The forex market has not been kind to the US dollar recently. Losses have been sustained across the board, and DailyFX.com has even proclaimed the dollar as on the ropes. And there is plenty of data to support that assertion. Retail Sales printed last week at a loss of 0.9% versus an expected gain of 0.2%. That by itself triggered huge concerns in the currency market because of the influence that retail sales has on consumer spending, which is 2/3 of the US economy.
This overall dollar weakness was felt throughout the forex markets. USD/JPY finally saw some real unwinding in the carry trade, further weakened by the decision made by Iran to accept yen in payment for oil. The decision may signal an overall shift away from dollar-dominated international trade. GBP/USD continues to test multi-decade highs, confounding industry “experts,” primarily through the central bank’s hawkish stance on inflation. The commodity currencies continue to kill in the market on the back of high oil and gold prices. Even the euro is threatening record levels, despite the historic unwillingness of the ECB to allow that kind of appreciation.
But investors might be underestimating the resiliency of the US dollar. The recent releases concerning job and wage growth both surprised to the upside, suggesting that the situation surrounding consumer spending might not be as dire as we may think. The New York Fed Factory Index printed this morning at 26.5, surprising a market that was only expected 18. The state of manufacturing nationwide looks pretty rosy and it can only be helped by the weaker US dollar. But that’s still not the main reason that I am still bullish on the greenback.
It’s because of inflation; more specifically, it is because the Fed continues to be worried about inflation. There is a growing movement internationally to focus on headline inflation, instead of core inflation, which is more commonly considered now but excludes energy and some food prices. Oil is still above $70/bbl and according to Bloomberg.com, we might be experiencing the biggest boom in food commodity prices in years. Headline inflation is likely to stay high because of those two factors, and that is likely to keep interest rates up. The only thing the Fed can really control is prices and as long as that is its focus, the dollar will not be lacking in support.
July 16, 2007 No Comments
You might have been expecting Patrick to talk about this one (he loves Canada), but he’s a little busy with China right. So you got me. The Bank of Canada raised its benchmark interest rate this morning to 4.50%, and the forex market…well the forex market basically yawned. The USD/CAD pair did retract somewhat from the 30-year low hit yesterday, but the growth did not amount to much. The loonie is still in a position of strength, and some currency analysts are even talking about parity in the USD/CAD.
Much of the recent growth in the Canadian dollar can be attributed to the international bull market for commodities. Commodities make up just about half of Canada’s exports. The price of oil just came down from its 10-month high, but it is still above $70/bbl. That is especially significant because there is an amazing 85% correlation between the price of oil and the value of the loonie with relation to the greenback. The prices of copper and gold are also on the ascent, and that is going to provide further support for the loonie.
But the story of the Canadian dollar cannot be explained only by commodity prices. Wages are up a phenomenal 3.5% this year. Core inflation, subtracting energy and food prices, was at 2.2% in May, an improvement over the 2.5% level in April, but still above the 2% target set by the central bank. This allows the bank some leeway to raise interest rates again this year. The appreciation of the Canadian dollar hurts exporters to some degree (and the world’s ninth-largest economy is still primarily driven by exports), but policy makers in Ottawa believe that a stronger currency might do more good than harm.
Basically, the bank is not going to let USD/CAD approach 1.000. The central bank will intervene in the forex market before that happens. But with the pair trading at a little above 1.05 now, do not be surprised to see levels of 1.04 soon. Some currency traders and analysts have already priced in two more rate hikes by next March. And they might not be far off, considering the following statement accompanied the interest rate announcement this morning: “some modest further increase in the overnight rate may be required to bring inflation back to target over the medium term.” For right now, I would bet on the Canadian dollar and be careful when I am on a submarine (dolphins apparently like to watch).
July 10, 2007 No Comments
The recent report on U.S. jobs growth came in stronger than expected. The forecast for new jobs in June was 125,000, but instead the report showed 132,000 new workers being added. This is below the 190,000 workers added in May, but it beat expectations nevertheless. Wages also increased as reports showed average hourly earnings to have increased by 3.9 percent in June. Further reports showed the unemployment rate to be held steady at 4.5 percent for the third month.
In response to this news of strong economic performance treasury yields have increased as investors are worried about inflation. During this week, the rate on the 10-year note climbed 15 basis points. This has been the biggest increase since the 16 point increase in the week of June 16, 2006. The economy has been doing better than expected amid the subprime mortgage crisis. This has given bond holders reason to believe that there is potential for increases in inflation, and thereby, have increased demand for higher yields. If inflation does go higher than the target level, then the Fed is likely to increase interest rates to cool to economy.
