Transparency But Not Truth!

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By Mike Conlon | April 26, 2011

Tomorrow will the be the first of the new, transparent Fed where Bernanke will attempt to get out in front of the population and attempt to get people to suspend their disbelief. While the Fed Chairman is clearly on the wrong side of public opinion with QE2 and the inflation it has caused, trying to convince people that what they are feeling in the economy is wrong just won’t work.

The reason is because there will be no truth to go along with the transparency. It will be very difficult to sway public opinion that there is no inflation when people see it in their daily lives. The debate over which metric of CPI to use to see the true effects of policy have left people with a lack of confidence in those in power. How this speech tomorrow will change this sentiment is anyone’s guess.

So in my opinion this will all amount to much ado about nothing, with the markets hanging on every word spoken, though I don’t think we will learn anything new.

Europe is open again after yesterday’s holiday and European stocks are higher as are US equity futures to start the day. Asian stocks were lower as are commodities, though today can’t be classified as either a risk-taking or risk-averting day.

In the forex market:

Aussie (AUD): The Aussie is higher as interest rate differentials and carry trades are driving market sentiment despite mild risk taking in the marketplace. An index of leading indicators came in higher than expected.

Kiwi (NZD): The Kiwi is the biggest gainer this morning ahead of tomorrow’s rate policy decision as maybe the market is sensing that the RBNZ could turn hawkish again. While the current expectation is the rates will be left unchanged, the added benefit of Dollar weakness has been driving price action.

Loonie (CAD): The Loonie is also mostly higher despite oil prices pulling back to just above $112. Friday’s GDP report will give more clarity into the Canadian economic situation.

Euro (EUR): The Euro is mixed this morning as both Dollar and Yen are weaker, though reports about a possible Greek debt restructuring have left the market un-phased. CPI data due out tomorrow is expected to show higher inflation.

Pound (GBP): The Pound is lower across the board ahead of tomorrow’s GDP report. CBI business optimism figures came in slightly lower than expected, and perhaps the distraction of the Royal wedding later this week has left the markets unimpressed with the Pound. (Click chart to enlarge)

Dollar (USD): The Dollar is weaker across the board ahead of tomorrow’s Fed meetings. There is increased speculation that the Fed will somehow try to continue to support the economy even though QE2 is expected to end in June. Consumer confidence figures are due out later this morning.

Yen (JPY): The Yen is also lower as the expectation of continued weak monetary policy has pushed traders toward higher yielding currencies. Retail sales figures are expected to show big declines later this evening, ahead of Thursday’s rate decision.

While I expect little in the way of learning something new tomorrow from the Fed, there is always the possibility of a surprise. However, the Fed has been pretty clear about its stance and its denials of inflation so I highly doubt that will change anytime soon.

But the market may be more concerned with how the Fed plans to exit QE2 and what that will do to the economy. What is clear is that the Fed needs to pick up the slack for the inaction occurring on the fiscal side of the equation, with politicians in Washington unable to work together.

Don’t expect to walk away from this new Fed format tomorrow with a warm and fuzzy feeling about the direction the US is going, and continue to be cautious. While there is always major volatility surrounding the FOMC meetings, I could see tomorrow turning out to be one big dud.

To learn more about how you can take advantage of world events through the currency market, be sure to check out our currency trading courses!

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Greek Debt Higher Than Expected

Greece’s deficit for 2010 was a higher-than-expected 10.5 percent for 2010 surpassing the projected 9.4 percent shortfall by more than a full percentage point. The news sent Greek bond yields higher and drew fresh comments suggesting Greece will require further assistance to avoid insolvency.

“I don’t think that Greece will succeed in this consolidation strategy without any restructuring in the future, or perhaps also in the near future,” Lars Feld, a member of the German government’s council of economic advisers, told Bloomberg Television’s Nicole Itano in Frankfurt. “Greece should restructure sooner than later.”

Source: Bloomberg

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Economic Theory Implies Canadian Dollar will Fall

Sometimes I wonder if I’m living in the clouds. All of my recent reports on the Canadian dollar were twinged with pessimism, and I argued that it would only be a matter of time before reality caught up with theory. While the continued surge in commodities prices has confounded everyone’s expectations, but other economic trends continue to work against Canada. In other words, I think that there is still a strong argument to be made for shorting the loonie.

To be sure, the rally in commodities prices has been incredible- nearly 50% in less than a year! Oil prices are surging, gold prices just touched a record high, and a string of natural disasters have driven prices for agricultural staples to stratospheric levels. Given the perception of the Canadian dollar as a commodity currency, then, it’s no wonder that rising commodity prices have translated into a stronger currency.

As I’ve argued previously, rising commodities prices are basically an irrelevant â€" or even distracting â€" factor when it comes to analyzing the loonie. That’s because, contrary to popular belief, commodities represent an almost negligible component of Canada’s economy. Canadian exports, of which commodities probably account for half, have recovered from the recession lows of 2009. On the other hand, the value of Canadian exports are basically the same as they were 10 years ago, when one US dollar could be exchanged for 1.5 Canadian dollars.

Consider also that Canada now imports more than it exports, and that the Canadian balance of trade recently dipped into deficit for the first time since records started being kept 40 years ago. Its current account has similarly plunged, as Canadians have had to finance this through loans and investment capital from abroad. Based on the expenditure approach to GDP, trade actually detracts from Canadian GDP. Any way you perform the calculations, commodities are hardly the backbone of its economy, account for about 15% at most.

As if that weren’t enough, the press is full of stories of Canadians that think their own currency is overvalued. Businesses complain that they can’t compete, and that banks won’t lend them the money they need to upgrade their facilities and become more efficient. Meanwhile consumers whine about higher prices in Canada, compared to the US. I think it’s very telling that their is now a 2-hour wait to cross the border from Vancouver, and shopping malls on the American side have reported a huge jump in business. Even the famous Big Mac Index shows that the price of a hamburger was already 12% higher in Canada back when the loonie was still hovering around parity with the US Dollar.

One area that higher commodities prices will be felt is inflation, which is nearing a two-year high and rising. At 3.3%, Canada’s CPI rate is now higher than in the EU. Given that the European Central Bank hiked rates earlier this month, it probably won’t be long before the Bank of Canada follows suit. In fact, forecasters expect the benchmark rate to rise by 50-75 basis points by the end of the year, from the current 1%.

This might excite carry traders, but probably few others. Besides, given that other central banks will probably raise rates concurrently, it can’t be assumed that carry traders will automatically gravitate towards the Canadian dollar. Not to mention that as I pointed out in my previous post, the carry trade is hardly a risk-free proposition. In this case, an interest rate differential of only 1-2% probably isn’t enough to compensate for the risk of a correction in the USD/CAD.

And that is exactly what I expect will happen. The fact that the loonie has shattered even the most optimistic forecasts is not cause for bullishness, but rather for concern. According to the most recent Commitment of Traders report, net long positions are reaching extreme levels, and it’s probably only a matter of time before the loonie returns to earth.

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Good Friday!

« Dollar Limbo! | Home

By Mike Conlon | April 22, 2011

But not good for forex trading!  Central banks are closed around the globe so liquidity is absent from the market.

I would avoid trading today even though the forex market is open, unless you want to line your broker’s pocket!

Happy Easter to those who celebrate it! 

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Forex Week in Review: April 16-21

It was a compact volatile trading week with the dollar hemorrhaging against all of its G10 trading partners and that includes Japan. With rate divergence influencing trade positions, this dollar bear market potentially still has ways to go. Some of the market moves have been exaggerated because of the lack of holiday liquidity, but, the dollars intention remains the same, and that is to underperform. The last dollar bear market between 1985 and 95 implies that the buck has ‘approximately-2% further to fall to match its depreciation at the same point in the bear cycle’.

