Driving Forces for 7 Major Currencies

09/29/2011 6:00 am EST

Focus: FOREX

Kathy Lien

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

Review important news items and fundamental themes that are driving price action in the US dollar, euro, British Pound, Japanese yen, and commodity currencies like the Canadian dollar and others.

Traders and investors around the world are focused on Europe, and rightly so, because it is where the greatest uncertainty lies. However, never lose sight of what is happening in the US, because once there is a resolution to Europe’s troubles (either positively or negatively), the market will quickly shift its focus back to the largest economy in the world. 

When that happens, they will realize that the Federal Reserve is at the brink of increasing stimulus. “Operation Twist” was announced less than one week ago and Federal Reserve officials are already talking about the need to do more. 

Part of the reason why they held off on a bolder move at their last meeting was because they wanted to see how the situation in Europe would evolve. If Greece is forced into default and the European Union fails to come up with a satisfactory package to rescue the euro, thus causing widespread volatility in the financial markets, the Fed may have to jump in with the G20 to save the markets.

As a result, we wouldn’t be surprised if the Fed is saving its last bullets for a coordinated move that is similar to the steps taken by the G20 back in April 2009.

Fed Presidents Lockhart and Fisher had far more negative than positive things to say about the US economy. According to Lockhart, Operation Twist will have a modest impact on the economy, but not enough to eliminate the need for more asset purchases. 

Considering the fact that he expects 1%-2% growth this year followed by 2%-3% growth next year, more quantitative easing (QE) should not be ruled out. In addition to the possibility of more QE, he also indicated that the central bank could use their communication tools as a means to set market expectations. 

This suggests that perhaps the Fed could adopt the suggestion made previously by Evans, who said interest rates could be tied to a piece of economic data like the unemployment rate.

Fed President Fisher was more skeptical about the central bank’s recent actions, saying that it could be ineffective, which implies that he also believes more needs to be done to support the US economy.

Although both of these Fed officials are not voting members of the Federal Open Market Committee (FOMC) this year, their thoughts are not likely to be all that different from other Fed officials because US economic data continues to show a meager recovery. 

The improvements in data that we have seen recently have been extremely mild. House prices rose 0.05% in July, consumer confidence ticked up marginally, while the Richmond Fed manufacturing index rebounded from -10 to -6.  

This means that the US dollar will remain an extremely attractive funding currency for the forseeable future. If risk appetite improves, expect the greenback to resume its slide quickly as investors lay on their yield plays.

The only time the dollar will rally in the current environment is in risk aversion, because for the time being, the pace of recovery in the US still trails behind other countries.

Durable goods orders are scheduled for release Thursday and a decline is expected. Orders for big-ticket items tend to be volatile, and for this reason, the durable goods report does not usually have a big impact on the market. 

NEXT: The Euro: Still Waiting for Inspiration

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The Euro: Still Waiting for Inspiration

The euro (EUR) traded higher against the US dollar (USD) for a third day in a row this week, but rumors, denials, and the lack of tangible announcements took the EUR/USD currency pair off its highs. 

Wednesday morning, European officials rejected all of the prior day’s rumors about increasing the European Financial Stability Facility (EFSF) and using the European Investment Bank (EIB) to bail the euro out.

Still, the euro has managed to hold onto its gains because investors still believe that a deal is in the works. Greece did its part by passing the property tax increase. Given how unpopular this motion was, it served as a test of the government’s commitment to austerity.  

The next step is for Finland to vote on the expansion of the EFSF tomorrow, followed by a vote in Germany on Thursday. Given how serious European leaders are about preventing contagion and how open they have been with their commitment to keeping Greece in the Eurozone, a deal certainly appears to be in the works whether they admit to it or not. 

It may not take the form of what the UK Telegraph or CNBC proposes, but it needs to be equally large and ambitious.

Based upon the results of the latest Italian and Spanish bond auctions, investors haven’t given up on Europe. Buyers of Italian and Spanish bonds demanded a higher yield at Wednesday’s auction, but the number of bids to the number of bonds available for purchase (bid-to-cover ratio) was strong. 

The euro is still waiting for a good reason to reignite its rally and investors are hopeful that inspiration will come soon. Economic data from the Eurozone is not nearly as weak as feared. Consumer confidence in Germany held steady in the month of October, which is encouraging considering the chaos in Europe. 

Swiss data, however, did not fare as well, with the UBS Consumption Indicator slipping from 1.28 to 0.79, the lowest level since September 2009. The Swiss franc (CHF) rallied against the US dollar and euro, but we do not expect these gains to last. 

Consumer Spending Causes British Pound Pullback

The British pound (GBP) joined in on the rally in recent days against the euro and US dollar despite weaker consumer spending numbers. According to the Confederation of British Industry, demand in the month of September fell to the weakest level since May 2010 with the CBI index dropping from -14 to -15. 

