The United States Federal Reserve’s interest rate announcement and accompanying statement is scheduled to be released today at 2:15 PM Eastern Standard Time. Barring a complete surprise, the Fed is likely to leave interest rates at 5.25% and issue a statement hawkish on inflation. With contradictory data regarding economic growth and interest rates, the bank cannot do any more. A move in either direction would prove harmful.
Economic growth in the United States is actually rather sluggish and does not bode well for the US dollar. In today’s GDP report, we saw that the economy grew 0.7% in the first quarter of 2007, the slowest pace in four years. This number was higher than the estimates last month of 0.6% but lower than the forecast of 0.8%. The economy certainly is not growing at the pace it was last year, when the last quarter of 2006 registered growth of 2.5%.
Various sectors of the economy have felt the effects of the economic slowdown. The housing market is undergoing it biggest slump in two decades. Demand for housing seems to fall with every new report, and the sub prime woes have led to the number of foreclosures reaching record highs. Consumer spending, which makes up the largest portion of the US economy, is cooling, mainly due to higher energy prices. Its growth this quarter is half what it was last quarter. Business investment is also falling, suggesting that the slow growth this quarter may not be an aberration. Yesterday’s durable goods report showcased a larger than expected drop in May.
But even considering all this bad news, the FOMC cannot lower interest rates to stimulate the economy. And the reason why is rising inflation. Prices continue to rise, at a pace with which the Fed is certainly not comfortable. Today’s numbers showed a 2.4% rise in core inflation, stripping out food and energy costs. That is certainly discomforting to policy makers, especially compared to the 2.2% rise that was expected. And when you consider that the Fed under Chairman Bernanke has professed to prefer inflation within a 1-2% range, you further get the sense that inflation is a big worry. That is why interest rates are not likely to change, and the statement from the Fed is bound to be tough on inflation (Kathy Lien has a more detailed discussion of the Fed’s decision on interest rates).
What does the Fed’s announcement mean for the US dollar? The cable should continue to rise, especially in anticipation of the likely interest rate hike in the next BoE meeting. GBP/USD should not have much trouble staying above 2.000. The euro should see some gains as well, with similar expectations on the interest rate decision of the ECB. The yen is a little bit more interesting. With core prices falling yesterday, the country’s battle with deflation is not yet over. As long as the Fed remains consistently hawkish in its statement, we might see a reversal of yen gains against the dollar with USD/JPY testing 125.00 soon.
June 28, 2007 No Comments
Carry trades are still a ubiquitous feature of the forex market, but the driving force in the market today is not Japanese interest rates. The ten-year US bond market has been the largest influence on international currencies. The bond market has suffered recently, and the high yields have provided crucial support for the US dollar. Especially with little US economic data on the docket for this week, currency traders are increasingly relying on yields to make their bets.
Yesterday, the US dollar gained ground against the Japanese yen, the euro and the Canadian dollar while losing ground against the New Zealand dollar, British pound and the Swiss franc. The most interesting part of that scenario is that, with the exception of the Swiss franc, the dollar gained against every currency over which it had a yield advantage and lost against the currencies that had a yield advantage over it. What we should ask ourselves is why US bond prices continue to fall? Unfortunately, there is not a clear cut answer to that question. But it might have something to do with the sub prime mortgage loan crisis in the United States, typified by the shutdown of two large hedge funds by Bear Sterns.
The effects of this on the currency market are startling. While carry trades are in play, much of the momentum for the USD/JPY growth is certainly coming from high US yields. With 10-year bond yields again reaching 5.15%, the forex market is simply shrugging off most other economic news. Wednesday’s European economic data was actually pretty heartening. PMI readings, especially in manufacturing, were better than expected, but the euro still fell against the dollar, as US yields determined the action.
The general situation repeated itself this morning. The Federal Reserve Report for Philadelphia came out, and there were more first-timers on the unemployment rolls. But the rest of the data was strong, with manufacturing picking up after a long layoff. But the movement in the currency market was dollar-negative. The US dollar lost most of its gains versus the Japanese yen and the Euro on the basis of falling bond yields. The Germany IFO Business Climate Report is scheduled to be released at 4:00 PM today, and the data is likely to be positive. But if recent forex activity has shown us anything, it’s that what happens to US 10-year bonds will matter more when it comes to currencies.
June 21, 2007 No Comments
The defining action this weekend had traders basing their decisions almost entirely on yield differentials between countries. In many cases, broad economic data was ignored in favor or inflation expectations and interest rates. That’s why it is so important for foreign exchange traders to study the futures charts and determine which central banks the market thinks are likely to raise interest rates. Example number one is the state of the US dollar. Friday’s CPI report drove the market for the dollar. Core prices rose only 0.1% in May, signaling that inflationary pressures were under control and in line with the growing economy. As such traders in the forex market see no reason for interest rate hikes in the near future, and the dollar has suffered as a result.
The Japanese yen and the Swiss franc have also fared poorly in the currency market mainly due to interest rates. The economic situation in Japan and Switzerland is completely different. The Swiss economy is robust and growing at a rapid pace, while the Japanese economy, despite satisfactory GDP growth, still has to contend with weak consumer demand. Yet both currencies are experiencing a similar freefall; low interest rates in both Japan and Switzerland make carry trading especially attractive.  The Bank of Japan not only did not raise rates in their meeting last week, but its comments suggested that it was unlikely to raise rates next time either unless consumer demand picked up. The Japanese economy is simply not ready for interest rate hikes.  In Switzerland, despite much stronger economic data, the SNB chose to only raise rates by 25 basis points. This did not do nearly enough to cut the rate differential between the franc and the other European currencies.