EUROPE

• Greek government denies press reports on restructuring.
• Finnish elections saw an unexpectedly strong showing for the anti-EU True Finns party. The result could complicate negotiations over an EFSF package for Portugal and the mechanism for enlarging the EFSF.
• Spain successfully auctioned their bills, but at a lower bid-to-cover than at the previous auction.
• Euro-zone flash PMI’s surprised to the upside (57.7 vs. 57.5), showing little negative impact from the Japanese earthquake or higher oil prices.
• German PMI manufacturing on hold at record highs (61.7).
• Euro-zone services PMI moderated slightly from 57.2 in March to 56.9 in April, held down by a lower German print. The surveys continue to be consistent with very strong GDP growth at around 3% and supports expectations of additional ECB tightening, while at the same time reducing the expected impact of fiscal stress in the periphery.
• Finnish Prime Minister-elect backs Portuguese EFSF, but suggested that the Portuguese program may require some changes to secure Finnish approval.
• Riksbank hiked +25bp to +1.75% and revised CPI forecast higher.
• Spain sold €2.4b of 2021 bonds and €885.2m of 2024 paper to strong demand, supporting market expectations of the sovereign’s ability to weather its maturity schedule without resorting to EFSF funding.
• BoE April Minutes showed an unchanged voting pattern. Six members voted for leaving rates unchanged and three members voted for a rate hike. The sentence, indicating that some members from the dovish camp saw the case for rate hikes strengthening has been removed.
• Greek inverted 2/10’s yield curve spread reaches fresh extremes-1,244bp
• A soft German Ifo print for April (110.4 vs. 111.1). The level continues to point to very solid growth.
• UK Retail sales surprised to the upside with a +0.2%, m/m, gain in March (ex-petrol). In real terms, sales are flat on the quarter and rising only +1.0%, q/q in nominal terms due to the VAT hike in January. No real reason to hike rates any time soon.
• M3 and mortgage growth remained steady in Switzerland. M3 growth moderated slightly to +7.1%, y/y, while mortgages grew at +4.5%, y/y. This is should not impose any pressure on the SNB to consider policy tightening.

Americas

• S&P cut the US long-term credit outlook. “The US government risks losing its AAA credit rating unless policy makers agree on a plan by 2013 to reduce budget deficits and the national debt”.
• March US headline housing starts (+7.2% or 0.55m) bounced back from February’s very low levels (-18.5%), but the details suggests the US housing sector remains very weak. Building permits have climbed +11.2%, m/m, to an annual rate of +594k. However, year-over-year, overall new home construction was down -13.4%.
• Canadian inflation data beat all analysts expectations, marking the biggest monthly headline gain in 20-years (+1.1% vs. +0.3%) and the largest annual advance in nearly three-years (+3.3%). It puts the Governor on the back foot to hike in July.
• Canadian leading index rose faster than expected last month (+0.8% vs. +0.5%), it’s sixth consecutive gain, led by increases in the stock market (+2.2%) and housing index (+2.2%).
• US Sales of existing homes rose slightly last month (+3.7% to a seasonally adjusted +5.10m), but prices remain weak. The median sales price for an existing home was $159k, down -5.9% from the revised year-ago median.
• Canadian retail sales posted its first positive print in both nominal and real terms in February, providing a lift to February GDP growth. Headline retail sales rose at a slightly slower pace than expected in February, up 0.4% m/m versus expectations of a 0.5% m/m gain, while core sales accelerated by 0.7% m/m as auto sales dipped for a third consecutive month.
• US initial jobless claims fell less than expected last week, remaining above 400,000 for the second consecutive week. Both the extended benefits and emergency unemployment compensation benefits experienced declines.
• Philly Fed’s Business Outlook Survey plunged from +43.4 to +18.5

ASIA

• PBoC hikes reserve requirements another +50bp, for a cumulative +450bp of hikes since the cycle began. Market now expects the PBoC to hike the RRR another +150-250bp and the lending/deposit rates a further +135bp/150bp.
• NZD has sold off after proving resilient to last week’s carry-trade correction, the catalyst being weaker-than-expected CPI inflation of +0.8%.
• PBoC governor Zhou stated that China’s central bank FX reserves, which rose about +$200b into +$3trn in the first quarter, had exceeded a reasonable level and may have led to excessive liquidity and had exerted significant sterilization pressure.
• It’s rumored that the Aussie government is considering tax breaks on foreign sovereign investments in Australia, a good enough reason to want to own the highest yield G10 currency.
• Australia witnessed a stronger terms-of-trade, where export prices rose +5.2% and import prices rose +1.4%, q/q, pushing the terms-of-trade close to their 2008 and 2010 highs. This will give the RBA a good enough reason to want to raise interest rates (+4.75%).

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Icelandic Kronur: Lessons from a Failed Carry Trade

A little more than two years ago, the Icelandic Kronur was one of the hottest currencies in the world. Thanks to a benchmark interest rate of 18%, the Kronur had particular appeal for carry traders, who worried not about the inherent risks of such a strategy. Shortly thereafter, the Kronur (as well as Iceland’s economy and banking sector) came crashing down, and many traders were wiped out. Now that a couple of years have passed, it’s probably worth reflecting on this turn of events.

At its peak, nominal GDP was a relatively modest $20 Billion, sandwiched between Nepal and Turkmenistan in the global GDP rankings. Its population is only 300,000, its current account has been mired in persistent deficit, and its Central Bank boasts a mere $8 Billion in foreign exchange reserves. That being the case, why did investors flock to Iceland and not Turkmenistan?

The short answer to that question is interest rates. As I said, Iceland’s benchmark interest rate exceeded 18% at its peak. There are plenty of countries that offered similarly high interest rates, but Iceland was somehow perceived as being more stable. While it didn’t apply to join the European Union (its application is still pending) until last year, Iceland has always benefited from its association with Europe in general, and Scandinavia in particular. Thanks to per capita GDP of $38,000 per person, its reputation as a stable, advanced economy was not unwarranted.

On the other hand, Iceland has always struggled with high inflation, which means its interest rates were never very high in real terms. In addition, the deregulation of its financial sector opened the door for its banks to take huge risks with deposits. Basically, depositors â€" many from outside the country â€" parked their savings in Icelandic banks, which turned around and invested the money in high-yield / high-risk ventures. When the credit crisis struck, its banks were quickly wiped out, and the government chose not to follow in the footsteps of other governments and bail them out.

Moreover, it doesn’t look like Iceland will regain its luster any time soon. Its economy has shrunk by 40% over the last two years, and one prominent economist has estimated that it will take 7-10 years for it to fully recover. Unemployment and inflation remain high even though interest rates have been cut to 4.25% â€" a record low. The Kronur has lost 50% of its value against the Dollar and the Euro, the stock market has been decimated, and the recent decision to not remunerate Dutch and British insurance companies that lost money in Iceland’s crash will only serve to further spook foreign investors. In short, while the Kronur will probably recover some of its value over the next few years (aided by the possibility of joining the Euro), it probably won’t find itself on the radar screens of carry traders anytime soon.

In hindsight, Iceland’s economy was an accident waiting to happen, and the global financial crisis only magnified the problem. With Iceland â€" as well as a dozen other currencies and securities â€" investors believed they had found the proverbial free lunch. After all, where else could you earn an 18% by putting money in a savings account? Never mind that inflation was just as high; with the Kronur rising, carry traders felt assured that they would make a tidy profit on any funds deposited in Iceland.

The collapse of the Kronur, however, has shown us that the carry trade is anything but risk-free. In fact, 18% is more than what lenders to Greece and Ireland can expect to earn, which means that it is ultimately a very risky investment. In this case, the 18% that was being paid to depositors were generated by making very risky investments. As the negotiations with the insurance companies have revealed, depositors had nothing protecting them from bank failure, which is ultimately what happened.
Now that the carry trade is making a comeback, it’s probably a good time to take a step back and re-assess the risks of such a strategy. Even if Iceland proves to be an extreme case â€" since most countries won’t let their banks fail â€" traders must still acknowledge the possibility of massive currency depreciation. In other words, even if the deposits themselves are guaranteed, there is an ever-present risk that converting that deposit back into one’s home currency will result in losses. That’s especially true for a currency that is as illiquid as the Kronur (so illiquid that it took me a while to even find a reliable quote!), and is susceptible to liquidity crunches and short squeezes.

When you enter into a carry trade, understand that a spike in volatility could wipe out all of your profits in one session. The only way to minimize your risk is to hedge your exposure.

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A Familiar Game!

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By Mike Conlon | April 18, 2011

The markets are starting the week lower as risk aversion is dominating the action in this holiday-shortened week. In what has become a familiar scene, oil is trading lower as it gets bid up on Friday’s as market participants do not want to go short over the weekend as the risk in the Arab countries is still present.

