the Air Last Updated 10/16/2008 5:00:52 PM EST (GMT +5)

TODAY’S BIGGEST PERCENTAGE MOVERS

AUD/JPY ( +475 pips or +7.30%)

AUD/USD( +350 pips or +5.37%)

NZD/JPY ( +316 pips or +5.30%)

THE STORIES IN THE CURRENCY MARKET

  • USD: CURRENCY RALLIES MAY BE LIMITED AS SCHIZOPHRENIC MARKET LEAVES PANIC IN THE AIR
  • EUR: ECB ACCEPTS ANYTHING BUT JUNK, LOOKS TO CUT INTEREST RATES
  • GBP: UK ON THE CUTTING EDGE
  • CAD: SHARP DROP IN MANUFACTURING SHIPMENTS
  • AUD: GOLD PRICES DOWN $42
  • NZD: BALTIC DRY INDEX CONTINUES TO SLIDE, OIL DOWN $2
  • JPY: WILL THERE BE A GLOBAL RESPONSE FROM ASIA?

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

CURRENCY RALLIES MAY BE LIMITED AS SCHIZOPHRENIC MARKET LEAVES PANIC IN THE AIR

The sentiment in the currency and equity markets have been oscillating between hope and fear on a near hourly basis. Having been down as much as 379 points intraday, the Dow Jones Industrial Average closed up 400 points. USD/JPY and other carry trades followed the movements in US equities which is why the recovery in risk appetite has helped these currency pairs close near their daily highs. However for the average investor who may not be day trading the financial markets, the sharp volatility may actually keep them on the sidelines, which could limit a meaningful recovery for the high yielding currencies. Many mutual funds and hedge funds are still moving to cash in hopes of locking in whatever profits they can before the end of the year. Although there are signs that the credit markets are beginning to thaw, the schizophrenic nature of the equity and currency markets still leaves some panic in the air.

Borrowing Costs Are Coming Down but VIX Hits Record High

Interbank lending, which has been one of the primary areas that central banks are focusing on is finally letting up. The 3 month LIBOR rate and commercial paper yields are falling, which means that banks are becoming more willing to lend to each other. The LIBOR-OIS and TED spreads, which are indices that we have been monitoring over the past few weeks have also been compressing. On top of that, gold prices have dropped more than $40, suggesting that risk appetite may be improving. However, the VIX, which is also known as the market’s fear index hit a record high of 80. High volatility is not a positive for the currency markets but it would be unrealistic to expect everything to change overnight. We are moving in the right direction across many asset classes and it may be just a matter of time before the currency and equity markets catch up to the stability that we are beginning to see in the interbank lending markets. The only thing that we need to point out is that stability does not necessarily equal recovery.

Weak Economic Data Continues to Cripple the US Dollar

The US dollar continues to struggle in the face of softer economic data. Everything from consumer prices to industrial production, the Philly Fed index and the Treasury International Capital report reeked of weakness. Headline CPI growth was flat last month, suggesting that inflationary pressures are abating. Although the number of weekly jobless claims dropped, continuing claims hit a new cycle high. Foreign demand for US assets was tepid, industrial production fell by the largest amount in more than 30 years while the Philadelphia index of manufacturing activity fell 41.3 points to the lowest level since 1990. There was nothing optimistic about today’s reports and if anything, the numbers will add pressure on the Federal Reserve to cut interest rates. Housing starts, building permits and the University of Michigan consumer confidence index are due for release on Friday. These numbers represent the most vulnerable areas of the US economy and therefore we do not expect the data to help the dollar.

November G8 Meeting: More Groundbreaking Reforms?

Meanwhile The UK, France and Germany have called for a meeting of the G8 nations and emerging market economies to discuss global bank reform. Their goal 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.

