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
Commodity currencies have been beating up on the US dollar and the Japanese yen recently and yesterday was no different. The Canadian dollar, the New Zealand dollar and the Australian dollar all hit new highs, an occurrence so common in that last couple of weeks that’s most traders simply yawned. Some of the underlying support for these currencies comes from high commodity prices, especially oil and gold, of course. But much of the gains should also be attributed to weakness in the US dollar and the yen carry trade.
It is pretty easy to spot the strength the commodity currencies have derived from greenback bears. The data released in the respective countries has not been really great. Canada’s inflation numbers yesterday printed lower than expected. Australia and New Zealand have not released much data recently, and what has been released has been worse than expected.  But the rise of the Loonie, Aussie and Kiwi cannot be stopped. And that can be traced back to the sluggishness of the US dollar. And the market consensus after Fed Chairman Bernanke’s speech is that US interest rates are likely to stay the same for some time. Bernanke also seemed more concerned about the slumping housing market than he has been in earlier speeches. And so the commodity currencies should continue to benefit from the weak dollar.
The other factor fueling the fresh highs in this area of the forex market is the yen-based carry trade. The interest rate advantage for Australia and New Zealand compared to Japan is enormous, and currency traders just cannot seem to get away from the high yields. And that differential is likely to get higher as the futures market lists a 66% probability that the Reserve Bank of New Zealand will raise the country’s interest rates, already the highest in the industrialized world, at its next meeting. Most currency analysts are pricing in another rate hike this year for the Royal Bank of Australia as well.
The appetite for risk (as well as the hunger for yield) in the market is tremendous, and the surging carry trade is reflective of that. AUD/USD is at an 18-year high and NZD/USD is at its highest level since the currency was floated in 1985. While the amazing rate of appreciation might be hurting the country’s exporters, the situation is only exacerbated by the weak greenback. It is because of this phenomenon that the Canadian dollar is up 12% already this year, with the USD/CAD hitting 1.0416 this morning, its highest level since 1977. But the latter pressure is not likely to go away anytime soon as many analysts are touting the weak US dollar as good for the American economy.
July 19, 2007 No Comments
It seems like every day the euro hits another high. At least, that’s been the story of the forex markets for the last five days. A combination of dollar weakness and the market’s belief in the Eurozone economy has pushed the euro to new heights. Yesterday was no different. Bear Sterns officially warned their hedge fund investors that there was no value left in the fund. With fears of the subprime crisis already strong in their minds, traders were worried that foreign investors would seek to move away from US assets. Especially after the recent diversification of foreign exchange portfolios (basically, the selling-off of US Treasuries), the Bear Sterns news triggered a dollar decline. Even the poor German ZEW survey released yesterday did little to stem US losses.
But today’s news may signal a top in the EUR/USD pair. Consumer prices in the United States rose 0.2% in June. It is the smallest gain in five months but still a reversal from the drop in headline PPI seen yesterday.  Core prices also rose 0.2% versus an expected increase of 0.1%. Housing starts also rose 2.3% this morning, providing further support for the greenback. Lastly, Fed Chairman Bernanke is scheduled to give his semiannual report to Congress at 10:30 AM. Today’s data probably eliminate the possibility of interest rate hikes in the near future, leaving Bernanke free to remain hawkish on inflation. That’s why DailyFX.com reports that his speech is likely to be dollar bullish. EUR/USD has been trading within a range of 80 points for the last five days, but if Bernanke’s speech goes as expected, we could see a dollar-positive breakout.
Euro bulls should also be concerned about recent developments regarding the European Central Bank. New French President Nicolas Sarkozy has called for European finance ministers to be granted more influence in monetary policy decision-making. The most direct consequence of such a move would be a loss of political independence for the ECB, and that would not be good news for the euro. German policy makers have traditionally been for an independent central bank, but a recent Bloomberg.com report suggests that German Chancellor Angela Merkel may be coming around to Sarkozy’s viewpoint. ECB President Jean-Claude Trichet has warned against the disastrous consequences of such a development, even suggesting that it may violate the European Commission Treaty. This is an important situation for traders to stay on top of because if Sarkozy is successful in imposing political control upon the ECB, we could see the bottom fall out of the euro soon afterward.