On the other hand, Janet Yellen, President of the San Francisco Federal Reserve Bank, has indicated that the Fed should not change interest rates. According to Yellen, the best way to achieve faster growth while maintaining a low level of inflation in the current state of the economy is by keeping interest rates steady. Despite a very robust economy, Yellen indicates that inflationary pressures are not strong enough to hurt the goods and labor markets. She is more worried about future problems that are yet to come from the subprime mortgage defaults.
It is difficult to say where the value of the U.S. dollar will stand in the next two months. There are mixed opinions among investors and policymakers as to where interest rates will be held. The next FOMC meeting is not until early August.
July 6, 2007 No Comments
The forex market has become used to dollar strength against the yen. This year, the yen is the worst performing currency against the dollar among all the highly traded currencies. But there are conflicting opinions as to whether that trend is likely to continue into the second half of the year. The majority of currency analysts call for a push upwards in USD/JPY, but there are some influential voices calling for caution for dollar bulls.
The Non-Farm Payrolls Report came out this morning, and the US economy added 132,000 jobs last month, versus the market prediction of 125,000. Job growth in May was revised upwards from 157,000 to 190,000. Wage growth also picked up, and unemployment remained at the 6-month low of 4.5%. Primarily, this data should signal a rebound in consumer spending, and it confirms the anti-inflationary bias for the Fed. At the very least, growth no longer seems to be a concern, and US interest rates are not likely to go down.
During their meeting last week, the Fed said that the low jobless rate created the potential for inflation. They were expecting a moderate pace of growth, with most economists predicting growth in 2.75% in the second half of this year. Seeing as how today’s NFP Report validates this thinking, the Fed’s hawkish stance on inflation is likely to continue.
And that spells bad news for the yen. Early morning trading today saw the dollar gain the most in three weeks against the yen. While much of this characteristic of overall greenback strength across the board, it also could signal a resumption of the USD/JPY carry trade after some time of profit-taking. The interest rate differential and the differing pace of consumer demand in the two countries reinforce the carry. The yen is also hurt by rising US yields, as treasuries took a beating with ten-year yields going to 5.18%. Also important to note, the ten-year bonds rose faster than the two-year bonds, suggesting an uptick in expectations of inflation.
But dollar bulls are not without significant opposition in the currency market. As first reported by Bloomberg.com, Federal Reserve Bank of San Francisco President Janet Yellen is somewhat dovish on interest rates. She advocates leaving interest rates unchanged for a long time, as that would best encourage growth and discourage inflation. Yellen warns carry traders specifically, arguing that “‘carry trades’…expose investors to ‘substantial exchange-rate risk’ that they may be underestimating.” The low borrowing costs in Japan have created an untenable situation.
Standard Chartered Plc, a London-based bank, does even further in its analysis of a possible carry trade unwind. Currency analysts at the bank argue that volatility in the dollar-yen exchange rate will decline as the interest rate differential closes up. Standard Chartered claims that by the end of the year, US rates will decline 0.25 percentage points to 5.00% and the overnight lending rate in Japan will increase 0.25 percentage points to 0.75%. These two moves, when coupled together, will kill volatility in the currency pair. The final diagnosis is that the dollar will fall to 122 yen by the end of the year.
When the analysis leads to two divergent positions (as we have now), how can we profit? The good news is that most of the disagreement is over the long-term positions of the two currencies. In the short-term, there is a forex market consensus of dollar strength. As Boris Schlossberg of DailyFX.com points out, retail investors in Japan just keeping hopping aboard the carry trade gravy train. We should see the pair test 125.00 soon, and possibly break the resistance on the back of today’s positive data.
July 6, 2007 No Comments
Those who thought the US economy was slumping (including me) are wrong. Or at least that’s what today’s information tells us. The ISM survey for the month of June reported at 60.7, up from 59.7 in May. The ADP Employer Report counted 150,000 new jobs this month. That is a significant increase from the 100,000 new jobs expected this month.
What does all this mean for currency traders? The job report is important with regard to interest rates. A number under 100,000 would have been increased speculation for an interest rate cut. The Non-Farm Payrolls Report is still scheduled for Friday, but today’s news suggests that growth picked up in the second quarter. Some economists are even suggesting the likelihood of a 3% surge in the economy by the end of the year.
