Currencies: Post Thanksgiving Breakout?

On the eve before Thanksgiving, the price action in the currency market has been very erratic. Equities rallied for the fourth straight trading session while the US dollar weakened against the Australian and New Zealand dollars but strengthened against the Euro, British Pound and Japanese Yen.

Currencies appear to be decoupling from equities on this low volume pre holiday trading session. Over the past few weeks, strength in equities has translated into strength in the EUR/USD but that was not the case today. US economic data was very weak, but hope continues to supersede reality as President Elect Barack Obama adds former Federal Reserve Chairman Paul Volcker to his team.

Obama’s Economic Dream Team

Rather than having to pick from Timothy Geithner, Larry Summers and Paul Volcker, Obama has decided to add all 3 of these well respected and talented men to his Economic Dream Team. The equity markets turned around after Obama announced that Volcker will the Chairman of a new White House advisory board that is tasked with stabilizing the financial markets and pulling the US economy out of recession. This new Economic Advisory Board will give their opinions in briefings to the President and include experts outside the government with the goal of “infusing ideas from across the country and from all sectors of the US economy.” Even before taking office, Obama is proving to be a President who wants to hear every possible viewpoint before making his decisions. He is on track to hit the ground running come January 20th and the equity markets have responded very favorably to his appointments and the initial details of his economic recovery plan. Over the next 24 days, Obama will play a critical role in helping to maintain confidence in the financial markets.

Latest String of Economic Data Hits Multi-Year Lows

Confidence will be extremely important as the US economy continues to come face to face with weak economic data. On the eve of Thanksgiving, we have had a harsh reminder of the problems plaguing the US economy. With the shortened holiday trading week, there were a lot of US economic data released today and a number of those indicators hit multi-year lows. As we have previously warned, because third quarter GDP only slipped by 0.5 percent, fourth quarter GDP could be very weak.

Is There a Risk of a Breakout on Friday?

For the currency market, the Thanksgiving Day holiday usually leads to low liquidity and thin volumes. Although this should mean range trading for all of the major currencies, watch out for a post Thanksgiving Day breakout. Low liquidity makes it extremely easy to exacerbate the volatility that we have been seeing in the currency market. In 2007 and 2006, the EUR/USD’s trading range on the Friday after Thanksgiving was more than 3 times its trading range on Thanksgiving Day.

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House Kills the Bailout Plan and the US Dollar

The rejection of the $700B bailout plan by the House of Representatives came completely out of the left field, driving a knife through both US equities and the US dollar. For the Bush Administration, it certainly feels like they are moving one step forward and taking two steps back but the severity of the financial crisis makes it absolutely necessary for Washington to put economics ahead of politics. Although traders were initially dissatisfied with Congress’ approval of Paulson’s plan, they were counting on a bailout. The combination of a huge liquidity injection by the Federal Reserve today and the hope that the bailout plan would move forward kept stocks from falling further. However those efforts and the sleepless weekend of debates turned out to be futile after the House rejected the bailout bill. For fairness, there was no was guarantee that Paulson’s plan would have helped average Americans, but at least it could have brought some stability to the financial markets. Unfortunately it is now back to the drawing board for Paulson who has to meet with Bush, Bernanke and Congress to discuss their next steps. Volatility in the financial markets benefits no one especially as more than $1 Trillion in market value has been wiped out from US stocks today. The VIX, which measures equity market volatility shot to the highest level in 6 years while gold prices jumped 3.8 percent. LIBOR rates have also skyrocketed while the TED spread continued to widen indicating that as a result of the House’s rejection of the bill, investors both domestically and internationally have become more risk averse. For those that are willing to part with their cash, they are demanding a high premium.

Dow 10,000 Could Mean 100 USD/JPY

dow092908 The Dow Jones Industrial Average closed down more than 770 points while the S&P500 dropped more than 8 percent. This is the largest single day drop in the Dow ever and the largest percentage decline in the S&P500 in 20 years. We have long argued that if the Dow hit 10,000, USD/JPY could fall to 100. That correlation remains intact today as the plunge in US equities drags USD/JPY towards 104.00. In the September 19th edition of the Daily Currency Focus, we argued that the US dollar could fall by another 5 percent. At that time, USD/JPY was trading at 107.40 and to many people a 5 percent move lower, which is the equivalent of 530 pips seemed like a farfetched possibility. However since then the dollar has already fallen close more than 300 pips, making a move towards 102 within reach. With the US stock market plunging and the US government looking to raise the national debt, in addition to hammering out the bailout plan, the Bush Administration will have to work extra hard to reassure foreign investors.

