(03/13/09) Currency Pair Review and Trading Opportunities

US Dollar: Breakouts

Breakouts are beginning to occur across the foreign exchange market. After consolidating for the past few weeks, we have finally seen an upside breakout in the EUR/USD with the currency pair trading at the highest level since February 24th. USD/JPY has also fallen significantly and is at risk of breaking its March lows while the Australian and New Zealand dollars are attempting to break month-long consolidations. The story today is dollar weakness. The greenback has weakened against every major currency except for the Canadian dollar. Other than the equity market's feeble attempt to extend Tuesday's gains, there was no major catalyst for the sell-off in the US dollar.

Laying the Groundwork for More Dollar Weakness?

Some economists believe that this could be the beginning of a longer phase of dollar weakness. Although we agree that the dollar will eventually turn, there are still many forces that could keep the dollar bid. The primary reason why the dollar has been strong over the past few months is fear and uncertainty over the financial markets. Unless this changes, and unless the stress tests for banks are behind us, we may not see the correction in the US dollar last. The dollar cannot rise forever, especially with the possibility of the US government buying Treasuries and China's decreasing demand for US dollars. Last night, China reported a massive decline in exports. If people are buying less Chinese goods, this means that they are buying less Chinese yuan, which reduces the need for China to offset a rise in the yuan with purchases of US dollars. The G20 meeting is coming up.

Retail Sales Preview

Turning to the US economy, retail sales and jobless claims are due for release on Friday, March 13. Although consumer spending recovered in January, the same is not expected for February. With 4.2 million Americans out of work since January 2008, it was surprising to even see an uptick in spending at all. If retail sales drop in February, that would mark lower consumer spending in six out of the past seven months. However, weak numbers are not a done deal. The International Council of Shopping Centers made the prediction last month that February Retail Sales would drop by 2%. This is largely on the back of their expectation that luxury retailers will face a 15% decline in sales for this year. However, the incentives produced by retailers may produce conflicting numbers. The fact that stores were forced to cut prices significantly may offer a slight boost to the figure. The strength behind America's largest retail chain, Wal-Mart, may also offset the weakness at luxury retailers. Wal-Mart exceeded its own sales estimates last month as shoppers eagerly purchased discounted goods. Macy's and Limited Brands also managed to produce better than expected numbers. However, the severe reduction in employed individuals may be enough to stunt any optimistic results from February's sales.

Dow and USD/JPY

This morning, we wrote a special report on the 90% negative correlation between the Dow Jones Industrial Average and USD/JPY. Seasoned currency traders will know that this is a unique phenomenon, especially since there has been a 78% correlation between the instruments since the beginning of 2008. With US and Japanese interest rates at virtually the same levels, yield is no longer the driver of USD/JPY since both currencies are known as safe havens. Japanese fundamentals have also been deteriorating significantly, making the problems in Japan too severe for yen traders to ignore. As indicated in the following chart, Japan has been running a trade deficit for the past three months, and unfortunately, the deficit is rising. Corporations in Japan are reporting losses for the first time in decades and have been forced to lay off workers. With interest rates no longer a driver for the currency pair, USD/JPY traders have returned to fundamentals.

EUR/USD: Weak Data Fails to Stifle Rally

The euro strengthened significantly against the US dollar despite weaker economic data. German producer prices fell 1.2% in January while factory orders dropped 8%. The rapidly deteriorating economic data reflects the troubles in the euro zone. Ratings agency Moody's said this morning that the credit risks in eastern Europe vary. Romania, Bulgaria, and Croatia are at the greatest risk of downgrades. Euro zone producer prices and industrial production are due for release Friday, and given recent downward surprises, more weakness is expected in the upcoming data. However, it remains to be seen whether it will have any impact on the EUR/USD, which has risen solely because of US dollar weakness. The aggressiveness of today's rally suggests that we should see follow through. A test of 1.30 is possible, but a break may not be likely, especially on the first attempt. The Swiss National Bank has an interest rate decision upcoming. It has been leaked that the SNB plans to cut interest rates by 25bp. If they mention quantitative easing, we could see further gains in EUR/CHF.