If the Fed does not have to worry about a slowdown in growth, then it can turn all of its attention towards inflation. We have already seen the importance of curbing inflation on the decisions and comments of monetary policymakers. Central banks around the world are maintaining hawkish stands in the face of growing worldwide energy prices. Now that we’ve seen the Fed’s expectations of moderate growth being met, the US dollar should see a rush of support. The greenback has been up today against both the pound and the euro. Carry trades should also pick up (or at least continue) as interest rates all over are destined to remain high.
July 5, 2007 No Comments
With oil prices still hovering around $70/bbl (and with a realistic possibility of $80 oil), world prices are not likely to go down anything soon. Both headline and core inflation are on their way up, and that makes inflation more of a concern for central bankers than growth. What that means for forex traders is continuing hawkishness for monetary policy makers and a steady rise in interest rates all around the world.
The Bank of England led the way today, raising interest rates to 5.75%. The accompanying statement was not as hawkish as some currency analysts were expecting, however. The central bank made the claim that inflation was starting to get under control, with CPI nearing the 2% target level. And new Chancellor of the Exchequer Alistair Darling came out and said that the higher interest rates should prove a burden on new debtors in England, especially those with fixed rate mortgages. Trade union groups as well as the business lobby have protested the rate hikes, citing a possible brake on growth.
But housing prices in Great Britain are still as high as they have even been in years. The financial services industry in London is booming, carrying the economy to its largest growth in three years. M3 money supply in England is growing at a dangerous pace, and the Monetary Policy Committee members recognize the inflationary risk there. Taking into account the rapid growth of credit and broad money, the MPC left open the possibility of future rate hikes this year. In fact, most forex market analysts expect at least one more move upwards in the interest rate, bringing it to 6.00%.
In confirmation of that fact, December short-sterling futures went up to 6.33% shortly after the interest rate decision. The British economy has been resilient thus far to interest rate hikes, and the Great Britain pound should benefit. GBP/USD is up 3% this year and GBP/JPY is up 6%. Fundamentals point to the pound continuing to be a great buy and currency traders should continue to provide bid support for the sterling. Look for the cable to test 2.0500 in the coming days and weeks.
July 5, 2007 No Comments
The pound reached a new 26-year high against the dollar last night. Still short of the important 2.0200 level, the gain was still impressive and primarily fueled by speculation on interest rates. Among the major forex countries, there are a number of central banks having their meetings this week, but the Bank of England is the only one likely to raise interest rates this time. With regard to GBP/USD, currency traders are being driven by the search for the highest yield. With the Fed not likely to change rates any time soon, the differential is pushing the cable to new highs.
The strength of the pound in the forex market should not surprise most market observers; Terri Belkas of DailyFX.com predicted the new high in the cable last week. The money supply is Great Britain is growing at an astronomical rate. House prices continue to surge, and labor conditions are extremely tight. The recent CPI report is at 2.5%, above the 2.0% level preferred by the BoE. The latter might be the most important factor leading to Thursday’s rate hike, as Monetary Policy Committee member Kate Barker has said that the bank’s credibility is dependent on keeping inflation in check.
The pound was down yesterday against the Japanese yen, the Swiss franc and the euro, but its long-term strength seems secure. Construction PMI printed this morning at 60.1, compared to the expected results of 57.7. The economy seems like it can withstand future rate hikes with the threat of collapse. With oil still above $70/bbl, worldwide inflation is not going to go away. The BoE is the only bank likely raise interest rates this week. And the futures market has even priced in another rate hike later in the year, which would bring the interest rate in Great Britain to 6.00%. It is no wonder, then, that even with new terror threats in London and Glasgow, market observers are predicting even greater highs in the forex market for the pound against the dollar.
July 3, 2007 No Comments
As U.S. interest rates remain unchanged at 5.25% for the 8th straight Federal Reserve meeting, and as terrorist arrests in London spur worldwide concern, the U.S. dollar has dropped against major currencies. The dollar fell 0.5% to 1.3605 per euro and 0.6% to 122.44 yen. Investors have become more risk-averse with the recent geopolitical events. As a result, demand for the yen and the swiss franc, a haven for security, has increased. According to Derek Halpenny, senior currency strategist at the Bank of Tokyo-Mitsubishi UFJ in London, interest-rate differentials will continue to move against the U.S. dollar as a result of the unchanged U.S. monetary policy.
This trend may continue in the long run. Despite recent positive reports of increased retail sales and job growth, investors are worried that losses from hedge funds owning subprime mortgage bonds will slow economic growth. This increase in risk aversion has caused an increase in holdings of risk free debt. Treasury holdings are at 35% of funds overseeing $315 billion in bonds. This is 1% higher than holdings in corporate and sovereign debt for the second consecutive week. In the previous month for the first time in a year, U.S. treasuries have outperformed corporate and emerging-market bonds.