Gold Becomes a Hedge for Inflation and the US Economy

Now more than ever, the US needs to rely on foreign funding. If Central Banks and Sovereign Wealth Funds around the world start to lose confidence in the US financial markets or the US government, we could be looking at a complete freeze in lending that expands beyond the banking sector. According to an article in the Wall Street Journal, central banks are already loading up on gold as European central banks cut their sales to the lowest level in almost 10 years. Gold prices are up more than $35 an ounce today as a hedge for inflation and a hedge for the US economy. Everyone is starting to realize that commodities are the only assets that have no counterparty or credit risk. Gold prices first jumped on inflation fears after the Federal Reserve’s liquidity injections this morning. Having more than doubled their swap limits from $290B to $620B, the Fed is trying to tell the market that they are serious about providing liquidity and given today’s sharp volatility, they will continue to do aggressively in the coming days.

TARP Drama Gets More Dramatic – Time to Play Defensive

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Bailout Plan Fails to Impress, Traders Worried More About Dominoes Effect

The Congressional agreement of the $700 Billion bailout plan has proved to be anti-climatic for the stock and currency markets. There was a relief rally in the US dollar Sunday evening, but it lasted for no more than a blink of an eye as more problems came knocking on the door for financial institutions. Investors quickly moved onto the latest problems with a string of bank bailouts announced in Europe and the practical failure of Wachovia. Being sold at $1 a share is almost the same as filing for bankruptcy.

THE DOMINOES EFFECT

The US dollar has weakened against the Japanese Yen, but its strength against the Euro and British pound indicate that the concerns for those currency pairs now shift to the prospect of further bank failures in Europe. In the Eurozone, Fortis was bailed out by Belgium, the Netherlands and the Luxembourg governments while the Hypo Real Estate group was bailed out by the German government. In the UK, Bradford and Bingley was nationalized by the UK government. If the US banking sector is a good model, then we know that this is just the beginning of bank failures as the dominoes effect triggers more losses. With the ECB interest rate decision scheduled for Thursday, the problems in the banking sector could pressure the European Central Bank to consider easing monetary policy.

On the heels of the bailout plan, the Federal Reserve has injected a tremendous amount liquidity into the global money markets by increasing their swap lines. This is driving gold prices through the roof as inflation fears soar and money flocks out of US dollars and into gold as the safe haven play. Nonetheless, the Fed is trying to tell the market that they are serious about providing liquidity with the size of today’s liquidity injection – they more than doubled their swap limits from $290B to $620B.

US COMPANIES PLAYING DEFENSE COULD BOOST RECESSION RISKS
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In the Financial Papers: Today’s Top Forex News 06.13.08

kathysmallHere is the “In the Financial Papers Radio Broadcast” (Length: 4:48minutes). The player should load automatically. Please let me know if you like it. Contact Kathy

In the Financial Papers:

 

Podcast Covers:
Consumer Confidence Hits 28 Year Lows
Consumer Prices Hot on Headline Level, Tepid on Core
Oil Falls as Saudi Arabia’s al-Naimi Says Meeting Will `Stabilize’ Prices
Stimulus Checks Aid Retail Sales
Economists Signal More Trust in Fed
ECB Calls for Better Access to Sensitive to Bank Data
EU Referendum Weighs on Euro
Risks for G8 Meeting
US Blamed for Economic Gloom Across the Globe
Stagflation, Asia’s Latest Export

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Weak Job Growth Does Not Always Equal Weak Retail Sales

The biggest event risk for the US dollar this week will be the April retail sales report. Since hitting a record low against the Euro the middle of last month, the greenback has strengthened significantly. However as the market finally latches onto the recent strength of the dollar, we are actually beginning to see a shift in its trend. Since Thursday, the EUR/USD has already climbed over 250 pips from 1.5280 to 1.5530.

The degree of consumer spending last month will play a major role in determining whether the recovery in the US dollar is over.

Weak Job Growth Does Not Always Equal Weak Retail Sales

The US economy has lost jobs for 4 months in a row , leading everyone to believe that consumer spending will contract. In fact that there are MANY reasons to believe that retail sales decreased in April including the following:

1. Four Consecutive Months of Negative Job Growth
2. US Consumer Confidence Hits a 26 Yr Low (According to the UMich Survey)
3. US House Prices Drop 12.7% in Feb, Foreclosures on the Rise
4. Gas Prices Break Above $4 a Gallon in Many States, Food Prices Increase

*Although higher gas and food prices also boosts the value of consumer spending, it could negatively affect spending volume.

However there are also many reasons to believe that retail sales may not be extraordinarily weak:
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