Category — United States Dollar

The state of the US economy is not dire, but it certainly does not bode well for the US dollar.  Job creation was at its lowest level since February, with the NFP printing at an abysmal 92K.  But even worse for the dollar is the fact that job numbers are not the cause of growth or decline in the economy.  Payrolls are a reflection of demand; as house prices depreciate and take personal income down with them, that creates less of an incentive for businesses to grow.  In recessionary times, businesses are always slow to cut jobs, as the fall in labor always lags behind the fall in production.  The chance of a US recession will lead the greenback to fall against all the other major currencies.

As of right now, however, the idea of a recession is a little overstated.  But even if the economy is only stumbling (and will pick up later in the year), the US dollar is still going to take a hit.  That is because in this current market, equities are on line to fall even further.  US stocks have already been underperforming for years now compared to foreign equities markets.  And with fixed income in the United States more and more attractive because of the rising risk aversion among traders, that phenomenon is only going to continue.

Even the Fed policy meeting on Thursday is not likely to improve the mood of traders or dollar bulls.  That interest rates will stay the same is a market consensus, and Bernanke seems less inclined than his predecessor to act as a stock market savior.  The “Greenspan Put” should be pronounced dead, and forex observers can expect the announcement on Thursday to remain hawkish on inflation.  The futures market is pricing in a 100% chance of an interest rate cut in early 2008, but I believe the Fed funds rate will remain at 5.25% through the end of 2008.

The problems in the US housing market are a concern, however.  American Home Mortgage declared bankruptcy this morning, becoming the second-biggest lender to do so amid the subprime fallout.  Bear Sterns continues to take hits, with S&P announcing a negative on its debt rating.  The primary beneficiary of the weakness in US assets is the euro.  Ever since its inception, the euro has acted as the anti-dollar, providing an alternative for currency traders soured on the US market.  That is certainly the case right now, as euro bulls are having a field day.  Look for EURUSD to test 1.3900, and if it can overcome the resistance there, then the pair should see clear sailing through 1.4000.

After the euro, the other major currency to benefit in this forex climate is the Swiss franc.  Look for the Swissie to be the biggest gainer against the US dollar this week.  The low-yielding currency has found support as the carry trade has unwound.  As painful as carry trade unwind has been for those shorting the franc, history tells us that we are not even close to done yet.  The franc already hit a two-year high against the US dollar early this morning, with USDCHF reaching 1.1868.  The Swiss franc is both a growth story and a safe haven in a time of risk aversion, making it extremely attractive to currency investors.

After modest gains this week, the U.S. dollar fell against the yen and euro on news of poor U.S. jobs growth. A government report today showed 92,000 jobs added for July, falling well below expectations as 126,000 jobs were added in June. Economists at Bloomberg predicted 127,000 new jobs for the past month. In addition, the unemployment rate rose unexpectedly to 4.6 percent up from 4.5. These are signs the U.S. economy is still hurting from the subprime crisis as investors are losing this week’s earlier appetite for risk. The dollar fell to $1.3727 against the euro this morning in New York, down from $1.3703 yesterday. The increase in risk aversion has also caused the dollar to fall against the yen from 119.21 yesterday to 118.93 this morning.

Poor U.S. job growth and resulting increase in unemployment may prompt the U.S. Federal Reserve to lower interest rates this year to reboot growth. This may be a sharp change in monetary policy as rates have been kept strictly at 5.25 percent for 2007. Mathew Strauss, a senior currency strategist at RBC Capital Markets Inc. in Toronto, comments: “The payroll number raised concern that the slowdown in housing may start to affect growth. It seems one supporting factor for U.S. consumers may start to lose ground—a strong labor market.” Investors betting on futures contracts on the fed fund rate due in December changed forecasts on the yield to 5.02 percent, down from 5.21 percent from a month ago. The Fed will next meet on August 7^th.

Currency Outlook and Forecast:
The decisive factor for the future U.S. dollar movement is the subprime crisis. The big question bothering investors is whether the U.S. housing slump will spill over into the rest of the U.S. economy. Speaking on this issue, Jim Rogers, co-founder along with George Soros of the Quantum Fund, believes losses from the subprime-market have a long way to go. According to Rogers: “This [subprime defaults] was one of the biggest bubbles we’ve ever had in credit.” He forecasts U.S. investment banks and homebuilders will take further hits. Bear Stearns stock fell 13 percent last week. Shares in other investment banks such as Merrill Lynch and Lehman Brothers also fell this week.

