Dollar Forecast Dependent on Testimony from Fed's Bernanke
Friday, 17 October 2008 22:00:18 GMT
Written by Terri Belkas, Currency Strategist
The US dollar ended last week almost completely unchanged, as lingering risk aversion in the markets leaves safe-haven flows supportive of the greenback. While there have been some signs of stabilization in the markets, such as the drop in overnight interest rates, there were also indications that high volatility and lower liquidity will leave the markets prone to wild price swings.
Dollar Forecast Dependent on Testimony from Fed’s Bernanke
Fundamental Outlook for US Dollar: Bearish
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- Retail sales drop for the third consecutive
- US industrial production falls by the most since 1974, adding to recessionary fears in Q3, Q4
The US dollar ended last week almost completely unchanged, as lingering risk aversion in the markets leaves safe-haven flows supportive of the greenback. While there have been some signs of stabilization in the markets, such as the drop in overnight interest rates, there were also indications that high volatility and lower liquidity will leave the markets prone to wild price swings. Indeed, the CBOE’s VIX Volatility Index continues to trade dangerously close to Thursday’s record high of 81.17 while the latest forex positioning report shows that open interest in pairs like EUR/USD and GBP/USD has been declining steadily, signaling lower liquidity. Fortunately for
Japanese Yen Forecast Remains Bullish on Financial Market Stress
Friday, 17 October 2008 21:47:48 GMT
Fundamental Forecast for Japanese Yen: Bullish
- Japanese Yen Plunges Against Australian dollar on Return To Risk
- US Recapitalization Plan Fails to Sink Risk-Friendly Japanese Yen
- Japanese Demand Falters, Stokes Recessionary Fears
The Japanese Yen was one of the few currencies to lose against the US dollar through the past week of forex trade, as a marginal improvement in global risk sentiment and the US Dow Jones forced pullbacks in the Japanese currency. Yet the recent lull in financial market stress hardly suggests that the worst is over for global equity markets. We maintain our fundamentally bullish bias for the Japanese Yen, as cursory look at key credit and equity market indicators shows that conditions are far from normal. The spread between 3-month US Dollar London Interbank Offered Rates (LIBOR) and 3-month US Treasury Bills remains at an astounding 362 basis points. Prior to the onset of the subprime crisis in 2007, this same Treasury-Eurodollar spread averaged below 40 basis points. It remains all-too-clear that recent central bank actions have not yet forced significant improvements in interbank lending markets, and this will continue to raise borrowing costs and crimp corporate earnings through the foreseeable future.
A closer look at equity markets likewise suggests that there remains significant stress below the surface—boosting prospects for safe-haven Japanese Yen. The US S&P 500 finished the week over 8 percent above recent multi-year lows, but its Volatility Index (VIX) continues to trade near astounding record highs. The VIX, often referred to as the “fear index”, measures 1-month volatility expectations on an annualized basis. Thus its current value of 70.33 percent implies that options traders predict the S&P 500 will fluctuate by over 20 percent through the next 30 days—a truly noteworthy sign that traders fear extensive equity market volatility. We believe that such clear signs of financial market stress will make it difficult for major currencies to rally against the highly risk-sensitive Japanese Yen. The US Dollar/Japanese Yen currency pair remains strongly correlated to the Dow Jones Industrials Average.
Domestic developments have had little effect on the Japanese Yen through recent forex trade, and there is little reason to believe that upcoming economic data will force any noteworthy moves in major Yen pairs. Instead, we will keep a close eye out for any flare-ups in broader market volatility—especially as it relates to price movements across major global equity markets. It will be important to watch whether Asian markets can set the pace for equity trading through Sunday’s open. A strong rally through last week’s Asian equity market session set the tone for a weaker Japanese Yen through Friday’s close. - DR
British Pound May Not Be The Only Currency Responding To 3Q GDP
Saturday, 18 October 2008 02:54:37 GMT
Event risk promises a volatile week for the British pound should risk trends give way to normal market operations when liquidity returns to the market. And, without doubt, the most market-moving piece of data for the sterling (and likely the entire currency market) will be the advance reading of third quarter GDP.
British Pound May Not Be The Only Currency Responding To 3Q GDP
Fundamental Outlook for British Pound: Bearish
- UK bails three banks as 500 billion pound bailout plan put into action quickly
- Unemployment claims rise to near two-year high as recession begins to take hold
- BoE says it will delay reporting those banks seeking emergency funds to avoid panic
Event risk promises a volatile week for the British pound should risk trends give way to normal market operations when liquidity returns to the market. And, without doubt, the most market-moving piece of data for the sterling (and likely the entire currency market) will be the advance reading of third quarter GDP. With the housing market collapse hitting a new stride, trade deficits ballooning to records, lending essentially evaporating and consumer spending souring with confidence, the 0.2 percent contraction forecasted for Europe’s second largest economy may ultimately prove modest. This would technically only be the first quarter of negative growth – a line that many Euro Zone members have already crossed in the period through June. Nonetheless, this would be the first contraction in growth for the UK in 16 years and recent data would easily bridge the gap for a technical recession. Obviously, this data would have a considerable impact on the pound – with a integral role in driving interest rate speculation – but this data will further have an impact on the entire currency market. As the first of the G7 economies to release its growth numbers, this indicator will confirm or deny growing forecasts that the world economy is heading toward recession.
