In the past week, EURUSD has lost more than 200 pips from its record highs.  But recent evidence shows signs of a retracing, with support for the euro regaining strength. But it’s not like currency traders have fallen back in love with the euro. Most of the movement in the currency pair in recent days has to do with softness in the US dollar, rather than any inherent strength in the European currency.
The data emanating from the continent is contradictory, to say the least. Recent sentiment reports in Germany and France have bordered on terrible. Retail Sales in Germany printed last night at a disappointing gain of 0.7%, versus 1.2% expected. But unemployment fell by 45K, bringing the unemployment rate in Germany to 6.3%, the lowest level in that country in 14 years. The forex market, understandably, is perplexed as to do what to do with this information. And so trading in EURUSD right now consists of range trading within 40-60 points, with a market consensus of about 1.37.
The fundamental status of the US dollar is important in this situation because the euro is where the forex market likes to register its response to status changes in the greenback. But even considering that, there’s no real direction for the currency market to follow. The PCE deflator was released this morning, and the inflation register came in at 1.9%, excluding most food and energy costs. This fits into the Fed’s comfort level of 1-2%, but the PCE deflator has a tendency to understate inflation. Along with that, consumer spending met expectations with a gain of 0.1%, but the pace of growth is the slowest in nine months. Home prices are also a concern, with the S&P/Case-Shiller index reporting that home prices in 20 US cities fell 2.8% in May—the biggest fall in more than six years. But those negatives are tempered by the fact that disposable income in the United States rose 0.4% last month, outpacing spending for the first time in months. The forex market did what it usually does with conflicting data like this: nothing. The dollar barely moved at all against the yen and the euro after the release of the government report.
Currency traders may be confined to range trading in the near future, especially when it comes to EURUSD. If you had to choose between the euro and the dollar, however, then your safer bet would be to go for the euro. The ECB is only charged with maintaining price stability while the Fed has a dual mandate of controlling inflation and promoting growth. Because of this, the ECB is likely to raise interest rates in September despite French President Nicolas Sarkozy’s concern for the negatives of a strong currency. In contrast, chances are good that the US Fed will lower interest rates by the end of this year. And so yield-hungry currency investors will abandon the dollar and flock to the euro.
One way to capitalize on this flow is to invest in a managed currency fund. Bloomberg reported this morning on record returns achieved by these funds this year, and they are an excellent way to diversify your portfolio. There are a number of very good funds out there right now, and one of the best in FXCM’s Sentiment Fund.
July 31, 2007 No Comments
Despite last week’s small gains against the euro, the U.S. dollar fell against the European currency on speculation of further weak U.S. growth. It may seem like old news, but investors fear further losses on securities backed by subprime mortgages to weaken the U.S. economy. Today, Germany’s IKB Deutsche Industriebank AG reported losses directly linked to the U.S. subprime mortgage crisis. Along with last week’s Deutsche Bank report, this indicates corporate debt to be at risk from the weak housing market. The dollar fell to 1.3678 against the euro this morning, a 0.3 percent drop from last week.
The risk of owning corporate debt has sky-rocketed, also a factor in the euro gain. Bond buyers have been demanding higher risk premiums on corporate debt as risk-aversion has increased. According to index data by Merril Lynch, the spread that investors demand on corporate debt instead of holding U.S. Treasuries has widened 20 basis points this week to 128 basis points. Investors fear corporate debt will be taking hits from the subprime meltdown.