Investors like Bill Gross of Pacific Investment Management Co. are speculating that the housing slump will restrain the economy for the rest of the year. The subprime mortgage crisis is the worst since 1991, and the effects may even be felt next year as well. Investors are speculating that the Federal Reserve will be forced to lower interest rates in the long run in order to induce consumption.
What will lower interest rates mean for the value of the U.S. dollar? Lower interest rates will cause a drop in the value for the U.S. currency. If the Fed does in fact decide to lower interest rates, in the attempt to avert further dampening effects on the economy by the housing meltdown, currency traders will decrease demand for the U.S. dollar. A decrease in demand in will bring down the value of the currency.
July 2, 2007 No Comments
The weakness of the Japanese yen in currency markets has been good news for Japanese companies. Exports have always made up a large part of the country’s economy, and a weak currency has given the companies a competitive advantage. But recent reports out of Japan suggest that the yen depreciation might not be all good. The rise in exports may be offset by higher input prices and lower purchasing power for domestic consumers. And we have not even considered how politically dangerous the yen depreciation could prove to be internationally.
Trading in the forex market was pretty yen-positive at the beginning of last week. The first few days were about strength in the Japanese currency, with gains across the board. But with overall household spending, manufacturing PMI, housing starts and inflationary data all coming in lower than expected, the currency took a nosedive. Even with this morning’s positive TANKAN release, Japan continues to wage a battle against deflation, preventing the Bank of Japan from raising interest rates. This allows forex traders to continue to cash in on their carry trades.
Using the real effective exchange rate compiled by the Bank of Japan, the yen has fallen to a 22-year low against the currencies of its major trading partners. And while that may create a competitive advantage with regard to exports, its costs may be even higher. Japan imports almost all of its energy needs, and with oil rising above $70/bbl, energy costs for companies skyrocketed 10-20% for Japanese companies.
The undervalued currency also creates problems in competition practices. Rhetoric regarding an “unfair advantage” (because of the currency) has been ratcheted up both by United States lawmakers and multinational competitors. The weak currency also makes many companies too dependent on export demand. Companies are able to do well so easily that it eliminates some of the incentive to improve. Conditions are starting to approach those of 1998, when the yen gained 10% against the dollar in two days following the Russian debt default. Mainly because companies had relied too much on easy exports, GDP ended up falling by 2% that year. A currency that is this undervalued is not conducive to steady future growth, and many companies are starting to realize the problem. And so the Bank of Japan may actually have some political cover regarding future rate increases this year.
July 2, 2007 No Comments
Reports in Canada showed unexpected zero economic growth for the month of April, the Canadian dollar came crashing down from a 30-year high. The Canadian currency dropped to 94.16 U.S. cents from yesterday’s 94.39. The zero growth report comes as a big surprise, for there had been a 0.3 percent increase in March. Investors have been betting on Canada’s Central Bank to increase interest rates in the attempt to lower the persistent inflation. A higher interest rate would mean an increase in value for the Canadian dollar. However, investors with long positions have been caught off guard as the Central Bank is very unlikely to raise interest rates as previously expected. Instead, interest rates are likely to go down in the attempt to reboot the economy.
Interestingly, the Canadian dollar had been trading at a 30-year high earlier today as crude oil prices rose above $70 per barrel. The value of Canada’s currency is highly dependent on the price of crude oil. This is because more than half of Canada’s commodities exports are crude oil. In January 2002, the Canadian dollar was at a record low at 61.76 U.S. cents when the price of oil was at $18 per barrel as compared to $70 today. Yet, today’s tumultuous drop in value shows that pessimistic investor expectations about future interest rates have a higher impact on Canada’s currency fluctuation.
The tremendous drop in value of the Canadian dollar against the U.S. dollar has hurt Canadian exports. As Canada and the U.S. have a close trade relationship, further impacts on the Canadian economy could be seen. Canadian exporters, such as Vancouver based Canfor Corp., have already taken hits. Canfor, as North America’s fourth largest lumber producer, posted a 1st quarter loss of $42.7 million Canadian. The company gets about 85% of sales in U.S. dollars. This is just another reason why the Central Bank will be unable to hike interest rates. Companies losing on the currency exchange will need lower interest rates for future investment purposes.
The U.S. Federal Reserve has reported marginal inflation increases and steady consumer spending may cause the dollar to become more attractive in the long run (Kathy Lien at DailyFX has more on the short term effect). This potential increase in value will likely further hurt the Canadian dollar.
June 29, 2007 No Comments
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