ECB ACCEPTS ANYTHING BUT JUNK, LOOKS TO CUT INTEREST RATES

Unlike the other higher yielding currencies, the Euro failed to strengthen against the US dollar today as the decline in oil prices prevents any major recovery in the currency. Since the beginning of the year, there has been a 70 percent positive correlation between the EUR/USD and the price oil. The continual decline is making it very difficult for the EUR/USD to rally. The market expects all major central banks with the exception of the Bank of Japan to continue cutting interest rates, but there is a growing speculation that the ECB could cut interest rates by another 50bp next month. This morning, monetary policy member Quaden said that economic activity has deteriorated rapidly while inflationary pressures have eased. He also indicated that the central bank will continue to monitor all economic, financial and monetary developments and act firmly whenever necessary. This follows the ECB’s announcement yesterday that they will take anything outside of junk or equity from bank balance sheets. This includes assets that are rated BBB and subject to some haircuts, BBB- as well. This move reflects the central banks’ commitment to maintaining liquidity in the financial system and to improve the balance sheets of banks. Of course, that also means that the central bank is taking a lot of these questionable assets onto their own balance sheet. Meanwhile the Swiss franc is also under pressure as Swiss economic data takes a turn for the worse. Retail sales were flat in the month of August while the ZEW survey dropped to a record low.

UK ON THE CUTTING EDGE

The British pound was up strongly against the US dollar and the Euro today as the UK proves to be the biggest innovator in this financial crisis. Not only has Gordon Brown’s plan been the model of everyone’s response to the credit crunch, but he is also pushing to rewrite the rules of the global economy. As we mentioned in the dollar portion of our commentary, Brown is calling for a G8 meeting to discuss the possibility of Bretton Woods 2. The UK has retransformed their image halfway through the financial crisis and this proactive nature is certainly being reflected in the price action of the British pound. It appears that the currency market is rewarding whoever handles the credit crisis better.

CANADIAN, AUSTRALIAN AND NEW ZEALAND DOLLARS SHRUG OFF WEAKNESS IN OIL AND GOLD

The Canadian, Australian and New Zealand dollars have completely shrugged off the weakness in commodities. For the first time since June 2007, oil prices dropped below $70 a barrel after the US government reported that inventories were two times greater than the market’s forecast. Gold prices tumbled more than 5 percent to $804 an ounce. Canadian manufacturing shipments were extremely weak indicating that by no means has Canada escaped the slowdown in the US. Given the export dependent nature of the Canadian economy, this report paints a very bearish picture for Canada. New Zealand business PMI was actually stronger than the market expected, but that has not altered the market’s expectations for a 25 to 50bp rate cut from the RBNZ at their next monetary policy meeting. The Baltic Dry Index continues to fall – this reflects the weakening demand for commodities and validates the sell-off that we have seen thus far. As we have previously indicated, the one good thing with the volatility in commodity prices is that it is driving down gasoline prices, which should offer relief for consumers.

WILL THERE BE A GLOBAL RESPONSE FROM ASIA?

The rally in the US equity market has driven all of the Japanese Yen crosses higher. The tertiary activity index, nationwide and Tokyo department store sales are due for release over the next 24 hours, but as usual, the data should have only a nominal impact on the Japanese Yen. Instead, many investors are worried about the exposure of Asian nations to the financial crisis. Even though banks in countries like Japan have been far less leveraged than their international counterparts, there is talk that a coordinated response may be coming from Asia. The sharp decline that we saw in Asian equities on Wednesday indicates that recessionary fears have hit Asia as well and some Asian leaders are beginning to call for coordinated action to match that of the G7. However we think that it is unlikely for Japan to agree to such action.

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

The EUR/USD continues to be the currency pair in play over the next 24 hours with the Eurozone trade balance due for release 5:00AM ET or 9:00 GMT and US housing market numbers due for release at 8:30AM or 12:30 GMT. US consumer confidence will also be out at 10:00AM ET or 14:00 GMT.

We also really like the way that the EUR/USD has been trading technically. It has obeyed our sell zone very well with weakness having remained the predominant theme in the currency pair given its failure to close outside of the zone, which we establish using Bollinger Bands. As long as the currency pair does not close above 1.3562, the 10-day SMA, there is decent chance that it could be headed for Friday’s low of 1.3260. Keep in mind that there is strong support right below current levels at 1.3330, which is confluence of 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.

 

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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