Currency Outlook and Strategy:
Tomorrow at 8:30 a.m. the U.S. Commerce department is due to release a report on U.S. consumer spending. Economists from a Bloomberg news survey speculate personal spending rose 0.1 percent in June, the least since September. Ever since U.S. personal spending has slowed from a 5-month high in December, the dollar has fallen 3.5 percent against the euro. Even though a weak spending forecast is already factored in the EUR/USD price, there is room for a further fall if the U.S. Federal Reserve decides to lower interest rates. Kenta Inoue, economist and currency analyst at Mitsubishi UFJ Securities in Tokyo, states: “I expect the U.S. economy to slow and the Fed to lower rates in the 4th quarter. There is still room for rates to rise in Europe, so investors will start to favor European currencies over the dollar.â€
And this brings up another question: Will the European Central Bank raise their federal funds rate above the current benchmark of 4.00 percent? There is much speculation the ECB will hold onto the current rate after its next meeting on August 4th, but is likely to raise rates later in September. This increase may mean further appreciation in the euro, a main worry of French President Nicolas Sarkozy. But recent data has shown an appreciating euro has not hurt the euro-region as a whole. Exports from the EU rose 9 percent in 5 months through May from a year earlier, the second fastest pace in 6 years. This begs the question why an appreciating euro has not hurt exports. The reason is that against the currencies of the EU’s 25 trading partners, the euro has increased less than half as a much as against the U.S. dollar. Exports to the U.S. may have been hurting, but with Germany as the world’s largest exporter, exports to other countries have more than made up for losses.
Another benefit from a rising euro has been lowered costs of oil, which is priced in U.S. dollars. The price of oil has risen 26 percent this year to $76.73 a barrel today. Despite hurting some European corporations like Airbus and Peugeot (charts), the overall euro-region seems to be withstanding the euro impact. The ECB is forecasting economic growth at 2.6 percent for 2007.
July 30, 2007 No Comments
Yesterday’s report on the extremely sluggish U.S. housing market sent equities markets crashing, investors dumping corporate debt, and currency traders unwinding carry trades. New U.S. homes sales for June fell 6.6 percent. This number has jumped significantly from the 2.2 percent decrease in May. According to a Bloomberg article, this may be a no end to the real-estate slump. The housing issue has even breached the international level as a report today by the U.K.’s Nationwide Building Society showed home values to have risen only 0.1 percent in June, the slowest in 15 months.
The faltering confidence in the equities markets has also brought shifts in forex. Despite having been on a six-week run against the dollar, the pound took its biggest fall in the last five months. The pound dropped 1.0 percent in one day to $2.0305 at 1:04 p.m. in London from $2.0491 late yesterday. On July 24th the pound had reached $2.0654, its highest level since May 1981. The pound and the euro also took major hits against the yen, indicating investors are losing confidence in their carry trades with the Japanese currency. Against the yen, the pound fell to 241.27 from yesterday’s close of 243.21. Steven Barrow, chief currency strategist at Bear Stearns Intl. Ltd. in London, states: There’s a reasonable degree of panic going on with the whole mortgage and credit issue and that has encouraged risk aversion.
Currency Outlook and Strategy:
The sharp fall in the pound has allowed the 14-day RSI for the GBP/USD to fall below 70. This indicates that a reversal will not come anytime soon. Kathy Lien, chief currency strategist at FXCM expects room for more losses in the pound. In addition, traders have taken steps to hedge against the risk of a rallying yen. The cost of options protecting against gains in the yen rose to a 3 year high. This movement of risk aversion indicates a revival in the carry trade may not happen anytime soon. Neil Jones, head of European hedge fund sales at Mizuho Financial Group Inc. in London, states: Investors are looking for some short-term protection on their exposure to the yen strengthening.
History has shown us an interesting pattern where the EUR/JPY pair has followed a very similar trend to that of the U.S. Dow Jones Industrial. As the Dow takes hits so does the EUR/JPY. See more on this pattern in an article by FXCM technical currency strategist Jamie Saettele. Overall, the leveraged-buyout financing era has taken a huge fall. There is much uncertainty as investors are shifting their portfolios toward less risky assets. Steve Pearson, chief currency strategist at HBOS Treasury Service PLC in London, reflects: [The] three year period where financial market volatility has declined to low levels is over. For now it is best to let the markets react and then change strategy.