Adding to risk sentiment are the usual Euro debt crisis rumors, which propose that rate hikes are going to cause Greece and Ireland to default. While this has to be a concern for the ECB, I’m surprised that more clarity isn’t being proffered. Perhaps some Euro weakness in the face of rising rates would be just what the ECB is hoping will happen.

In an attempt to slow down inflation, China raised the reserve requirements for banks again which is intended to curb lending.

Overnight, New Zealand reported CPI data that showed that inflation increased slightly less than expected. In the UK, asking prices for homes came in higher as lack of supply and overall inflation contribute to seller confidence. I guess it doesn’t hurt that London has become the “preferred destination” of former Arab dictators so the market could remain strong for some time.

It will be interesting to see if the US market can shake off the lower start and turn it around by the end of the day. Recently, the US market has seemed immune to negative news and keeps going higher, as Bernanke’s dollar destruction leaves traders few other alternatives.

In the forex market:

Aussie (AUD): The Aussie is mostly lower on risk aversion, but is faring better than the other commodity currencies due largely to its interest rate differential. The minutes from the RBA rate policy meeting are due out tomorrow, which I expect to have a dovish tone as a result of the recent run-up.

Kiwi (NZD): The Kiwi is lower across the board as CPI data came in lower than expected, perhaps dampening hopes of a rate hike any time soon. CPI showed a quarterly increase of .8%, pushing the YoY number to 4.5%, vs. expectations of 1% and 4.6% respectively. (Click chart to enlarge)

Loonie (CAD): The Loonie is also lower as oil has pulled back a day ahead of the release of CPI data. While Canada has not been seeing the inflation that some other regions have, building permits and housing starts figures will show whether or not the economy is moving forward.

Euro (EUR): The Euro is lower against all but the Kiwi as the rumors of a Greek debt restructuring and a possible block of aid to Portugal are making the rounds. PMI data is expected to contract slightly, and PPI data is expected to increase. (Click chart to enlarge)

Pound (GBP): The Pound is mixed under what would be considered a “normal” risk aversion day despite the fact that home asking prices came in higher than expected. The BOE rate policy meeting minutes will be released on Wednesday which could show increased worry over inflation. Retail sales figures come out on Thursday.

Dollar (USD): The Dollar is mostly higher on risk aversion, and Friday markets are closed here in the US. It’s a light week for news in the US, without today bringing some Fedspeak at various locations, and the Philly Fed is due out on Thursday, which could see higher volatility as we have a long market weekend.

Yen (JPY): The Yen is higher across the board on risk aversion as Asian markets were down over night. Trade balance figures are due out on Tuesday night, and I am a little surprised to see Yen continue to strengthen considering the major economic challenges they are facing.

We’ve seen this one before, folks. The markets push both oil prices higher on Friday’s because of the risk in the marketplace and when nothing significant happens, it sells off going into Monday. This helps take markets down (which isn’t a bad thing), and then US stocks tend to rebound to start the week. Rinse and repeat.

Except there is going to be the time when this game does not work, and the selling that starts the day could bring about a “big one”. The markets have been so pumped up on Fed easy-money steroids that sooner or later the bubble is going to burst. What the exact catalyst will be is anyone’s guess but at this point these markets are climbing the “wall of worry.”

In times like these it makes sense to proceed cautiously as no one knows where or when the next risk event may come from.

To learn more about how you can take advantage of world events through the currency market, be sure to check out our currency trading courses!

To follow these events live with a free, real-time practice account, click here! Don’t miss out on the world’s fastest growing market!

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UK Growth Expected to Decline

The British economy continues to wrangle with very weak growth even as consumers are being hammered by surging prices. The result is an inflation rate double the target “ideal” of two percent annual inflation. And while the last few years have not been a walk in the park, there appears little prospect for immediate relief.

In a speech delivered in mid December, Charles Bean, Deputy Governor for Monetary Policy and member of the Monetary Policy Committee (MPC), noted that the economy is showing signs of improvement, but cautioned that “it may be some while yet before normality is restored”.

That assessment was made four months ago and one would be hard-pressed to see any progress since then. Indeed, for the first quarter of the year, the situation may have actually worsened.

For four straight quarters in 2010, Gross Domestic Product made positive gains yet for the first quarter of this year, GDP actually fell by 0.5 percent. Despite this, the government still expects growth for the full year to be in the range of 1.7 percent â€" this may prove to be a bit optimistic.

Last week, the International Monetary Fund (IMF) reduced its outlook for the UK from 2 percent growth to 1.7 percent. The Organization for Economic and Development (OECD) cut its position even deeper dropping its earlier 1.7 percent prediction to just 1.5 percent. This makes it unanimous â€" the 2011 perspective for the British economy is actually bleaker now than at the beginning of the year.

Adding to the quandary is that consumer prices are rising at a much faster rate than overall growth. According to Britain’s Office for National Statistics, consumer prices rose another four percent in March following a 4.4 percent increase in February. The resulting inflation is rapidly outpacing gains in salaries and wages and is seriously undermining consumer buying power.

Consumer Price Index â€" Annualized Rate

Nov 2010 â€" 3.2%
Dec 2010 â€" 3.3%
Jan 2011 â€" 4.0%
Feb 2011 â€" 4.4%
Mar 2011 â€" 4.0%

 
Will Get Worse Before It Gets Better

Like several other developed economies, England faces a huge deficit made worse by the recession’s double whammy of reduced tax revenues and greater expenses arising from monetary stimulus to support the economy. Truth be told however, Britain has struggled with deficits for many years now and the situation has finally reached the point where it can no longer be ignored. Even with higher revenues expected this year, the budget shortfall for the current year is estimated at £140 billion (US$228.5 billion).

In its last budget, the government outlined plans to introduce significant spending cuts to the tune of £83 billion (US$133.5 billion) over the next four years. This is thought to be sufficient to balance the budget assuming higher government revenue as the economy recovers. This also assumes that the spending cuts will not impact those revenues and this is where things tend to get a bit sticky.

For the past six months, Bank of England Governor Mervyn King has argued against hiking interest rates to deal with the mounting inflation. King defends his position by blaming rising food and energy costs for a “temporary” spike in consumer prices suggesting that “core” inflation is actually quite low. King also suggests that as the impact of government’s spending cuts take effect, overall growth could decline even further.

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Where are Exchange Rates Headed? Look at the Data

At this point, it’s cliche to point to the so-called data deluge. While once there was too little data, now there is clearly too much, and that is no less true when it comes to data that is relevant to the forex markets. In theory, all data should be moving in the same direction. Or perhaps another way of expressing that idea would be to say that all data should tell a similar story, only from different angles. In reality, we know that’s not the case, and besides, one can usually engage in the reverse scientific method to find some data to support any hypothesis. If we are serious about finding the truth and not about proving a point, then, the question is: Which data should we be looking at?

I think the quarterly Bank of International Settlements (BIS) report is a good place to start. The report is not only a great-read for data junkies, but also represents a great snapshot of the current financial and economic state of the world. It’s all macro-level data, so there’s no question of topicality. (If anything, one could argue that the scope is too broad, since data is broken down no further than US, UK, EU, and Rest of World). The best part is that all of the raw data has already been organized and packaged, and the output is clearly presented and ready for interpretation.

Anyway, the stock market rally that began in 2010 has showed no signs of slowing down in 2011, with the US firmly leading the rest of the world. As is usually the case, this has corresponded with an outflow of cash from bond markets and a steady rise in long-term interest rates. However, emerging market equity and bond returns have started to flag, and as a result, the flow of capital into emerging markets has reversed after a record 2010. Without delving any deeper, the implication is clear: after 2+ years of weakness, developed world economies are now roaring back, while growth in emerging markets might be slowing.

Economic growth, combined with soaring commodities prices, is already producing inflation. (See my previous post for more on this subject). However, the markets expect that the ECB, BoE, and Fed (in that order) will all raise interest rates over the next two years. As a result, while investors expect inflation to rise over the next decade, they believe it will be contained by tighter monetary policy and moderate around 2-3% in industrialized countries.

The picture for emerging market economies is slightly less optimistic, however. If you accept the BIS’s use of China, India, and Brazil as representative of emerging markets as a whole, rising interest rates will help them avoid hyperinflation, but significant price inflation is still to be expected. I wonder then if the pickup in cross-border lending over this quarter won’t slow down due to expectations of diminishing real returns.