The pullback in demand for furniture, clothing, and groceries were the sharpest and consumers expect to cut back even further next month. This is the fifth consecutive month of weaker consumer spending figures from the CBI, and this implies a similar pullback in the official retail sales report. 

Based upon recent economic data from the UK and dovish comments from policymakers, it is quite clear that the UK central bank is at the cusp of increasing stimulus. They have an active interest in keeping the pound weak, and one way to do so would be through another round of QE. 

Normally, comments such as these would be very bearish for sterling, but after having fallen more than 1000 pips over the past month, the improvement in risk appetite has overshadowed the growing possibility of more stimulus for the time being. No economic reports are scheduled until Friday, leaving the pound to trade on risk appetite.

NEXT: Latest for Commodity Currencies and Japanese Yen

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Commodity Price Recovery Boosts Canadian Dollar

The Canadian (CAD), Australian (AUD), and New Zealand dollar (NZD) all strengthened against the greenback mid-week as risk appetite returned to the market. Canadian Prime Minister Stephen Harper will meet Finance Minister Jim Flaherty, and central bank Governor Mark Carney gave a rare public glimpse into their closed-door meetings as they review Europe’s debt crisis. 

Flaherty and Carney hold regular private meetings to discuss the economy, and publicizing today’s event aims to assure Canadians the government is focused on the recovery. The meeting is likely to give a sense that the government is on top of the current economic developments. 

There are numerous downside risks right now, so it is appropriate to give every indication of concern and to attempt to keep in front of issues. Bank of Canada government council member Macklem will be speaking this week. 

Commodities rose for a second day—the best run this month—as copper rebounded from a 14-month low, oil rose the most in six weeks, and gold and silver futures rose the most since March 2009, all amid optimism that European leaders will take steps to resolve the region’s debt crisis. 

The aussie advanced against the greenback for a third day as Asian shares extended a global rally, supporting demand for higher-yielding assets. Currently, traders are pricing in at least a 50-basis-point cut to the Reserve Bank of Australia’s rate by the end of the year. 

The central bank has held its key rate at 4.75% since November 2010. This will likely produce a weaker Australian dollar, which will be generally positive because it is an export-driven economy. 

New Zealand’s currency rallied for a second day as prices for commodities advanced, boosting prospects for the nation’s resource exports. New Zealand has been experiencing a relatively strong domestic recovery, and this would likely see expectations of rate hikes from the Reserve Bank of New Zealand (RBNZ) ramped up, spurring further gains in the kiwi. 

However, rallies from here could be more contained, as the aussie and kiwi are trading around international factors in the near term. On the docket for New Zealand this week are building consents and the NBNZ business confidence index.

Japanese Yen: Prices Fall, Confidence Rises

The Japanese yen (JPY) weakened against all the major currencies mid-week as risk appetite returned to the market on optimism that European leaders are close to an agreement to contain the region’s debt crisis. Japanese equities rallied as well, gaining the most since March and rebounding from a two-and-a-half-year low. 

The corporate services price index for August printed at -0.4%, in line with expectations, following a -0.3% report in July. The index has been negative since September 2008 and is being held under pressure by the strong yen. 

Small business confidence has also been hit by the yen strength and printed at 47.2 for September. It did rise from the 46.4 reading in August, in response to Prime Minister Yoshihiko Noda pledging to provide subsidies for small companies, prompting them to stay in Japan. However, it still stayed below the key 50 line, reflecting deteriorating business conditions. 

The biggest increase in Japanese vehicle production in three decades means tiremakers will make the most sales ever, reigniting a rally in rubber prices. Japanese vehicle output more than doubled in three months as factories reopened after the March earthquake. The Japan Automobile Manufacturers Association said forecast sales in the September-to-March period will increase 17% from a year earlier. This is a huge increase considering demand on the whole this year may drop 14% in the wake of the March natural disasters. 

A Nissan Motor Co. senior executive urged Japan to take “decisive” action to prevent the strong yen from hollowing out the country’s industrial base, saying he hopes Tokyo can learn from Switzerland’s intervention in the foreign exchange markets to weaken its currency. The remarks are the latest in an increasingly vocal campaign by Nissan and other Japanese automakers to push Tokyo into doing more about the yen’s strength. 

The Fukuskima desolation is proving to be the worst since Nagasaki as residents flee the area. A devastating radioactive zone is emerging in Fukushima. It is bigger than that left by the 1945 atomic bombings at Hiroshima and Nagasaki. 

Fukushima’s $3.2 billion-a-year farm industry is being crippled, and tourists that hiked the prefecture’s mountains and surfed off its beaches have all but vanished. 

On the docket this week is retail sales for the month of August. Expectations are for a decline of 0.6% following an increase of 0.6% in July. A miss is possible due to depressed household confidence and a strong yen.

By Kathy Lien of KathyLien.com

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