Kathy Lien, chief currency strategist at FXCM, forecasts August to be a tough month for the U.S. dollar. She believes tighter credit and the housing blowup will have significant negative effects on the U.S. economy this month (see her article at dailyfx.com). Don’t expect steady long term gains in the dollar anytime soon, especially as the Fed may be lowering the borrowing rate later this year.

The US Non-Farm Payrolls report disappointed the forex market this morning, listing only 92K new jobs.  We should have expected this based on the dreadful ADP survey, but ADP has a history of missing the mark on Non-Farm Payrolls.  And so economists were actually expecting 127K new jobs, and the US labor market did not deliver.  With less than 100K new jobs, the NFP puts the Fed on track to cut interest rates in early 2008, which may benefit the equities market when it happens but it kills the US dollar in the meantime.

The US dollar has benefited from risk aversion recently (or at least been sheltered from the turmoil in the equities markets) by its status at a store of value.  People find US assets safe, and so those traders invested in riskier environments (the carry trade) have parked their money in dollar-denominated assets for the time being.  But the euro is also safe, and right now there is great opportunity to trade EURUSD with this morning’s jobs report.  A general description of how that trading should be done can be found on DailyFX.com.

The important thing to consider is that most currency traders had already priced in high expectations for US payrolls.  Had the economy met those expectations (or even exceeded them) the market would have just yawned.  But the downside disappointment is surprising and so the negative FX reaction to the NFP should be steep.

The foreign exchange market should not destroy the US dollar, at least in the short-term, because of the inherent value that many traders place in the stability of the US currency.  But the American economy is reeling from the housing and mortgage crisis (exacerbated by the falling stock market), and the news will provide impetus for many traders to move out of dollar-denominated assets.  One place to move into is Europe, because as Kathy Lien of FXCM notes, the surprise press conference for the ECB yesterday almost certainly confirms an interest rate hike in September.

Jim Rogers, the man who made billions with George Soros in the 1980s and correctly predicted the commodity boom in 1999, calls the US housing market one of the biggest credit bubbles ever.  The US economy may not be able to just absorb the shock and move on.  Manufacturing will not be able to sustain its strength forever.  There are even reports in Bloomberg that risk appetite is returning to the market.  If this continues, then the US dollar will fall even more, as the ability of US Treasuries to store value will no longer be as prized.  There does not seem to be much good news for dollar bulls in the current FX environment, and the future does not look much brighter.

We’ve been talking about the carry trade unwind for the past couple of days.  The moves in the forex market yesterday and during Asian trading last night ran counter to that assumption.  There was a reversal upwards in the yen crosses, especially CADJPY, AUDJPY and NZDJPY.  The late rebound in the Dow also buoyed USDJPY, as that currency pair has assiduously followed the ups and downs in the equities markets for some time now.  But I am here to tell you that the prognosis with regards to the currencies in the United States and Japan is still yen-positive and dollar-negative.

Let’s starts with the bad news for the US dollar.  The bond market is pricing in a 100% chance of an interest rate cut in January.  DailyFX.com has a fascinating take on the interest rate speculation through a look at the comments of various US monetary policy makers, with the ultimate scenario suggesting a more dovish outlook for the Fed.  The ADP survey shows terrible job growth numbers, coming in at only 75K.  Earnings for most US corporations continue to be relatively stellar, but the money refuses to trickle down, and dollar bulls may have to come to terms with a slowdown in US expansion.

Coming to the yen, most currency analysts see still more room for the room to grow.  The Chicago Board Options Exchanges’ market volatility index (VIX) hit a yearly high yesterday, and greater volatility is a death knell for the carry trade.  Kathy Lien of FXCM posts a two-year chart of USDJPY that will not provide comfort for yen bears.  The interesting thing about the chart is not that it necessarily signals a move downward in the currency pair but that it demonstrates the potential of a possible drop.  And that drop would be disastrous for those still long on the carry trade.

For some months now, dips in the yen crosses have not really been something to worry about; rather, these dips have been seen by Japanese retail investors as opportunities to short the yen.  There has been talk all over the market about “Japanese housewives” beating the pros and serving to stabilize the market by keeping carry trades alive.  But a recent Bloomberg report claims that the risk appetite for Japanese traders is dropping.  They are wary of selling the yen now because they anticipate still more appreciation for the currency, which has the potential to be a self-fulfilling prophecy.  And contributing to the growth of the Japanese yen are the losses all over the hedge fund market in the United States.  The hedge funds were some of the primary drivers of the carry trade, and their exits from the forex market (at least in this limited capacity) might serve notice to the rest of the market that the carry trade is, indeed, unwinding.