Any sudden optimism in the Dollar and Euro (and the Pound, to a lesser extent) must be tempered, however, by their serious fiscal problems and consequent volatility. As a result of the credit crisis (and pre-existing trends), government debt has risen substantially over the last three years, topping 100% of GDP for the US and 200% of GDP for Japan. Credit default swap rates (which represent the markets’ attempt to gauge the probability of default) have risen across the board. To date, gains have been highest for “fringe” countries, but regression analysis suggests that rates for pillar economies need to rise proportionately to account for the the bigger debt burden. According to a BIS analysis, US and UK banks are very exposed to Eurozone credit risk, which means a default by one of the PIGS would reverberate around the western world.

While I worry that such a basic analysis makes me appear shallow, I stand by this “20,000 foot” approach, with the caveat that it can only be used to make extremely general conclusions. (More specific conclusions naturally demand more specific data analysis!) They are that industrialized currencies (led by the Dollar and perhaps the Euro) might stage a comeback in 2011, due to stronger economic growth and higher interest rates. While GDP growth and interest rates will undoubtedly be higher in emerging markets, investors were extremely aggressive in pricing this in. An adjustment in theoretical models naturally demands a correction in actual emerging market exchange rates!

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Where's The Love?

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By Mike Conlon | February 14, 2011

Happy Valentine’s Day!Though there was no love for me this morning as I had some computer issues which have prevented me from doing a video this morning. Apologies to my audience.

And today there is also no love for the Euro, which is trading lower across the board as Portugal reported that its economy shrank by .3% last quarter for the first time in almost a year as government spending declined and taxes were raised. Portugal is potentially the next shoe to drop in the European debt crisis as there is still no meaningful resolution in place. Adding to Euro declines was the industrial production figures, which showed a slight decline in December.

Tomorrow is a news-worthy day; as the Euro zone will be reporting GDP figures.

This is also a big weak for the Pound, as tomorrow will bring CPI data which is expected to show rising inflation of 4%, nearly twice the BOE target. This will be followed on Wednesday by the BOE Inflation Report and jobless claims numbers which will show if there is any sign of a slow-down.

Japan will also have its rate policy decision tomorrow after reporting that GDP shrank less than expected. There is no change expected for the rate decision.

So today is kind of light on news, with important data due out later in the week. Markets are flat to slightly higher, electing to pause a bit after the excitement of Egypt last week. Going forward, it will be interesting to see if there is any contagion from the events that spread to other areas in the Middle East, and what that does to risk themes and markets overall.

In the forex market:

Aussie (AUD): The Aussie is higher across the board as gains in home loans rose more than expected. This helped prompt some risk appetite as Asian stocks were higher overnight, also benefiting from better than expected GDP in Japan and higher expected CPI data from China.  Tomorrow is the release of the RBA board meeting minutes.

Kiwi (NZD): Unfortunately for the Kiwi, it is not benefiting from risk appetite but perhaps that is helping to mitigate losses as retail sales figures came in worse than expected, showing a decline of 1.1% vs. an expectation of a decline of .4%.

Loonie (CAD): The Loonie is trading mostly higher as oil is slightly higher to start the day. On Friday, CPI data will be released which will show if there is any inflation that might concern the BOC and cause a potential rate hike in the near future.

Euro (EUR): The Euro is lower across the board after industrial production figures came in slightly lower than expected, showing a decline of .1% vs. an expectation of no change. In addition, Portugal’s reported GDP decline as the market re-focusing on debt as Portuguese bond yields are starting to rise. With no solution in sight to the debt crisis, keep an eye on Portugal as potentially the next domino to fall. (Click chart to enlarge)

Pound (GBP): The Pound is mostly higher ahead of tomorrow’s CPI and home price data and Wednesday’s Inflation Report from the BOE. The Central Bank may be running out of time to do something about monetary policy if inflation continues to rise and any rise in jobless claims will be perceived as negative.

Dollar (USD): The Dollar is trading mostly lower, as recent strength due to Euro weakness and risk aversion from Egypt have abated slightly. There’s no news here in the US today, but Tuesday will show advance retail sales figures followed by CPI data on Thursday. Expect the inflation talk to heat up this week, but with no real fixes in sight.

Yen (JPY): The Yen is also mixed this morning as GDP in Japan contracted less than expected, showing a decline of 1.1% vs. an expectation of a 2% decline. While the Japanese rate policy decision is expected to produce no change tomorrow, a focus is now on Japanese fundamentals could induce further weakness despite any risk events. (Click chart to enlarge)

There will be no love lost this week when some of the inflation data gets reported. Higher prices are being seen around the globe and this was one of the initial catalysts of the uprising in Egypt. It is only a matter of time before outrage reaches “most established� economies as well.

The UK will be first to react, as inflation there is approaching 4% and the BOE has still not made any changes. Here in the US, we will most likely be told again that there is no inflation so the Fed can maintain low interest rates. While the usual supply and demand rhetoric will be used to explain away the problem, I can assure you that low interest rates here in the US are one of the major contributing factors to global inflation.

It is no secret that the US is trying to inflate away its debt, and will attempt to do so on the back of the consumer. So keep an eye on the CPI data, and whether or not there is any public backlash over rising prices.

To learn more about how you can take advantage of world events through the currency market, be sure to check out our currency trading courses!

To follow these events live with a free, real-time practice account, click here! Don’t miss out on the world’s fastest growing market!

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Geithner Warns U.S. Debt to Hit Record

The U.S. has benefited from low-cost debt to rebuild the economy but the Treasury department issued a warning that the cost to service the debt will triple as interest rates rise. By 2016, it is expected that the interest cost alone to service the debt will reach 3.1 percent of Gross Domestic Product.

“It’s a slow train wreck coming and we all know it’s going to happen,” said Bret Barker, an interest-rate analyst at Los Angeles-based TCW Group Inc. “It’s just a question of whether we want to deal with it. There are huge structural changes that have to go on with this economy.”

Source: Bloomberg

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Forex Markets Look to Interest Rates for Guidance

There are a number of forces currently competing for control of forex markets: the ebb and flow of risk appetite, Central Bank currency intervention, comparative economic growth differentials, and numerous technical factors. Soon, traders will have to add one more item to their list of must-watch variables: interest rates.

Interest rates around the world remain at record lows. In many cases, they are locked at 0%, unable to drift any lower. With a couple of minor exceptions, none of the major Central Banks have yet raised their benchmark interest rates. The same applies to most emerging countries. Despite rising inflation and enviable GDP growth, they remain reluctant to hike rates for fear that they will invite further speculative capital inflows and consequent currency appreciation.

Emerging markets countries can only toy with inflation for so long. Over the medium-term, all of them will undoubtedly be forced to raise interest rates. The time horizon for G7 Central Banks is a little longer, due to high unemployment, tepid economic growth, and price stability. At a certain point, however, inflation will compel all of them to act. When they raise rates â€" and by much â€" may well dictate the major trends in forex markets over the next couple years.

Australia (4.75%), New Zealand (3%), and Canada (1%) are the only industrialized Central Banks to have lifted their benchmark interest rates. However, the former two must deal with high inflation, while the latter’s benchmark rate is hardly high enough for carry traders to take interest. In addition, the Reserve Bank of Australia has basically stopped tightening, and traders are betting on only one or two 25 basis point hikes in 2011. Besides, higher interest rates have probably already been priced into their respective currencies (which is why they rallied tremendously in 2010), and will have to rise much more before yield-seekers take notice.

China (~6%) and Brazil (11.25%) are leading the way in emerging markets in raising rates. However, their benchmark lending rates belie lower deposit rates and are probably negative when you account for soaring inflation in both countries. The Reserve Bank of India and Bank of Russia have also hiked rates several times over the last year, though again, not yet enough to offset rising prices.

Instead, the real battle will probably be fought primarily amongst the Pound, Euro, Dollar, and Franc. (The Japanese Yen is essentially moot in this debate, and its Central Bank has not even humored the markets about the possibility of higher interest rates down the road). The Bank of England (BoE) will probably be the first to move. “The present ultra-low rates are unsustainable. They would be unsustainable in a period of low inflation but they are especially unsustainable with inflation, however you measure it, approaching 5 per cent,” summarized one columnist. In fact, it is projected to hike rates 3 times over the next year. If/when it unwinds its quantitative easing program, long-term rates will probably follow suit.