July 18, 2007 No Comments
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
Recent developments in the forex market do not bode well for the US dollar. Short-term economic data is bearish. The long-term outlook for the US economy is getting worse every day. And the currency crosses are not just about dollar weakness as there is strong support for the other highly traded currencies (even the yen). To exacerbate matters for dollar bulls, there is a movement to unravel the dollar’s preeminent position as the financial medium of choice internationally.
A good place to start is the economic data released today: US Retail Sales. The Commerce Department reported a drop of 0.9% blowing past initial estimates of a drop of only 0.1%. It is the largest one month drop since August 2005. With oil prices above $70 per barrel and home values tumbling, consumers are being stretched further than many economists had anticipated.
The recent numbers put the US economy in a precarious position. Higher job and wage growth should be conducive for a steady pace of expansion. But the retail sales number is particularly significant. Retail Sales accounts for one half of all consumer spending which itself accounts for two-thirds of the economy. A slowdown in this sector could be a harbinger for a larger contraction.  Concern over this matter, coupled with the continuing problems over subprime loans sets the stage for greater bond demand and lower interest rates.
As if that wasn’t enough bad news for the US dollar, Iran has made some very troublesome moves. Bloomberg News has reported the National Iranian Oil Co. just asked Japanese oil refiners to pay for their oil imports ($10.1 billion worth) with yen instead of dollars. With rising tensions with the United States, the Iranians are trying to hedge their risk by limiting their dollar exposure. To this end, Iran is also seeking to diversify their foreign exchange holdings, limiting US dollar reserves to 20% of the total while buying more euros and yen. Central bankers in Venezuela, Indonesia and the United Arab Emirates are pursuing much the same course with regard to their foreign exchange reserves. USD/JPY is now down 0.22% to 122.13. Much of the reason the US dollar has been able to maintain much of its strength all these years despite long-term double deficits is because of its preeminent position as the currency of exchange throughout the world. If that position is being eroded (and it looks like it might be), then the decline of the dollar might be just beginning.
July 13, 2007 No Comments
The problems with sub prime mortgages might not be as contained as some observers have tried to claim. The S&P announced yesterday that they may cut the credit ratings on $12 billion worth of bonds backed by sub prime mortgages. And it is increasingly likely that if this decision is made, it will force a reevaluation of all similar assets in the US market. Rather than have the crisis confined to a particular sector, the mortgage situation reveals a poor and rotting basis for the entire economy.
This is bad news for the US dollar. The sub prime fiasco will spill over into the overall market for US securities and bonds. With US dollar-denominated assets less attractive, demand for the US dollar in the forex market goes down. The domino effect does not end there, however. The US market is the most important one globally, and problems there will trigger another bout or world-wide risk aversion. What that means for currency traders, primarily, is an unwinding of the carry trade. The problems with sub prime mortgages and CDO’s in the United States have some currency analysts suggesting that it may not even take an interest rate hike by the Bank of Japan to end the carry trade. Investors have even started to abandon US assets for Japanese ones, driving Japanese bond prices to their highest levels since last August, with USD/JPY nearing 122.00.
Dollar weakness is running rampant throughout the currency markets today. EUR/USD is approaching stratospheric heights with concerns in the dollar compounded by the likelihood of higher interest rates in Europe. A similar situation (although with better fundamental data) is playing out with the cable, as it crashes through 2.0300.  And the irony is this entire situation is that the US economy is generally pretty healthy. According to Bloomberg, growth is at the moderate target level and inflation is under control. Economically, the country is humming along like a trusted old car; it is not going to impress anyone but it isn’t going to give you any problems either. Despite all that, you might want to stay away from the greenback until further notice.
July 11, 2007 No Comments
Our monthly reports tell you what countries and currencies offer the best deals. Travel and buy smart!