July 27, 2007 No Comments
The GDP release for the second quarter came out strong this morning, printing at 6.4% annualized growth versus 3.2% expected. This was on top of a revised 0.6% pace for the first quarter of 2007. The dollar was already trading upwards early this morning and in European trading in anticipation of a positive release. EUR/USD had fallen as low as 1.3650, and it is hovering at about 10 pips over that right now. For a good primer on how you should trade an event risk like the US GDP report, try the GDP analysis on DailyFX.
US GDP rebounded for a variety of reasons. Rising exports, aided by the weak dollar, made up for the high input costs of $70 oil. There was a gain in commercial construction, balancing out the slump in the housing market. And finally, there was a significant rise in government spending last quarter, which probably cannot be sustained and certainly should not be counted on for future growth.
But the engine of the US economy is consumer spending, with consumption comprising 70% of GDP. And this sector only rose 1.3% the past three months, a troubling amount considering the 3.7% rise in the first quarter of this year. If the American consumer is tapped out, and that looks to be the case, then that does not bode well for growth the rest of the year.
The report this morning did beat expectations. And it probably fooled the traders in the Fed Futures market that have priced in a 90% chance of an interest rate cut by the end of the year. But economic prospects in the United States are not aligned for expansion either. Risk aversion seems to be killing the market (and the carry trade) as well. It is in times like these that it seems the best that individual traders can do is tread water. And that’s why managed funds seem so attractive. Most forex managed funds will not offer returns much different than mutual funds, but they do provide extra diversification important in market downturns. And one of the best that you might want to check out is called the Sentiment Fund by FXCM. Trading has been up and down in the forex market recently, and it’s hard for even the professionals to stay on top of things. And so it’s helpful to have an experienced hand at the top.
July 27, 2007 No Comments
In the London market last night, EUR/USD underwent the correction that we had predicted yesterday. The euro fell amid concerns that the forex market was overextended. But there’s another currency that has performed even better against the US dollar: the British pound. GBP/USD seems to reach new multi-decade highs every day. The early momentum in this pair might have been about the interest rate differential between the two countries, but that is not the driving factor anymore. If it was, then we would have seen a correction already because of the recent dovish data. The Bank of England is still on track to raise interest rates to 6.00% this year, but the actual decision might not be for another couple of months.
The real reason for the success of the pound is the growing popularity of British assets. British assets are denominated in pounds, and so when foreigners want to buy British assets, they are compelled to purchase pounds on the forex market. Just recently, the investment fund of the Dubai royal family bought a stake in HSBC Bank, and the Chinese government bought shares in Barclay’s Plc. DailyFX.com has some great analysis on the rise of the cable. The demand for pounds is skyrocketing, and that is the main driver of growth in GBP/USD.
This very phenomenon is the reason that the US dollar has been so stable and strong through the years despite the twin deficits (budget and trade). The demand for US stocks, US real estate and US Treasuries never waned, and the US dollar was the prime beneficiary. But the global environment has changed. Iran recently asked Japan to pay for its oil in yen instead of dollars. Six Middle Eastern countries (Saudi Arabia, Kuwait, UAE, Qatar, Bahrain and Oman) are planning to drop their dollar pegs and establish a single currency for the region. The growing protectionism in the United States (the scrapped deals for Dubai Ports World and CNOOC) certainly does not help matters. American real estate is not as attractive in this market with prices sinking and the bottom in danger of falling out. And US equities are not doing as well from an international perspective due to the depreciation of the US dollar.
In the face of the shifting paradigm, the pound did hit some stumbling blocks in the forex market today. GBP/USD declined from its 26-year high last night, falling as low as 2.0539. But the fall was not due to changes in the currency’s fundamentals. Rather, the losses in the US equities markets triggered a bout of risk aversion, and the carry trade unwind led many currency traders to pare back on pound holdings. But futures traders have positioned both the US stock market and the British pound for a rebound in later trading. The sterling is looking like the currency du jour in the forex market, and traders would be smart to go along for the ride.