The situation is only exacerbated by the possibility of interest rate hikes by both the Bank of England and the European Central Bank. The currency market is loading up on both the pound and the Euro in anticipation of in anticipation of those future rate hikes. Hawkish comments about inflationary pressures by European Central Bank council members continue to bid up support for the Euro (EUR/USD at highest in two months) despite poor Industrial Production and Retail Sales data. In England, BoE Governor Mervyn King is as hawkish as ever concerning rising inflation. The likelihood of rate hikes is being priced into both currencies, leading to gains across the board, especially against the US dollar, Japanese yen and Swiss franc.
June 18, 2007 No Comments
The Yen was hammered last night in the forex market. In the Bank of Japan meeting there was a decision to keep the overnight lending rate at 0.5%, the lowest among all the major currencies. All the major currencies increased against the Japanese yen as it became obvious that rate differentials were not going to compress. But as Boris Schlossberg of DailyFX.com points out, the losses probably had as much to do with the bank’s reluctance to commit to a rate hike in August as they had to do with today’s decision. The policy makers in Japan admitted that they were more worried about the still-lagging domestic consumer demand than they were about the admittedly undervalued currency.
Carry traders continue to rejoice with the non-move in interest rates. With no danger of a US rate cut, USD/JPY reached a fresh 5-year high. There is cause for some worry for carry traders in the currency market. The undervalued yen has led to an advantage for Japanese companies overseas. There has already been complaining in Europe about this advantage. If policy makers in the US jump on this bandwagon as well, it could lead the BoJ to institute a preemptive rate hike.
Going back to the dollar, there are a few signs of continuing dollar strength. On June 14, we saw PPI numbers that positively surprised the forex market. Almost all recent data that has come out the US has been higher than expected and supported dollar bids. And in the last week, high bond yields have continued to suggest an interest rate hike by the Fed.
But today’s data shows creeping signs of dollar weakness. Home mortgage rates last month reached record highs, as did foreclosures. With that kind of negative push on the US economy, it might be unwise to raise rates at the time. In addition, today’s CPI report came in surprisingly tame, with a lower-than-expected rise in prices. Production at factories, mines and utilities declined last month, and consumer expectations have been underwhelming. A repeat of this kind of performance in coming days might give the Fed some cover for a rate cut. And it is that fear that allowed EUR/USD to gain so strongly yesterday.
June 15, 2007 No Comments
The US stock market rebounded from recent lows yesterday. The Dow rose 187 points, and that has a significant effect on the international currency market. This is especially true with regard to the carry trade, specifically, with regard to the Japanese yen-based carry trade. Through the years, technical analysis comparing the forex market with the equities market has shown a long-term positive correlation between the carry trade and the stock market (more on the relationship between the carry trade and the Dow).Â
           The stock market rose on the back of this month’s Beige Book Report, which was slightly more optimistic than last month’s report. The relatively decent condition in all the Fed districts gave many traders a reason to invest. And as we would expect, carry trades took off yesterday. The Yen currency crosses rose, with the USD/JPY hitting a four year high and the Australian dollar was up to a 15 year high. As the Dow continues to rise (and there’s no reason it should stop), this should support the carry trade and drive the Yen lower.Â
           But investors should be wary of uninterrupted gains through the carry trade. Goldman Sachs Groups Inc. has just issued a notice for carry traders, warning of higher volatility upcoming in international markets. This volatility would not only be evident in the stock market, but in the currency markets as well, proving disastrous for carry traders. There is a feeling among some forex traders that we are approaching a bottom in volatility. Of course, for a one-way bet like the carry trade, low volatility is essential for continuing positive returns. But we might be approaching the mature end of the current growth cycle, and history has proven that traders have had difficulty predicting monetary policy at these times.Â
           There are examples of this in recent forex market developments. Traders in both the US and Canada have been moving back and forth in the futures market on the subject of rate hikes or rate cuts. Speculation has been rife on future policy changes by central banks in Asia, Europe and the Americas. A return to high volatility in either equities or foreign exchange could spell the doom for carry traders. In the end, the carry trade should be a viable strategy for now, but traders should not hope for positive gains forever.Â
June 14, 2007 No Comments
The rise of prices in base metals has caused possessiveness and even theft of various common items made of these now more valuable metals. This theft and vandalism, what some call the “Red Gold” Rush, has been hurting basic functions of society. In Italy copper has been ripped off of bridges, train equipment, and tombs. In some cases, like at South Africa construction sites, the crime is organized.
The value of the metal has gotten to the point where it is worth more than the coins it is used to make. This excerpt in from the Wall Street Journal:
U.S. Mint officials said they were putting into place rules prohibiting the melting down of one-cent and five-cent coins. The rules also limit the number of coins that can be shipped out of the country. Officials said they had received a number of inquiries from the public in recent months concerning the value of the metal in the coins and whether it was legal to melt them.
Because of the prevailing prices of copper, zinc and nickel, the cost of producing pennies and nickels exceeds the face value of the coins.
A nickel is 25% nickel and 75% copper. The metal in one nickel costs 6.99 cents. When the Mint’s cost of producing the coins is added, the total cost for each nickel is 8.34 cents.
Modern pennies have 2.5% copper content with zinc making up the rest of the coin. The copper and zinc in a penny are worth 1.12 cents.
December 15, 2006 No Comments
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