A worldwide credit crunch and economic problems (mainly in the United States) have torched the equities markets for the past two weeks.  There are fears that the subprime mortgage crisis and the housing problems will escape their respective sectors and infect the market as a whole.  The losses are magnified by the uncertainty of many traders, exemplified by the VIX volatility index surging past previous levels.  As is usually the case in a situation like this, risk aversion is controlling the market.  With regard to foreign exchange trading, two phenomena emerge: a flight to safety for capital and a carry trade unwind.  As Boris Schlossberg of DailyFX.com notes, the only winners in this scenario are the US dollar and the Japanese yen.

Flight to safety in the forex markets is beneficial to the US dollar, at least temporarily.  This is because investors pare back from riskier investments and park their capital in dollars for the time being.  The result is a peculiar situation where the crumbling of US markets is actually a boon for the US dollar.  But traders should realize the dollar strength will not last.  As for the US stock market, there is a sense that the credit crisis is reaching other areas; there are reports in Bloomberg that situation with subprime mortgages are hurting the earnings of companies across the spectrum.

And the economic reports have been mixed.  The regional manufacturing surveys (Philly Fed and Chicago PMI) have disappointed, confounding observers who thought the weak dollar would allow exports to support the manufacturing sector.  But unemployment is in line to grow by 100K for the NFP report later this week.  How traders react to that data will determine the long-term direction of both the US economy and the US dollar, but on a short-term basis, the dollar looks good.

Growing risk aversion also creates problems for carry trade longs.  Yen bulls have killed the fx market for the last two weeks.  There has been a 1000 pip decline in GBPJPY (from its record high), and the yen has also gained 700 points against the three commodity currencies.  In fact, the yen improved against all 16 most highly traded currencies last night.  Carry trade lovers cannot start crying over their losses yet, however; Kathy Lien of FXCM claims there is still plenty of room for the yen to appreciate.  Fear is the dominant factor ruling the currency market right now, signaling a strong near-term weakness in the Australian dollar and the New Zealand dollar, two currencies that have gone up significantly on the back of the yen-based carry trade.  I am not one who believes that the credit crunch puts us in line for a global slowdown (and the great thing about trading currency is that it doesn’t matter—there is the same opportunity for profit in a bear market as there is in a bull market).  But I think traders should be wary of high risk investments and focus instead on more stable currencies and economies.

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.

Global equities markets took a beating last week. The phenomenon began in the United States (on the back of subprime mortgage concerns) and it spread to the financial markets in other countries. For the forex market, the primary impact of the losses was a return of risk-aversion. The risk appetite of currency traders has waned, and as a result, the yen-based carry trade has begun to unwind. The US dollar has also appreciated significantly as investors run to the safety of US assets. But the search for yield and the changing fundamentals of the market complicate matters, and the current trends may not last.

Regarding the carry trade, it is risk aversion driving the FX market. Japanese fundamentals stink, with Retail Sales disappointing to the negative and deflation sill a concern. But the yen continues to gain as greater market volatility hurts the carry trade. But this is all dependent on the equities market. If the Dow recoups its losses this week, we will see a renewal of the yen carry trade.

The US dollar also saw some improbable gains this past weekend. With investors more conscious of risk, the stability offered by dollar-denominated assets is more appealing. Americans, concerned about losing their gains overseas, repatriate their holdings into US dollars. For international traders, the US dollar becomes a store of value, just like holding gold or silver. Emerging markets in Asia were especially hard hit as overseas investor sunned riskier assets in favor of American ones. This particular phenomenon is controlling the currency market, overpowering economic factors that would pull back the US dollar (like the disastrous Existing Home Sales report).

But the forex market changes very quickly, and if last week’s equities market decline proves temporary, then we could see both a resumption in the carry trade and a plunge in the US dollar. The yen already began giving back some of its gains in European and Asian trading this morning with EURJPY, GBPJPY, AUDJPY and NZDJPY all riding upwards. And the US dollar cannot maintain its status as a store of value forever.

The latter situation is pretty interesting. The dollar benefits from its use as the currency of choice in international trade and as the primary denomination in foreign reserves. We have talked in the past about how other countries are starting to move away from the US dollar both in terms of international trade and in terms of foreign reserves. And there are reports in Bloomberg today of increasing protectionism with regard to foreign ownership of assets in the United States and Europe. This hurts the dollar and the euro because it makes dollar- and euro-denominated assets less attractive. And US fundamentals do not look like they are going to get better anytime soon. A recent Fed report suggests that even the weak US dollar may not help the trade deficit. We may see temporary gains in the greenback and the yen, but a long-term outlook does not bode well for either currency.

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 4^th quarter. There is still room for rates to rise in Europe, so investors will start to favor European currencies over the dollar.”

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 4^th, 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.

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 24^th 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.  

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.