July 25, 2007 No Comments
EUR/USD has been establishing fresh highs almost daily for the past two weeks. The upward movement in the currency pair is due to a variety of factors pointing to both euro strength and dollar weakness.  Economic growth within the Eurozone is forecast to be 2.6% in 2007, putting the 13-country region at a pace behind only Great Britain among the industrialized world. Also, most currency analysts expect at least one more rate hike this year, probably in October. Money follows yield in the forex market, and that is certainly true with the euro. And when analyzing this currency pair, it is impossible to ignore the recent comments of ECB members Stark and Papademos when they talk about the strength of the economy and the threat of inflation.
The weak dollar is also to blame for a lot of the support underneath EUR/USD. Subprime mortgage losses and concerns in the credit market overall have scared off a lot of dollar investors. Countrywide Financial Corp., the country’s largest mortgage lender, reported its third straight quarterly decline in profit and lowered its forecast for next year. The price of credit has surged as traders continue to be worried about the possibility of the subprime crisis spilling over into other parts of the economy. If the issues spread into the larger credit market, we will see a significant knock on growth, and it is this problem that has led to the significant dollar selling in the forex market. Yesterday, we talked about how the weak dollar made US assets cheap and attractive. But if the dollar continues to slide, then the assets being held drop in value. Just the perception of dollar weakness can ignite a massive sell-off in dollar-denominated assets.
It is not certain, however, that we will see the bottom fall out in the US dollar. Today’s currency trading has provided mixed signals for the future. French consumer spending was a positive, coming in at 1.6% vs. 0.7% expected. Italian Retail Sales was a slight disappointment, however, rising only 0.1% vs. 0.3% expected. Even worse, the manufacturing PMI reading fell to 54.8. Not only is that lower than the 55.5 forecast, but it is the first time the reading fell below the 55.0 level since February 2006. The Eurozone economy is much more dependent on manufacturing and exports than either the United States or Great Britain, and this may be the first sign that the high exchange rate is dampening European growth. The mixed bag of data threw currency traders for a loop and kept the euro trading around 1.3800.
So what can we expect from the forex markets in the future? New French President Sarkozy is still clamoring for more political say in the decisions of the European Central Bank. What that means for us is that he wants a larger emphasis placed on stimulating growth as opposed to containing inflation (low interest rates). ECB President Trichet should be able to resist this intrusion, and the monetary policy makers are likely to raise rates to 4.25% by October of this year. That is fundamentally positive for the euro, especially since the US Fed is likely to keep rates constant for the rest of 2007. But technical analysis of the forex market does paint a different picture, as most signs point to the euro being overbought and the US dollar being oversold. As such, instead of seeing the EUR/USD march toward 1.4000, we should instead see a correction and a rise in the value of the dollar.
July 24, 2007 No Comments
Inflation has always been an important concern for currency analysts, if only because it has a direct relationship with interest rates. Central banks have a mandate to keep inflation under control, and so signs of rising inflation indicate a strong currency. But the new paradigm of an increasingly international economy could leave monetary policy makers impotent in the face of global inflationary surges.
Commodity prices are near record highs, and interest rates do not have the power to completely moderate supply-side inflationary pressures. Oil is selling for almost $80/bbl, and there are market analysts who believe we are likely to see $100 oil by 2008. That would put oil at the $100 level one full year before Goldman’s now infamous oil projections of last year. Gold and food prices are also through the roof (they are the primary driver of high prices in Australia and New Zealand). With growing demand for commodities from developing economies, price pressures are not in line to let up anytime soon. In the forex market, the most prominent consequence of the commodity boom is the incredible rise of the three major commodity currencies (Canadian dollar, Australian dollar and New Zealand dollar).
But more troubling for fans of domestic monetary policy is that inflation is also being stoked by rising prices for finished goods and services. This phenomenon has surprised many observers because it seems counterintuitive to the idea of globalization. Free trade was supposed to lead to higher efficiency and lower prices. But with emerging markets all over the world on the rise, we are seeing more and more wealth in the developing world. A booming economy naturally leads to higher prices, and the Chinese yuan, Indian rupee and other emerging market currencies have appreciated significantly this year. Goods from these countries are now more expensive, and so as we buy imports from the rest of the world, we see China and India and Brazil exporting inflation.