Before the 3Q growth number hits the wires and absorbs the entire Forex market, sterling traders will have plenty of event risk to trade against. Starting things off immediately through Sunday’s illiquid hours with the Rightmove House Prices gauge. As the leading sector indicator, this report may generate interest; but the actually influence it has on price action will be limited as the market is already well aware of the housing recession n the United Kingdom. Perhaps more interesting though will be Thursday’s BBA home loans report for September. This indicator is not only leading housing indicator; but it is also a key measure for consumers’ demand for credit and their level of confidence. Net public borrowing figures on Monday will give a similar reading for rotating loans. Elsewhere, reports on both manufacturing and retail sector health will offer last minute adjustments to speculation on the GDP report. However, we shouldn’t expect much of a reaction form the markets to either of these reports. The CBI quarterly industrial trends report is a broad reading of factory activity, but its proprietary release renders its an impotent indicator. For most currencies, governmental retail sales readings are often top market movers; but for the UK, the data is volatile and even the BoE has said it was paying the data little heed when deciding monetary policy. – JK
Euro Traders Growing Critical Of Growth And Interest Rates
Saturday, 18 October 2008 02:50:52 GMT
The past week was riddled with comments and data that suggests Euro Zone growth and interest rates will deteriorate faster than market participants had initially expected. This balance will be the primary concern for fundamental traders over the coming week – barring any unforeseen bank collapses or broad seizures in overnight lending.
Euro Traders Growing Critical Of Growth And Interest Rates
Fundamental Outlook for Euro: Bearish
- Euro Zone policy makers commit over 1.1 trillion euros to bring an end to the financial crisis
- Investor confidence nears record low as lending and capital markets seize
- Though well above the ECB’s target, slowing Euro Zone CPI broadens the scope for follow up rate cuts
The past week was riddled with comments and data that suggests Euro Zone growth and interest rates will deteriorate faster than market participants had initially expected. This balance will be the primary concern for fundamental traders over the coming week – barring any unforeseen bank collapses or broad seizures in overnight lending. Over the next few weeks and months, traders in all markets focus will be on the effectiveness of European and other nationalized bailout efforts. Late to the game, officials from the largest member economies took sweeping and dramatic steps last weekend to extinguish ballooning fears and revive counterparty confidence to revive borrowing and investment. However, aside from a vow by ECB President Trichet to offer unlimited short-term funds to banks, most of the endeavors by policy officials have been domestic – an ineffective approach for a collective economy whose banks cross boarders. By Trichet’s own admission, it will be “up to all market participants and institutions to take the measure of what is done by the authorities.” Should traders and/or banks realize the credit bubble is far from deflated, we will once again see how quickly panic spreads and what else policy officials can do to stem the tide.
Though fear is an all consuming emotion for a trader when capital is on the line, the next concern is returns. Should volatility settle it will merely expose the euro to speculation on growth and interest rate expectations – the primary pricing tools for currency traders. Just a month ago, the euro was considered one of the few currencies that would be able to hold its interest rates at its relatively high 4.25 percent yield. That all changed however when European banks began to fail and the monetary authority was forced to cut the benchmark by 50 basis points. On the other hand, there may still be skepticism in the market that Trichet and company won’t follow up on this extraordinary move – and this is where the next leg of the larger bear wave will come from. Overnight index swaps measured by Credit Suisse suggest there is a 100 percent chance that the central bank will cut by another 25 basis points on November 6th. Economists on the other hand, believe the fight against inflation will keep the benchmark lending rate at 3.75 percent.
Another burning issue for the euro is the outlook for growth. Speculation over the severity and length of a Euro Zone recession will be held up to forecasts for all of the economy’s major counterparts; and the currency will derive its direction from this relation (the same comparison holds true for interest rates in the stead of growth). The economic docket will fuel this valuation with leading sector readings. The advanced readings of manufacturing and service sector activity for October are expected to lows not seen since the euro started trading. With the European economy already one step into recession, this figures would merely further fears that confirmation in inevitable from GDP numbers next week. - JK
Visit our recently updated EUR/USD Currency Room for more resources dedicated to the Euro.
Questions? Comments? Send them to John at jkicklighter@dailyfx.com.
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