The European Central Bank will probably act next. Its mandate is to limit inflation â€" rather than facilitate economic growth, which means that it probably won’t hesitate to hike rates if inflation remains above its 2% threshold. In addition, the front runner to replace Jean-Claude Trichet as head of the ECB is Axel Webber, who is notoriously hawkish when it comes to monetary policy. Meanwhile, the Swiss National Bank is currently too concerned about the rising Franc to even think about raising rates.

That leaves the Federal Reserve Bank. Traders were previously betting on 2010 rate hikes, but since these have failed to materialized, they have pushed back their expectations to 2012. In fact, there is reason to believe that it will be even longer than that. According to a Bloomberg News analysis, “After the past two U.S. recessions, the Fed didn’t start raising policy rates until joblessness had fallen about three- quarters of the way back to the full-employment level…To satisfy that requirement, the jobless rate would need to be 6.5 percent, compared with today’s 9 percent.” Another commentator argued that the Fed will similarly hold off raising rates in order to further stabilize (aka subsidize) banks and to help the federal government lower the real value of its debt, even if it means tolerating slightly higher inflation.

When you consider that US deposit rates are already negative (when you account for inflation) and that this will probably worsen further, it looks like the US Dollar will probably come out on the losing end of any interest rate battles in the currency markets.

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Week in Review-Feb 11th

It was a tough week for the carry trader. The markets started out acquiring higher yields driven by solid global growth and seasonality in the carry and momentum strategies. By week’s end, the dollar is broadly firmer, as popular carry trades continue to correct lower. There is no obvious macro driver for that move.Thrown in the concerns about Egypt, the PBOC’s decision to fix USDCNY higher, cautious comments from RBA’s Stevens and a BOK leaving rates on hold are seemingly weighing on global sentiment. Let’s not forget the Euro-peripheries, Portugal is back on the radar. Below, we have some of the highlights of the week.

EUROPE

• Cold weather took a toll on German factory orders in Dec. Orders declined -3.4%, m/m, well south of the consensus forecast at -1.5%. However, this can be partly attributed to cold weather and also to a base effect from the very strong +5.2% gain reported in Nov.

• German IP came in weaker than expected at -1.5%, m/m in Dec. vs. +0.2% consensus forecast (-0.6% in Nov.). Again, the weakness can be attributed to exceptionally cold weather. In the 4th Q combined, IP still rose a solid +0.8%, q/q.

• Bundesbank President Weber will drop out of the race to succeed ECB President Trichet in October. Weber was considered the front-runner, and his departure throws the field wide open. Weber is considered a hawk.

• The UK trade deficit reached a new record high in Dec., with the deficit increasing to £9.2b (vs £8.6b expected). However, again, cold weather is to be blamed. On the positive side, last month’s trade balance was revised to £8.4b from £8.7b.

• UK industrial production for Dec. came in line with expectations. IP advanced +0.5%, m/m, after a +0.6% print in Nov. (revised up from +0.4%). The result is respectable considering the weakness in services and construction due to cold weather, but the growth was concentrated in the utilities sector. Manufacturing production declined -0.1%. The BOE left rates unchanged as expected (+0.5%). The market is pricing in a hike as early as May.

• Swiss CPI fell -0.4%, m/m in Jan. despite a Jan VAT hike. As a result, headline inflation fell to +0.3%, y/y from +0.5%, y/y in Dec., much weaker than the consensus forecast of +0.6%, y/y.

Americas

• Canadian monthly building permits rose in Dec. +2.4% vs. market expectation of +2%. It was the first in permits in three-months following a -10.5% decline in Dec and a -6.2% decline in Oct.

• Treasury’s $24b 10-year auction drew the most demand on record from a class of investors that includes central banks. Indirect bidders bought 71.3% of the notes, compared with 53.6% last month and an average of 46.4% for the past 10 sales.

• Bernanke kept to ‘his’ script and doused the hawkish comments of his colleagues, Lacker and Fischer who implied earlier this week that the Fed was nearing a change in course with QE2. Yesterday’s statement indicates that helicopter Ben has a strong hold on the FOMC despite the ‘undercurrents of discontent’. He stated that inflation was a problem overseas and not an issue in the US and believes that commodity prices will not undo a benign inflation environment. In translation, QE2 will run its course.

• US weekly claims fell south of +400k. It managed to print a 30-month low (+383k vs. +419k) and extended its declines for a second consecutive week. Over the recent months initial jobless claims have been volatile, alternating between flirting with the +400k mark and adding +40-50k to those levels.

• Federal Reserve Governor Kevin Warsh, who was one of Chairman Ben S. Bernanke´s closest financial-crisis advisers before becoming the only governor to question the expansion of record monetary stimulus in Nov., resigned after five years at the central bank. It should allow Obama to appoint another dove to the Board.

• The dollar value of the US trade deficit came in line with expectations, widening to -$40.6b in Dec. from -$38.3b in the prior month. The underlying details were broadly stronger, with petroleum accounting for most of the widening.

• Prelim UoM Consumer Sentiment advanced to 75.1 an eight-month high, a sign falling US unemployment and rising equity prices may be comforting consumers.

• Canada posted its first trade surplus in 10-months in Dec., as energy and metals powered the biggest jump in exports in three-decades (+$3b vs. -$0.4b). The surplus with the US now sits at +$5.1b (the widest in two years). It seems that exports are holding up well to CAD appreciation thus far.

ASIA

• Australian retail sales disappointed, advancing +0.2% over Christmas, after a revised +0.4% gain in Nov. The market had been expecting a +0.5% increase. Higher market interest rates was likely the main reason why consumers tightened their purse strings.

• The Chinese central bank (PBOC) hiked its deposit and lending rates by +25bp, in response to prescient inflationary pressures. Analyst’s believe their tightening will be front-loaded in order to quickly normalize policy. The market projects another +160bp of hikes in the one-year lending rate to +7.66% and another +175bp in the one-year lending rate to +4.75% by the end of 2011. This was only the second policy rate hike in this cycle, with PBOC preferring to hike commercial banks’ reserve requirement ratio (RRR) instead.

• China has joined India, Indonesia, Thailand and South Korea in boosting interest rates this year as Asian policy makers seek to cool the economies leading a global rebound.

• New Zealand Finance Minister English said that GDP may have contracted in the 4th Q as a result of higher-than-expected savings rates and weaker-than-expected consumption and housing market (release date is Mar. 24th). This should leave us with a more dovish RBNZ profile until at least the middle of this year. A stall in the economy should keep interest rate spreads moving against the NZD.

• The Aussie has reacted negatively to the mixed employment data, forcing the liquidation of the weak long carry trades who have been influenced by the market pricing for RBA rate hikes over the next 12-months dropping. Total employment rose +24k in Jan., higher than the +17.5k expected, but part-time employment (+32K) accounted for the rise, with full-time employment down-8k.The unemployment rate was unchanged at +5.0 %

• RBA Governor Stevens in his testimony to parliament that market pricing of no rate hikes until late this year was reasonable and that the RBA is ahead of ‘the game’ and can afford to stay on hold for the time being. Market pricing for rate hikes over the next 12-months fell 4bp to +34bp.

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Spin Doctors!

« Chinese Fireworks? | Home

By Mike Conlon | February 9, 2011

At least that’s what is going on this morning as there is little economic data due out that would sway markets in one direction or another. We have been hearing from various Fed officials recently and today the head honcho Bernanke will be out there trying to sell his version of economic reality.

This is not exclusive to the US as overnight the Finance Minister in New Zealand pulled out the “recession card” claiming the country could fall into one in the second half of the year. Talk about not pulling any punches! While it is true that normal economic drivers of growth are not present yet, this blatant attempt to lower the value of the Kiwi has not gone unnoticed.

In the Euro zone, a speech later today from the head of the EFSF (emergency bailout fund) could produce some market activity.

And the countdown to the BOE rate policy decision begins as tomorrow will show whether or not the Central Bank is serious about attempting to control inflation or whether they are content to allow the reduction in government spending to hopefully quell demand.

So stocks markets are lower to start the day, perhaps feeling some residual effect from the Chinese rate hike yesterday.

In the forex market:

Aussie (AUD): The Aussie is lower despite rising consumer confidence figures as risk aversion is starting to increase. Tomorrow is the Australian employment report which will show how the economy is faring. The market may be more concerned with the Chinese rate hike than it let on yesterday.

