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.â€Â 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
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. Â
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. Â
July 2, 2007 No Comments
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
The market for emerging market currencies is entering an interesting phase. As I mentioned yesterday, global risk aversion is on the upswing. That would suggest a capital flight from emerging markets to more blue chip investments like the US dollar. But conversely, record commodity prices all over the world have boosted demand for these emerging market currencies to an extent that has not been seen in recent years.
To illustrate this dilemma, it’s important to understand what risk aversion does to forex demand in different parts of the world. US Treasury bonds have historically been some of the safer investments internationally. With the recent volatility in the foreign exchange market and the US equities market, demand for bonds has skyrocketed. Bond yields have dropped to 5.07%. Investors have bailed out of riskier investments, including high-yielding and emerging market currencies. Even when bond yields were at record highs a couple weeks ago, empirical data has shown that international central banks had not been the ones to start the sell-off.
But counteracting this flight to safety is the attractive of emerging markets. Brazil is a great example. The Brazilian real is at 1.905 per dollar, up 9.6% this year and 59% over the past three years. The real’s meteoric climb has been supported by a pair of factors. Record commodity prices in iron ore, orange juice and soybeans have led to record current account surpluses. Foreign investment in Brazilian stocks and bonds has led to record capital account surpluses. Most economists believe that the currency level will stay constant for the rest of the year. But there is some hope for short sellers as a vocal minority warns of a drop to 2.5 reals per dollar on the back of lower commodity prices.
The rest of Latin America is caught in a similar situation. Risk-averse investors are cashing out right now. But overall, the appetite for high yields is insatiable. High demand for commodities, from corn to copper to oil, continues to push currencies higher. But investors must proceed with caution. The market for emerging market currencies is relatively illiquid; meaning the risk for potential volatility is much higher.
June 26, 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 yen carry trade remains strong in the foreign exchange market, but before analyzing why that is the case, let’s look at some specific exchange rates. The US dollar has fallen in recent trading versus the euro (EUR/USD) and the pound (GBP/USD). Bond yield in the US have declined from their record highs. Home builder confidence is at its lowest in sixteen years. And the CPI numbers last week (with core prices rising only 0.1%) demonstrate the slowing pace of inflation. Put those factors together, and you get weak support under the dollar.
The pound and the euro, however, continue to receive strong bids in the currency market. Much of this has to do with a growing consensus among traders concerning the likelihood of a rate hike by both the ECB and the BoE. President Trichet of the ECB recently came out and said the new emergence of many fast-growing economies around the world is creating a upward pressure on prices. These hawkish comments were coupled with remarks by other ECB members asserting the ability of other European economies to withstand a future rate hike.
The flipside of this strength is the persistent weakness of the Japanese yen. There is optimism among Japanese policymakers (after the GDP and Industrial Production data), but the growth is still not robust enough to survive higher interest rates. This is especially true with regard to the Japanese consumer. And the low interest rates in Japan prove irresistible to carry traders.
Take the EUR/JPY pair. It hit an all-time high of 166.12 yesterday eventually settling at 165.91. The euro-yen has been a one way bet recently, and the tame US inflation reports will keep it that way. The carry trades are unlikely to be interrupted in the near future considering the low risk of global inflation in the current currency market. The US inflation data signals lower volatility in international exchange rates in the future. So traders have more confidence that they can capture the differences in yields in two countries without the risk of losing those gains thorough market swings in the exchange rates.
But there is one important caveat for enthusiastic carry trades. BoJ governor Fukui has said that it is important for the country to raise real interest rates to help domestic pension plans. There is also a concern for political repercussions in Europe and the United States if the continuing devaluation of the yen proves to be too much of an advantage to Japanese exporters. Lastly, 10 year bond yields in Japan have reached 1.935%. Yield levels of 2.00% or higher could lead to a return to the domestic bond market for Japanese institutional investors. That by itself could push the Japanese currency up, destroying carry trades.
June 19, 2007 No Comments
Our monthly reports tell you what countries and currencies offer the best deals. Travel and buy smart!