Currencies Rally With Aid on the Way

If the equity market managed to rally despite news that 533k jobs were lost from the US economy last month, then Obama’s pledge to increase spending this weekend and the developments for the Big 3 automakers will only help. Risk appetite appears to be slowly returning to the markets with the low yielding US dollar and Japanese Yen losing ground to higher yielding currencies such as the Euro, Australian and New Zealand dollars.

Aid is on the Way

The market’s immunity to bad news suggests that everyone is tired of hearing the obvious, which is that the US economy is in bad shape and will worsen before it improves. It appears that all of the weakness in the first half of the 2009 is priced in and instead investors are latching onto the stimulus plans for hope that they will help to trigger recovery in the second half of 2009. This weekend, President-elect Barack Obama laid out his plan to create or preserve 2.5 million jobs . His focus is on infrastructure – upgrading public buildings to make them more energy efficient, building roads and highways and modernizing school buildings. He is hitting the ground running and is expected to announce a $500B to $700B stimulus plan in the first days of his administration.

At a time when uncertainty about the US economy is at elevated levels, the prospect of a major stimulus package and a decision on aid for the Big 3 automakers is helping to improve investor sentiment. The Big 3 automakers have dominated the headlines for the past few weeks and regardless of whether GM and Chrysler will be forced into bankruptcy, the markets will be relieved that there is a resolution.

Of course, there is still plenty of reasons to be skeptical about the rally in currencies and equities. The layoffs keep coming in as Dow Chemical announces an 11 percent reduction in their workforce, which translates into 5000 jobs. Bonus cuts, salary freezes and warnings about earnings have also become the norm.

But it is important to realize that equities and currencies have become extremely oversold in the past few weeks and the lack of any major US economic data until Thursday is helping to fuel the recovery. I think that we are witnessing a bear market rally and that we have yet to hit a long term bottom.

Here is the video of President-elect Barack Obama laying out key parts of Economic Recovery Plan:
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Will the US Dollar Become the Lowest Yielding Currency in the World?

Fed fund futures are already pricing in a greater chance that the central bank will cut rates by 75bp on December 16th than 50bp. That would bring US interests down to 0.25% and turn the US dollar into the lowest yielding currency in the developed world.

Source: Bloomberg

Source: Bloomberg

Since Japan’s interest rate is currently 0.3%, if the US takes rates below Japan’s levels we could see a downward adjustment in USD/JPY. At this point, taking interest rates to zero may only have limited impact on the financial markets because short term yields are already trading near those levels. Beyond that comes quantitative easing and in many ways, the Federal Reserve’s latest announcements about buying Fannie and Freddie debt already constitutes quantitative easing.

However there is hope as the continual decline in oil prices will help to cushion the blow of a softening economy for US consumers while the prospect of 4.5 percent mortgage rates could help to reinvigorate the housing market. In addition to the retail sales report, we also expect pending home sales, the trade balance, producer prices and the University of Michigan consumer confidence survey from the US this week.

CAD: Bank of Canada Expected to Cut Rates to 1.75%
EUR: Will it Remain Immune to Weak Data?
GBP: May Continue to Underperform the Euro
JPY: Recovery in Dow Takes Yen Crosses Off Multi Year Lows
AUD: Construction PMI Sinks to 32.0
NZD: Retail Sales on Tap Next Week

Kathy’s New Book: Second Edition of Day Trading the Currency Market

The second edition of Day Trading the Currency Market has been released!

If you liked the first edition, you will love the second.

I have added 3 new trading strategies and 4 new chapters and updated many sections.

New Trading Strategies:

1. How to Trade News
2. How to Time a Turn
3. How to Follow the Flow

PLUS

1. Tips on How to Trade Like a Hedge Fund Manager
2. Taking Advantage of Seasonality in the Currency Market
3. New Cross Market Correlations