Six Key Drivers of the Forex Markets Right Now

05/04/2010 12:01 am EST

Focus: FOREX

Kathy Lien

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

The volatility in the forex markets over the past 24 hours provides traders with a taste of what to expect this week.  Many Asian markets were closed for May Day, and most Japanese traders are off for Golden Week, which suggests that had those traders been at their desks, volatility could have been even greater. The euro was under pressure Monday morning, and the dollar has benefitted from the combination of global uncertainties and better-than-expected US economic data.

Dollar Gains Accelerate on Stronger Data

The acceleration of personal income and consumption in the month of March indicates that the US economy is improving, giving consumers the confidence to spend. Personal spending rose 0.6%, the strongest in five months, while incomes rose 0.3%. The PCE deflator rose from 1.8% to 2.0%, which reflects growing inflation pressures. If the labor market continues to improve, we could see a further pickup in incomes and spending. Manufacturing Sector ISM also rose from 59.6 to 60.4, which was the fastest pace of growth since 2004. The manufacturing sector continues to fuel the US recovery, while the pickup in prices paid signals growing inflationary pressures. The Federal Reserve can't be cautious forever. With activity in the manufacturing sector accelerating, payroll’s growth in excess of 200k on Friday could push the Fed to drop their "extended period" language in June.

The Six Key Drivers in the Forex Market

Aside from the US economic reports, there are six key developments affecting the forex market today, and each of these stories will contribute to volatility throughout the week:

1) Greece 

The biggest story is of course Greece. Even though euro zone finance ministers have approved a EUR110 billion bailout package, there still needs to be Parliamentary approval from individual nations that will affect the speed and size of the final bailout. Eventually, Germany will come through because underneath all of the political backtracking, the government knows that in order to avoid a more damaging and embarrassing bailout of German banks, they need to bail out Greece first. There will be strikes and protests, but at the end of the day, the aid is needed to stabilize the region's economy, support investor sentiment, and prevent the euro from falling further. There is even talk that the Germans could be fast tracking their vote. However, even if Greece is successfully bailed out, investors could turn on countries like Spain, Portugal, Italy, and Ireland at anytime, especially if there are additional downgrades by rating agencies. As a result of these developments, the European Central Bank has already amended their collateral rules to include Greece regardless of their rating, which suggests they will refrain from saying anything hawkish on Thursday to support the fiscal austerity measures.

2) China

The second top story in the markets today is China's decision to raise their reserve requirement ratio for the third time.  Although raising the RRR is less hawkish than an all-out rate hike, it reflects the Chinese central bank's commitment to gradually tighten monetary and fiscal policy. Their attempt to cool the economy has contributed to the risk aversion in the markets because almost every major nation will be affected by slower Chinese growth.

3) Australia

This week, the Reserve Bank of Australia is expected to raise interest rates, and their announcement about higher taxes on the profits for commodity producers reflects their commitment to taming inflation and preventing asset bubbles.   The tax hike suggests that prices and growth have not cooled enough to satisfy the RBA.

4) Gulf Oil Spill

Aside from tighter fiscal and monetary policies in Asia, the worsening oil spill in the Gulf of Mexico has boosted oil prices and raised concerns about the impact on the US economy, the environment, and cleanup costs.

5) Goldman Sachs

The possibility of a criminal investigation into Goldman Sachs remains a risk for the equity markets.

6) UK Elections 

Elections in the UK on May 6 remain a risk for the British pound since a hung Parliament, under which there is no majority, becomes increasingly likely.  

The only hope for risk appetite this week would be a round of positive US economic data. We have already seen some healthy reports this morning, and if the leading indicators for non-farm payrolls support a strong number, this prospect will help to support risk.

By Kathy Lien of GFTForex.com

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