Kiwi (NZD): The Kiwi is lower after the Finance Minister said it was possible that New Zealand could slip into recession in the second half of the year. The MSCI Pacific stock index was lower, helping take the Kiwi lower. (Click chart to enlarge)

Loonie (CAD): The Loonie is mixed as higher oil prices and increased money flows from the Kiwi and Aussie offset general risk aversion in the market. There is no economic data to speak of for Canada due out this week.

Euro (EUR): It’s also quiet in the Euro zone as German exports decreased last month 2.3% vs. an expectation of a gain of .8%. The head of the EFSF will speak later today and I can’t imagine a scenario where this provides positive sentiment.

Pound (GBP): The Pound is mostly higher after the BRC Shop Index showed prices increased 2.5% lending further credence to the inflation proposition. The UK current account deficit came higher than expected, and a higher-valued Pound would not help correct this situation. Tomorrow’s rate decision couldn’t be more important.  (Click chart to enlarge)

Dollar (USD): The Dollar is benefiting from risk aversion this morning and with no news on the docket it will be up to Fed Chairman Bernanke to light the proverbial fuse.

Yen (JPY): The Yen is mostly weaker despite the mild risk aversion in the market as the Chinese rate hike does indeed affect Japan as well. The focus has shifted toward Europe and the US as worries over the Japanese fundamentals still persist.

Trading days like today can sometimes be difficult as the market hangs on every word of the “spin doctor” who is speaking. One never knows what will set off the market or when a proverbial bomb could drop sending the markets into a tailspin.

Generally speaking, these officials know better than to disrupt the markets with anything deemed overly positive or negative. But unfortunately this type of rhetoric has become accepted as a policy tool designed to affect a currency’s value.

Look no further than New Zealand for proof of that. As irresponsible as it may seem, that is the nature of the beast. These speeches can sometimes provide major volatility to the markets, which is welcomed by those who know how to trade, but feared by those who don’t.

Which type of trader are you?

To learn more about how you can take advantage of world events through the currency market, be sure to check out our currency trading courses!

To follow these events live with a free, real-time practice account, click here! Don’t miss out on the world’s fastest growing market!

Tags: account, AUD, Aussie, blog, cad, course, currenc, currency, currency trading, dollar, dow, economy, Euro, forex, forextrading, free, fx, fxedu, gbp, Il, jpy, market, Mike Conlon, nzd, practice, ssi, time, trade, USD, Yen

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Investors Return to Yen-Based Carry Trade

With Japan’s benchmark interest rate holding steady at 0.1 percent for over two years now, investors in Japan are turning to foreign investments in the search for better yields. Investors outside Japan are also entering into carry trades selling the yen in order to buy other, higher-yielding currencies.

“The prospect of any rate rise in Japan is so far away that at some point over the next year it will return as a funding currency,” noted Greg Gibbs, a currency strategist at RBS Australia in Sydney.

Source: Bloomberg

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CFTC / NFA Enhance Regulation of Forex

In 2010, the US Commodity Future Trading Commission (CFTC) formally released a series of new regulations governing all retail foreign exchange dealers. Having given all applicable firms almost six months to bring their operations up to speed with the new regulations, the CFTC is now moving to bring enforcement actions against those that are still not in compliance.

Among other things, the regulations required all retail forex broker-dealers to register accordingly with the National Futures Association (NFA), and for firms that “solicit orders, exercise discretionary trading authority or operate pools with respect to retail forex” to register as introducing brokers. Out of curiosity, I scoured the NFA Background Affiliation Status Information Center (BASIC) to see if/how forex brokers have registered themselves.

As you can see from the table above, there are approximately [I would be grateful if you could inform me of any known omissions!] 28 registered forex firms. However, only 12 of these firms are registered as retail foreign exchange dealers (RFED), and the CFTC recommends that (US) retail forex traders that manage their own accounts should deal with these firms exclusively.

Unfortunately, many firms continue to advertise that themselves as forex brokers when they aren’t registered as such, or even worse, aren’t registered at all. As a result, the CFTC recently filed simultaneous enforcement actions against 14 forex firms, alleging that, “In all but two of the complaints…a defendant acted as an RFED; that is, it offered to take or took the opposite side of a customer’s forex transaction without being registered. In the remaining two complaints, ZtradeFX LLC and FXPRICE, the CFTC alleges that the defendant solicited customers to place forex trades at an RFED without being registered as an Introducing Broker.” The following companies stand accused:

To be a fair, NFA membership doesn’t necessarily imply compliance with NFA regulations, nor does it even guarantee upright behavior. In fact, the NFA is currently scrutinizing all of its member firms “for any signs they are designing computer systems to take advantage of what is known in the industry as ‘slippage,’ or small price movements that happen between the time a customer orders a trade and when that trade is actually executed.” In October, the NFA settled two such cases with IKON FX and Gain Capital, assessing a combined $800,000 in fines. Let’s hope that this isn’t the real explanation for the fact that forex trading is vastly more profitable for brokerages than other types of retail securities trading.

While the NFA hasn’t indicated that this is the case, the current retail forex MO (whereby brokers also act as market-makers) could be under attack. As one advocate for traders told the WSJ, “If a foreign-exchange firm is acting as a market-maker, or taking the other side of a client’s trades, it is doubtful the investor is getting the best possible price.” The problem is at the moment, the industry remains far from transparent, and if not for the NFA investigations, traders probably wouldn’t be able to establish whether their broker(s) acted unscrupulously.

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Who's Working?

« Tensions Flaring! | Home
By Mike Conlon | February 4, 2011
That is the question that will be answered later this morning as today is “jobs Friday� and we eagerly await the release of the Non-Farm Payrolls report and the unemployment number. This is one of the most important data releases as it shows whether or not meaningful jobs are being created. The expectation is for a gain of 140K jobs.
The unemployment rate is also due out and this can sometimes be a deceiving number as the participation rate will sometimes affect the overall numbers. A higher participation rate usually means that workers are less discouraged and looking to get back in the workforce. Our neighbors to the north, Canada will also be reporting their unemployment rate. As goes the US, so goes Canada. At least that has been the market action of late, as part of the fate of Canada’s economy lies with US economic recovery, for better or worse.
There is no other economic data due out for the rest of the day, so expect the markets to trade off of that NFP number.
The Aussie is higher as the RBA lifted both its economic and inflation forecasts despite the recent natural disasters and previous comments form the RBA head.
And lastly, the Euro zone head honchos are meeting today in Brussels for a debt summit where the hope is that they will produce some meaningful response and solution to how to deal with the crisis. Don’t count on it.
In the forex market:
Aussie (AUD): The Aussie is higher across the board as the RBA raised its GDP outlook for 2011 to 4.25% growth from a previous forecast of 3.75% and they raised their inflation outlook with CPI set to increase 3% from a previous forecast of 2.75%. If they are correct in the new assessment, then we will see further rate hikes in Australia some time this year unless another global crisis emerges. (Click chart to enlarge)

Kiwi (NZD): The Kiwi is mostly lower getting a bit of follow-thru from the negative employment report that came out on Wednesday night. In addition, money flows are potentially returning to the Aussie after the RBA raised its outlook.
Loonie (CAD): The Canadian employment report just came out and showed a gain of 69.2K jobs vs. an expectation of 15K, handily beating the estimate. The unemployment rate remained steady at 7.8%. (Click chart to enlarge)

Euro (EUR): The Euro is slightly positive ahead of the US NFP report and has been in a tight range holding just above 1.36. While there was no meaningful data out this morning, the debt summit could produce fireworks if the sides don’t move any closer to resolution.
Pound (GBP): The Pound is somewhat mixed as a reading of house prices showed a gain of .8% for last month vs. an expectation of a decline of .3%. While on reading does not make a trend, this does contribute to the overall sentiment that inflation is rising in the UK.
Dollar (USD): All eyes will be on the NFP report where the US economy is expected to add 140K jobs. The unemployment rate is expected to tick higher to 9.5%, though that may be a function of the participation rate scenario that I mentioned above. Back in the day on the trading desk, we used to wager on the number so I will proffer my guess. My feeling is that the economic data has been too rosy of late so I think the number may disappoint. So I’m calling for a gain of 94K. Note: this is not a trading recommendation or advice, but rather a guess.
Yen (JPY): The Yen is slightly lower as Asian markets were higher overnight and it really is just puttering around waiting for the NFP number. A better than expected number will likely encourage some Yen selling and risk-taking through carry trades, and a worse than expected number could induce Yen strength as a safe haven going into the weekend with Egypt situation still unresolved.
Today’s NFP report really serves as a barometer for the economy and this is one of the reasons why it is so closely watched. While the economic data of late has been better than expected, my intuition always tells me that when expectations are high, they sometimes disappoint.
I am not trying to be Debbie downer here, its just that I think that while the economy is recovering, I don’t think it is happening as fast as people would like to believe. If I’m wrong, I’ll be more than happy to admit as much.
But realize that just because I have a certain view, doesn’t mean that I am married to it and as a trader I will perfectly happy to throw that view aside and join the trade to go the other way.
I also wanted to mention the situation in Egypt, which is still uncertain as to what the likely outcome is going to be. So we could see some selling later in the day and Dollar strength as the flight to safety trade picks up ahead of the weekend.
So be careful around the NFP number as the volatility will be intense. And trade well!
To learn more about how you can take advantage of world events through the currency market, be sure to check out our currency trading courses!
To follow these events live with a free, real-time practice account, click here! Don’t miss out on the world’s fastest growing market!