Growing wealth in the world’s developing areas has other consequences of inflation as well. Rich foreigners buy assets in the developed economies, and more buyers drives up the price of these assets. This is partly the cause of exploding real estate prices in London. For those concerned about the US dollar, we should note that the weak dollar makes US assets especially attractive. It is as if US products were being sold at a discount relative to prices in the past. This is why foreign ownership of US securities reached record levels last May. But forex traders should still keep track of the current state of the US dollar. Traders like to invest in markets that are growing (and economies that are healthy. So while a weak dollar might be good for the US economy, a weakening dollar is bad. And with central banks less powerful in the face of the new global economy, we might not be able to do anything about it.
July 23, 2007 No Comments
As the U.S. dollar fell to record lows against the euro last week, technical analysis may indicate an earlier than expected rebound in the short run. Last week traders speculated long-run rebounds due to the U.S. economy benefiting from a weak dollar and from pressure on the ECB by Nicolas Sarkozy to cool a strengthening euro. But as traders have been eyeing the Relative Strength Index (RSI) on the EUR/USD pair, there is a possibility of a short-run rebound.
The RSI measures the strength of a currency pair price movement typically within the past 14 days. When the RSI is over 70 there is a good chance the price movement will fall. At over 70 most sellers who have been looking to sell perceive the current price to be the best price. On the other hand, buyers will likely wait for the price to fall when the RSI is in fact over 70.
Thus, in the context of the current EUR/USD pair, the RSI is at 76.34 today hinting at a future fall in favor of the dollar. The U.S. currency did in fact make a small gain to $1.3817 per euro this morning. This level is up from last week’s record low of $1.3845, but not enough to indicate an actual rebound. Nevertheless, the high RSI value may indicate a rebound sooner than expected.
Currency Outlook and Strategy:
On July 25th, the National Association of Realtors is due to report figures on last month’s existing U.S. home sales. It is expected that U.S. existing-home sales have fallen the lowest in 4 years. This could further hurt investor confidence in the dollar. Looking across the Atlantic, European Central Bank Executive Board member Lorenzo Bini Smaghi states he is not worried about euro appreciation. But Nicolar Sarkozy, newly elected French President, thinks otherwise.
Tim Shea, currency analyst at FXCM, concludes: “This week in the Euro looks very quiet news-wise. We’ve got next to nothing on the European calendar, and pretty much just housing data and GDP in the USA. So, watch the housing numbers and the Dow for some direction, and don’t forget about $75 per barrel oil.â€Â Â
July 23, 2007 No Comments
The Chinese government has been under a great deal of pressure recently to allow the country’s currency to appreciate. The yuan has been on a managed flat regime since July 21, 2005, when it was first taken off its fixed dollar peg. And since that date, the yuan has actually appreciated 9.3% against the dollar. But that has not done much to cool China’s overheated economy. Most market observers agree that the domestic stock market is overpriced and likely nearing the bursting point of a bubble. China’s exports are hitting record highs bringing with them enormous trade surpluses that only exacerbate the trade inequality between the United States and China. US lawmakers have whipped themselves into a frenzy criticizing China and its exchange rate regime (saying the yuan is undervalued).
China has tried to deal with these problems in a variety of ways. Earlier this summer, the government raised the country’s capital gains tax, hoping to cool the stock market rush. Just last night, the central bank raised borrowing and lending costs by 0.27%. But market speculators suggest that in conjunction with the release of that decision, the government also sold large quantities of yuan on the open market. And so between the announcement of the interest rate hike and the close of trading at 5:30 PM in Shanghai, the yuan actually fell 0.14% to 7.5740.