GBP/USD: Quantitative Easing Takes First Steps|pagebreak|

We have finally seen a recovery in the British pound even though it is modest compared to previous losses. Like the euro zone, economic data was weak with the trade deficit widening more than expected and GDP is expected to fall 1.8%, according to NIESR. The Bank of England has officially started its asset purchase plan under the priorities of quantitative easing. The hype behind their use of the technique was initialized during last week's rate meeting, which showed an undeniable plea to rely on other methods to improve financial conditions. The bank purchased ?2B worth of governments bonds today, kicking off a plan that should see regular purchases on freshly printed money. Of course, the purpose behind the initiative is to push rates lower to appeal to the needs of the risk adverse financial institutions. Furthermore, as the yields on these already low-yielding assets are brought down even lower, the attractiveness of other securities like corporate bonds and equities suddenly regains incentives for investors. However, the success of the plan will only be unveiled if lending conditions improve materially, an act that bringing rates down to 300-year lows has not achieved.

NZD/USD: RBNZ Cuts Rates by 50bp

The New Zealand dollar rallied after the Reserve Bank cut interest rates by 50bp to a historic low of 3%, and because the comments from the central bank were surprisingly hawkish (instant insight on RBNZ outcome). The RBNZ said that with the latest rate cut, current interest rates are very stimulatory and that their pace of easing will slow significantly in the coming months. Their optimistic comment that the economy will start growing in the second half is a breath of fresh air for the beleaguered currency. Zero interest rates are not needed for New Zealand since fiscal and monetary stimulus along with a weak currency is supporting the economy. Interest rates should bottom at 2.5% but could fall as low as 2% if the recovery is delayed. The Canadian dollar was the only currency to lose value against the euro. Although Canadian finance minister Jim Flaherty had some rare words of optimism to share with investors, stating that Canada will be one of the first countries to emerge out of the grips of recession, the IMF on the other hand believes that tougher times are ahead for Canada. Australian employment numbers were due for release Thursday night. They should be weak given the sharp decline in the employment component of service, manufacturing, and construction sector PMI. Home loans came in at 3.5%, far below last month's 6.7% increase. Investment lending is under pressure as well, showing a reduction of 3.8%. It is obvious that Australia will have to improve credit conditions if they intend to avoid recession completely.

USD/JPY: Falls Most Since January

The Japanese yen is experiencing some of its most pronounced strength since the beginning of the year when the tremendous USD/JPY rally came to a halt. The pair slipped by more than 140 pips on a day marked by widespread dollar weakness. It seems that an attempt to rally past 100.00 has been thwarted, at least temporarily. There is still uncertainty as to whether US fundamentals warrant the strength granted by the breaking of the pivotal 100.00 level. Japan reported that machine orders declined by less than expected at 3.2%. However, the fourth straight monthly decline in the figure reflects the weakness of Japanese exports and their impact on the industrial and manufacturing sectors. In addition, four monthly declines in the figure have not been experienced in the country since 1987. China sent shockwaves through the markets when they announced that their trade surplus has slipped by more than 80% this year. The implications for Japan are that the reemergence of the pressing need for stimulus may push the Chinese government to promote a new spending package. Such an event would be beneficial to Japan's exporters. Later today, Japan is expected to announce Gross Domestic Product. The figure is expected to plummet by an unheard of 13.4% on an annualized basis. In the wake of such a number, the strength of the yen may be evaporated.

EUR/USD: Currency in Play for Next 24 Hours

The currency in play for the upcoming 24 hours is EUR/USD. Among the list of indicators to be released are EZ Producer Price Index at 6:00 am ET or 10:00 GMT and German Industrial Production at 7:00 am ET or 11:00 GMT. The US will release its retail sales numbers at 8:30 am ET (12:30 GMT) on Friday.

After yesterday's strong rally on broad dollar weakness, EUR/USD finds itself within the confines of the Bollinger band buy zone. Once again, the main levels to watch in EUR/USD movement are that of 1.3000 and 1.2500. Both have established a relatively well-defined range that the pair has traded in over the last couple of months. For resistance, 1.3000 is the level to watch, not only for its psychological impediment, but also because it is the 23.6% retracement from December to March lows. As for support, we continue to watch 1.2500, which has done a good job of cushioning declines on several instances. However, the significance of 1.3000 is extreme. A break could see prices head toward 1.3319, or the 38.2% retracement.