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Weekly Forex Review

A messy NFP report has many scratching their heads. When Canada can create twice the number of jobs than its much bigger cousin we could be in big trouble. A Trichet ‘balanced inflation’ statement coupled with geopolitical risk premium being applied has taken the wind out of the EUR bulls sails this week. Below, we have some of the highlights of the week.



EUROPE

• Manufacturing PMI releases across Europe surprised to the upside with Ireland (+5.6pts) and Italy (+4.2) posting sharp increases, driven by strong forward looking orders components. Elsewhere in the Euro periphery, Spanish new orders also improved but Greece remained the weak spot with January manufacturing PMI still deep in contraction territory. The Euro-zone final manufacturing PMI printed slightly better than flash estimate at 57.3 with the German index holding at an elevated level. The data supports ECB tightening prospects, but the financing stress, especially through March and April, will undermine ECB pricing again in the weeks ahead.
• German joblessness fell further than expected last month (-13k) sending the German unemployment rate down to its lowest level since March 1992 (+7.4%).
• In Switzerland, retail sales were particularly weak at -0.4% in December from revised +1.8% in November. Manufacturing PMI fell slightly in January, but orders and employment components were more resilient, posting a smaller rise for the month. Overall, leading indicators point to fairly robust growth in 1st Q.
• Sterling all week got its bid from surprising headline prints. In the UK, January manufacturing PMI hit a record high at 62. New orders rose to 65.6 from 59.3 and employment rose to 58.8, from 57.8. Both indicators are at their highest levels in history and suggest that the manufacturing sector’s share of the private sector is creating jobs. Inflationary pressures are also strengthening as input prices surged to 84.9 from 80.3 and output prices to 62.8 from 58.6. The market anticipates that there is an increasing risk that MPC rhetoric continues to shift in a hawkish direction, especially after the UK services PMI rebounding sharply last month to 54.5 vs. 51.3. UK data this week suggests that the weaker 4th Q GDP growth had been largely weather related.
• Spain is committed to achieving a fiscal deficit of +3% in 2013 and their deficit target in 2010 is in no doubt.
• Ireland was downgraded one notch to A- by S&P’s, and a further downgrade is possible as the government tries to contain bank-rescue costs.
• Germany is making its agreement to an expanded rescue effort for Europe’s most-indebted countries conditional on tighter finance controls.
• Trichet did not disappoint, as expected kept base rates on hold at +1%. Most of the EUR’s early week gains had come on the back of investors believing that the recent hawkish comments from Trichet warrant a Euro-zone rate hike sooner rather than later. His communiqué was less hawkish even after a firm January CPI. ‘Inflation risks are balanced and could shift to the upside which would require careful monitoring’.

AMERICAS

• The first of US job indicators got off on the correct foot, ADP +187k. The second, weekly jobless claims remain volatile, retreating -42k to +415k and reversing nearly 80% of the prior week’s gain.
• The composite manufacturing and non-manufacturing ISM picked up in January, adding +2.3pts to 59.6.
• The US service sector continues to accelerate, unexpectedly picking up last month (59.4 vs. 57.1). January marks the fifth consecutive month of accelerating activity and the highest index in six-years. It’s worth noting that the services sector accounts for two-thirds of the economy, a third of exports and 80% of all private-sector jobs. Most of the subcomponents posted gains, including new-orders, backlog of orders, current ‘production’ and employment. US momentum continues.
• Canadian employment numbers blew analysts estimates out of the water, beating them by four times (+69.2k vs. +18.2k). The unemployment rate jumped two ticks to +7.8%. Just less than 2/3rd of the report was supported by the Public sector. Is that sustainable? The gain was split between full-time (+31.1k) and part-time jobs (+38.0k). Less of the headline job rise will flow through to an expansion of hours worked given the 55% weighting on part-time jobs.
• The market witnessed a messy NFP release, with a disappointing headline print (+36k vs. +136k) and a market appealing unemployment rate (+9% vs. +9.5%). It was not a weather report despite headlines on the massive number of people who could not make it in to work due to snowstorms. Making it to work or not is not the relevant issue. It’s whether you were still counted on payrolls for any part of the reference period that matters. There are 43.8% of Americans or 6.2m been out of work for six-months or longer. It solidifies Bernanke’s QE2 agenda.

ASIA

• A moderation in China’s PMI (-1 to 52.9) is reducing fears of an aggressive PBOC tightening cycle. Stronger European PMI’s are helping to support the EMEA currencies because of their dependence on core European growth. Historically, PMI on average rises slightly in the month of January, however, analysts believe that the Chinese New Year holiday may have been somewhat distorting.
• Cyclone Yasi, the perfect storm, hit already flooded Australia, managing to miss many of the major centers. The cyclone will probably further dent March quarter GDP following the floods.
• AUD has found some support from a surprisingly hawkish Statement of Monetary Policy from the RBA. The Central Bank has tweaked this years forecast, but, crucially, left its medium-term forecasts for inflation and GDP unchanged at rates that point to further policy tightening over the next year. Policy makers are ‘looking through the near-term flood affect, focusing on continued tightening in the labor market and the investment surge. Pricing for the RBA over the next year rose another +5bps to +37bps Geopolitical reduced risk sentiment has pared the AUD advance.
• BOJ officials are trying to ‘jawbone’ Yen lower. Hidetoshi Hamezaki said they are watching the FX markets ‘carefully’ for they are having a toxic effect upon Japanese corporate profits.
• Chinese New Year holidays

WEEK AHEAD

• The US Treasury department will sell $72b new bonds next week, matching market consensus ($32b-3’s, $24-10’s, $16b-30’s).
• UK will be the focus of the week in Europe with its production numbers, Asset Facility and the BOE rate announcement.
• We will get building permits and housing starts out of Canada, ending the week with its Trade number.
• Bernanke is due to testify on the economic outlook and monetary and fiscal policy before the House Budget Committee. We will finish the week with the US’s Trade Balance and Preliminary UOM Consumer Sentiment release.
• Down-under, the market will focus on the Aussie job numbers out mid-week.

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Despite Recent Rise, Euro Still Looks Weak

As the Euro moves past $1.38 per Dollar towards a 1-year high, many traders are wondering if perhaps the common currency’s woes aren’t in the past. This would be a mistake. That’s because most of the forces behind the Euro’s rally actually have very little to do with the Euro.

The main cause of Euro strength has been a pickup in risk appetite. Investors are becoming increasingly more confident in the prospects for global economy recovery, and the crisis mentality is rapidly fading. Ironically, the flurry of positive economic data emanating from the US has been terrible for the Dollar. You can see from the chart below that except for a gap in 2010 Q4 (due to a flareup in the EU sovereign debt crisis….more on that below), the US stock market rally has coincided with a shift away from the Dollar and towards the Euro.

In fact, the Euro still remains extremely vulnerable to the ebb and flow of investor risk tolerance. That applies not only to events endogenous tot the EU, but also to global market shocks. That means that any reminder of the Eurozone’s fiscal issues (such as last week’s downgrade of Ireland’s credit rating) is likely to be reflected in a weaker Euro. For another example, look no further than the recent political turmoil in Egypt and the wider Middle East. Summarized one analyst, “In itself, Egypt is not that big an economy. But there is some worry about the supply of oil through the Suez Canal. It does impart a negative vibe on risk.”