Most analysts believe the yuan is on track to gain in value, however. Standard Chartered Plc, which does 2/3 of its business in Asia, forecasts a gain of 1.9% to 7.42 by the end of this year. By the end of 2008, the yuan should be all the way up to 7.00 per dollar, according to bank forecasts. But the appreciation is expected to be modest in character as the Chinese government is loath to use the currency to manage the economy. An undervalued currency is still too important for the export-driven economy, and inflation and liquidity (while at high levels) are not at crisis points yet. And so look for the yuan to stay undervalued with relation to the dollar for the time being.
Speaking of the US dollar, forex traders saw a consolidation of the currency after Fed Chairman Bernanke’s congressional testimony yesterday. The greenback stemmed its losses and looks as if it has entered a period of relative stabilization. The US dollar might even be ready to break out against the pound, euro and yen in the coming days and weeks. For a more detailed evaluation of those and other popular currency pairs, check out DailyFX.com’s 2007 Third Quarter Forex Market Outlooks.
Bernanke spent a good deal of time on the subprime mortgage crisis, even admitting that the total losses could amount to over $100 billion. But most of his testimony concerned the growth and inflation forecasts for the US economy in 2007. This is in marked contrast to his predecessor as Chairman, Alan Greenspan who loathed forecasts and projections. Bernanke’s style is formatted to a more transparent rendering of Fed decision-making, and this is good news for forex traders. More information and more transparency mean less volatility in the currency markets. Admittedly, a decrease in volatility is less exciting for some traders, but I would gladly sacrifice the excitement (and anxiety) for more safety and security in my investments. Especially since, over the long run, Bernanke’s style is conducive to a more profitable investment strategy.
July 20, 2007 No Comments
The Chinese economy has grown at its fastest rate in 12 years during the second quarter. China’s GDP growth has increased to 11.9 percent from a year ago. This figure has exceeded all expectations from 23 economists at Bloomberg. Inflation has risen to 4.4 percent in June, the fastest rate since September 2004. The Chinese economy is on fire and needs cooling. The most obvious is a change in monetary policy. There is much speculation the Chinese central bank will increase interest rates and in turn this will strengthen the yuan. But is revaluation by direct policy of the yuan needed?
According to Glen Maguire, chief Asia economist at Societe Generale SA, a strict revaluation by the central bank is needed in order to quell the surge. He indicates the yuan may even need to appreciate as much as 3.5 percent in a single day. A stronger yuan would slow down the economy by making exports more expensive and thereby reducing China’s enormous trade surplus. U.S. lawmakers have been very keen on a strengthened yuan, claiming that U.S. companies have been taking hits by its artificially low value. Senator Charles Grassly has spoken on the issue extensively stating the Chinese currency has not risen fast enough.
Despite U.S. and Chinese economists having met and agreeing on the same direction for the yuan, the Chinese central bank does not want a fast acceleration. Bank of China Governor Zhou Xiaochuan has stated he does not want the yuan to accelerate nearly as fast as the U.S. would prefer. Other currency analysts do not see the yuan appreciating to unprecedented levels anytime soon. According to Tim Shea, a currency analyst in the Sales and Trading Department at FXCM, “China has shown since the initial dropping of the peg in 2005 that the strengthening of the yuan would happen gradually and at their own pace.” He points out, “…that a 3 percent change in one day would be a move of 2200 pips, the equivalent of all the movement made since January. This would not be in line with past policy.â€
We have also seen changes in Chinese fiscal policy to help the cooling process. Inflation has actually outpaced the return on bank deposits spurring investments in the equities market. The benchmark CSI 300 stock index for the Chinese market has gained 87 percent this year. In response, fiscal measures have included legislation allowing the 20 percent tax on interest income to be reduced or even taken away. As a result, fixed-income investments have increased to 26.7 percent in the first half of the year from a year ago. Even though this increase in savings is modest in comparison to the spurring equity run, a future meltdown of the Chinese economy is unlikely. With the right fiscal and monetary policy the Chinese economy will continue to grow at a controllable pace. The yuan will strengthen, but most likely at a pace unsuitable to U.S. lawmakers.
July 19, 2007 No Comments
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