US Dollar: Is the Recession Really Over?

07/29/2009 12:01 am EST

Focus: FOREX

Kathy Lien

Managing Director and Co-Founder BKForex LLC, BK Asset Management

If there is one word to describe the price action in the currency markets on Monday, it would be hesitancy. Although the US dollar traded lower against most of the major currencies, its losses are nominal. After selling off to near year-to-date lows against many of the major currencies, short dollar positions have hit extreme levels. Without overwhelmingly positive news to lift risk appetite, the hesitancy in the forex markets reflects the market’s skepticism.

Newsweek Declares Recession Is Over

On the cover of Newsweek magazine this week are the words “The Recession is Over.” Recent economic data has shown that the pace of contraction in the US economy is slowing, but can the recession really be behind us? According to Newsweek, all signs point to the possibility of GDP growth turning positive in the third quarter, which could mean that technically, the recession is over. However, it won’t feel like that for most Americans and “you might wait a while before adding Judy Garland's rendition of "Happy Days Are Here Again" to your iPod. GDP growth alone can't feed a family, or pay a mortgage. Cursed with a high national debt load and blessed with a dynamic, growing workforce, the US economy needs annual growth of at least 1.5% just to feel like we're standing still.” On Friday, second quarter GDP numbers will be released. If the pace of contraction slows as much as the market expects, we could be one step closer to the recession being over. Economists predict that growth contracted by 1.5% in Q2, compared to 5.5% in Q1. The price action in the currency markets today suggest that forex traders are also skeptical about the outlook for the US economy, and we may have to wait until Friday’s reports to get some real action in the US dollar.

Economic Data: Review and Preview

In the meantime, new home sales surged 11% last month, which is encouraging because it was the strongest pace of growth since December 2000. The rise in both existing and new home sales continues to confirm that the housing market is recovering. However, despite the blockbuster report, equities are struggling to hold onto their gains and the US dollar has barely budged. The problem is that inventories are moving primarily because of price cuts. The median price of a new home sold last month was 12% lower than the previous year and 5.8% lower than the previous month. A total of 384k new homes were sold in June, which is dramatic departure from the 1 million plus homes that were sold back in 2006. Nonetheless, the housing market is rebounding, which is very important for the US recovery. Sales increased in every part of the nation except for the south, while the inventory of new houses for sale now represents 8.8 months worth of sales, down from 10.2 months in May. Overall, risk appetite remains fragile. The S&P/Case-Shiller Housing Price Index, consumer confidence, and the Richmond Fed manufacturing Index are due for release tomorrow. The drop in the University of Michigan survey suggests that we could see weaker numbers. The Treasury is also auctioning a record amount of debt this week. In fact, it will be busiest week in 24 years with eight auctions on the calendar. Solid foreign demand could lift the dollar.

Volume in the Forex Market Shrinks

Finally, central banks from across the world reported today that foreign exchange trading volume has decreased significantly between April 2008 and April 2009. On the heels of the Lehman Brothers failure in 2008 and global deleveraging, investors large and small have reduced and unwound carry trades aggressively. According to the Bank of England, average daily turnover in forex spot fell 28% in April 2009 compared to a year ago. The Federal Reserve reported a 25.2% decline in volume, while the Tokyo Foreign Exchange Committee reported a 16% decline. The lack of participation may explain why the major currency pairs have been stuck in a range since the beginning of May. In New York, for example, forex spot trading volume fell to the lowest level in more than three years.