The Euro’s recent appreciation is also rooted in technical factors. What began as a modest rally quickly turned into a upward surge as investors moved to cover their short positions. The WSJ reported that “much of the recent rally was fueled by hedge funds and other speculative investors covering short positions…Investors are ‘not going out and buying the euro because they love it.’ ” This apparent short squeeze can be seen in the sudden and massive reversal of positions that was documented in the most recent CFTC Commitment of Traders Report.

On a related note, there are signs that Euro puts (which allow investors to hedge Euro exposure by giving them the right to sell) are unusually cheap at the moment. “Demand for euro puts, which give investors the right to sell the euro in the future, appears to be growing, relative to euro calls, which allow them to buy, analysts say. That reverses a recent trend that had investors actively selling euro puts or sitting on their hands as the euro climbed…[and] suggests investors are becoming more biased towards selling the euro.” If speculators think that the options market is mis-pricing risk, they might start buying up puts and exert downward pressure on the Euro.

The only factor which could be construed as legitimately positive for the Euro pertains to interest rate differentials. Currently, Euro rates are just as low as in the US and the rest of the G4 world. However, that could soon change. The European Central Bank (ECB) is notoriously hawkish when it comes to conducting monetary policy. If you recall, it foolishly raised its benchmark interest rate during the height of the credit crisis. With inflation already running above 2%, you can bet that it will only be a matter of time before it reacts in kind. For the sake of contrast, consider that the Fed is still in the process of easing, via QE2.

While rate hikes would certainly provide a boost for the Euro, it is unlikely that rate differentials will be wide enough to spur any serious among yield-seeker in the immediate future. In short, I think the downside risks to the Euro (which is apparently on the verge of “disintegration,” according to George Soros) far outweigh any further upside support, and I think the rally will peter out soon.

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EUR sympathizes with Sterling

No one really cares that the Spanish 3 and 6-month Bill auction saw a huge improvement over December, with its bid to cover ratio doubling. It’s the fourth quarter UK GDP (-0.5% vs. +0.5%) print that’s caused Cable to plummet and the EUR to sympathize. The extreme cold weather, the unquantifiable factor, had the quarter reflecting a full 1% deviation from the median forecasts. Sterling has found some buyers, but continues to look heavy, with the currency expected to dominate trading even further the longer it cannot find traction. Even with the double-dip fear revived, initial market reaction has overshot the mark. Dealers expect better levels to own EUR/GBP and sell Cable outright.

The US$ is stronger the O/N trading session. Currently, it is higher against 14 of the 16 most actively traded currencies in a ‘volatile’ O/N session.

Today’s US consumer confidence release is the first of a slew of data that is expected to begin a strong week for USD. Combined with large net Treasury issuance, this week’s data could push US yields higher, benefiting the currency. Some of the luster has been taken away by the dismal UK release this morning. Markets are calling for double-dip recession in the UK. The dollar may shine because of uncertainty and not necessarily on the back of stronger data.

The USD$ is higher against the EUR -0.42%, GBP -1.30%, CHF -0.10% and JPY -0.20%. The commodity currencies are weaker this morning, CAD -0.14% and AUD -0.27%. The loonie traded under pressure yesterday, especially on the crosses, but in a tight range ahead of this morning’s CPI data. Oil rhetoric from OPEC members had the CAD trading skittishly in a tight range. The fear of China extending a tighter monetary policy has also had commodity sensitive currencies on the back foot. An unexpected Canadian November retail sales print on Friday (+1.3%) gave the CAD some positive temporary momentum that ended up being an ideal opportunity for some speculative longs to offload their positions. Year-to-date, the loonie has benefited by association with stronger US data. The BOC dovish position, after keeping rates on hold at +1% last week, has also helped to push the loonie to back off from its strongest level in two-years as the market digests rates being on hold and an economic recovery being threatened by a European fiscal crisis. Investors will see if the dovish BOC stance is justified after this morning inflation numbers. If so, expect dealers to be pricing rate hikes even further out the curve (0.9963).

The AUD immediate reaction was to fall -0.5% after the release of the CPI data showing headline inflation falling to +2.7%, y/y from +2.8% in the fourth quarter, vs. a market expectation of +3%. Since then, it has managed to claw back some of this losses, but not with much conviction, especially with softer commodity prices widespread. Market pricing of RBA rate hikes for the next 12 months fell to 28bp from 35bp. Weaker inflation and the devastation caused by floods will very likely delay further RBA hikes beyond the first quarter. Futures dealers expect the RBA to resume its tightening bias in the second half of the year, given rising wages, construction and housing related costs and energy and food prices. Last weeks data out of its largest trading partner, China, has the market convinced that the PBOC will move to hike their reserve rates. Their actions will reduce further the demand for the commodity sensitive growth currency. Earlier this week, Treasury Secretary Swann stated that the country faces an ‘enormous’ economic fallout from floods. ‘Queensland’s rapid development has meant that its economic performance has a much bigger influence over our national economy’. With growth expected to slow this quarter, a tightening policy would not be the prudent course of action. Currently, the market pricing of rate cuts (4.75%) for the RBA February policy meeting and of rate hikes later in the year remains broadly unchanged. Offers again appear at parity (0.9937).

Crude is lower in the O/N session ($87.60 -27c). Crude prices never had a chance at taking on the $90 level yesterday, especially after the Saudi Oil Minister indicated that OPEC may increase production levels to meet increasing global fuel demand. His comments have certainly put a medium term cap on the black stuff. He indicated that global demand was expected to increase around +2% this year. Last week the IEA raised its estimates for this year’s global demand for a fourth consecutive month as the economic recovery seems to be gathering momentum. They anticipate that global consumption will increase by +1.69%. Last week’s US inventory report provided another excuse to offload oil contracts. Crude stockpiles increased +2.62m barrels to +335.7m. Not being left behind were gas supplies rising +4.4m to +227.7m barrels. It’s worth noting that the four week gas demand was +2%, y/y, higher and averaged +9m barrels a day. US refineries ran at +83% of total capacity, a drop of -3.4%. The supplies of distillates (diesel and heating oil) rose by +1m to +165.8m barrels vs. an expected weekly increase of +900k barrels. OPEC believes that supply and demand are ‘in balance’. There is far more oil in storage, more fuel capacity and more idle oil wells to limit a stronger market rally in the medium term. The commodity is expected to test key support levels around $85.

After capping its third consecutive weekly loss on speculation that borrowing costs will rise as the US economy recovers, gold prices are again piggybacking their two month lows with some bottom feeders happy to want to own some as global equities rally, eroding the metals appeal. Even the announcement by the Central Bank of Russia planning to buy 100 metric tons of gold to replenish their reserves has done little to spur frantic bullish buying now that key support levels are being tested. To date, buying has been modest in the commodity, off to its worst start in 14-years and down -5.7%, year-to-date, only weeks after recording a +30% return. There is serious discussion being given to whether the gold market has peaked or if it is simply making a short-term correction. Recommendations by hedge funds to cut long positions last week, has the lemming one directional trade firmly eyeing an exit door. Aiding the metal is the Euro sovereign-debt crisis and this despite the Euro-finance minister’s pledge to strengthen a ‘safety net for debt-strapped countries’. On a macro level, analysts expect the losses may be limited on concern that inflation will accelerate. Technical analysts believe that gold ($1,327 -$17.20) will outshine other precious metals in 2011 and peak somewhere above $1,600 in 2012. Current trading however does not feel like it.

The Nikkei closed at 10,464 up+119. The DAX index in Europe was at 7,080 up+13; the FTSE (UK) currently is 5,924 down-20. The early call for the open of key US indices is lower. The US 10-year eased 2bp on yesterday (3.40%) and is little changed in the O/N session. The belly of the US curve printed six-week high yields last week, as economic data in the US and the Euro-zone boosted speculation that a global recovery is building momentum which dampens the need for government debt as an alternate for safe heaven requirements. The 2’s/Bond spread tightened for a second consecutive day ahead of today’s $35 short-bond issue and on speculation that the increases in long-bond rates cannot be sustained (+393bp). In total this week, the Treasury will auction $99b of new debt which should require dealers to make more room to take down product and flatten the curve. Stronger fundamentals are creating a choppy trading environment with medium term support levels for 10’s becoming questionable (+3.50%).

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