EUR/USD: Lifted by Stronger German Consumer Confidence

Stronger consumer confidence has helped to lift the euro against the US dollar. Consumer sentiment has improved for the third month in a row despite a strong currency as consumers pin their hopes to a recovery. Price pressures are low and equity markets are improving, but rising unemployment remains a major drag on the region’s economy. When the IMF announced that they still expect the euro zone economy to contract next year, they said stronger sentiment has not translated into real activity, and so lies the primary problem for the euro zone. We need to start seeing consumption indicators turn around before we can believe that Germans will start spending money instead of saving it. In France, the labor market is improving with the unemployment total falling for the first time in a year. Unfortunately, only 25% of the 18.6k people who dropped off the unemployment rolls found jobs or began a training course. The rest failed to renew their registration, were sick, or were excluded for other reasons. There will be no meaningful economic reports from the euro zone tomorrow, however, Switzerland will be releasing the UBS Consumption Indicator. Traders will be looking to see if the index falls for the third month in a row. The Swiss franc traded lower against the dollar and was virtually unchanged against the euro.

GBP/USD: BoE Is in a Sticky Situation

Of all of the major currency pairs, the only one whose month-long trading range has not been tested is the GBP/USD. The pair has failed to break its June high of 1.6744 and with a light economic calendar this week, more range trading is expected. The only piece of economic data released today was the Hometrack Housing Survey, which came out last night, and unfortunately, the flat reading failed to ignite any volatility in the currency pair. For the third month in a row, housing prices remained unchanged at £155,600. Hometrack noted that the housing markets remained fragile due to the 7.7% decline in prices from a year earlier. For the time being, the Bank of England’s next course of action remains unclear. Last week, it seemed that the massive stimulus efforts have come to an end, with the BoE’s Sentance noting that growth prospects were better than expected. However, after Friday’s GDP number, the mood shifted to pessimism with traders calling for an expansion of the quantitative easing programs. The Financial Times also warned that credit defaults could be one of the biggest risks facing the UK economy in the coming months. Interestingly enough, the OECD said the UK may have the highest inflation rate out of all G7 countries. For an inflation-targeting bank like the BoE, this problem will have to be addressed. To make matters worse, the weakness in the pound and the upcoming termination of sales tax breaks may push inflation even higher. However, some easing may already be on its way since the Chancellor of the Exchequer is pushing banks to lower rates for small businesses. Economic data will be light for tomorrow, with only the CBI Distributive Trades survey due for release.

USD/CAD: Loonie Strengthens for Seventh Straight Day

For the seventh trading day in a row, the Canadian dollar has extended its gains against the greenback to a ten-month high. There was no economic data on the calendar, but oil prices also rose for the ninth consecutive trading day. For the time being, the 1.08 level is still important support for the currency pair. The Bank of Canada’s surprisingly optimistic outlook has fueled the rise in the currency pair. There is absolutely no Canadian economic data on the calendar until Thursday, so oil prices will be the primary driver. However, the excitement will pick up for the Australian and New Zealand dollars this evening. Both the Aussie and Kiwi have advanced today, with the AUD/USD coming within five pips of its year-to-date high. For Australia tonight, we have Conference Board Leading Indicators and the NAB Business Confidence report. RBA Governor Stevens will also be speaking, and his outlook on the economy and monetary policy could impact the price action of the AUD/USD. New Zealand, on the other hand, has trade data on tap. A drop in exports and a rise in imports are expected to drive the surplus lower.

USD/JPY: Nikkei Streak Continues, Best Since 1988

USD/JPY only briefly touched a three-week high but has since pulled back thanks to weaker US equities. Japanese stocks, on the other hand, have posted an amazing nine-day rally, their longest winning streak in more than 20 years. Clearly, Japanese investor sentiment has improved, but it is not on the back of any economic data. The rallies are probably led by low valuations, which have made many stocks too cheap to resist. Yen crosses did rally today, as AUD/JPY posts its fourth consecutive daily gain. Today has seen little in the form of market-moving data except for last night’s corporate service price index, which came in worse than expected at -3.20%. However, the coming days may be crucial for the continuation of the Nikkei’s rally. For tomorrow in particular, there will be retail trade data alongside large retailers’ sales figures. Wednesday’s trading may even be more important, with both small business confidence and industrial production data due.

By Kathy Lien, Director of Currency Research at

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