Dollar, Stocks And Risk Appetite Reaction To Fed's Stress Test May Not Be Straightforward

The steady and relatively unimpeded rise in risk appetite over these past few months may have finally been put off its pace. After a bout of high volatility that coincided with heavy event risk, the markets seem to have lost their clear bias with momentum receding and the fundamental outlook for global growth and financial markets growing more complicated.

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• Dollar, Stocks And Risk Appetite Reaction To Fed’s Stress Test May Not Be Straightforward
• US 1Q GDP Sets A Disappointing Precedence For Global Growth
• Yields Continue To Contract With The RBNZ Cut Lowering The Ceiling On A Key FX Rate

The steady and relatively unimpeded rise in risk appetite over these past few months may have finally been put off its pace. After a bout of high volatility that coincided with heavy event risk, the markets seem to have lost their clear bias with momentum receding and the fundamental outlook for global growth and financial markets growing more complicated. This time around, traders and investors may require a tangible source of support to bolster their exposure while the future of risk and reward are still unbalanced. Taking measure of the market’s health though, there are a few irrefutable improvements in general conditions. The key improvement comes through the DailyFX Volatility Index. Though this indicator ticked higher week-over-week; at 13.7 percent, the forecasted range of price action over the next three months is nonetheless just off its lowest levels since the September (just before the panic that led to the panic sell off in equities and a deleveraging for so many other asset classes). This is a trend that cannot be ignored as its consistency reflects an underlying improvement in a critical component of the risk/reward equilibrium. For the potential yield or return side of that same equation, the forecast is not as bright – yet. Benchmark interest rates among some of the highest yielding currencies continue to fall and will do so until there is a genuine economic recovery underway. In the meantime, the global rates will trend closer and closer to zero and subsequently close the gap (or carry) along the way. However, we have seen in this market, things can change on a dime.

How risk appetite (or aversion) develops is becoming more and more a factor of sentiment rather than a natural response to fundamentals. The effects of recession are familiar to nearly every market participant; but policy officials, economists and speculators are quickly coming to a consensus that the global economy is beginning to stabilize and is likely to recover sometime at the end of this year or into the beginning of 2010. At the same time, the slighter than expected improvement in the pace of the United States’ recession through the first quarter certainly pushed this outlook back somewhat. As further growth readings from the industrialized and emerging markets cross the wires, the outlook will find further adjustments. Expansion and economic activity are inherently a platform for returns. As such, the timing of the eventual recovery will play a significant role in how quickly the rebound for speculation will be. Should the correction happen immediately, there will still be substantial yield differentials to work with and spur investment. However, with each month that passes, income producers like the Australian and New Zealand dollar will see their rates steadily depreciate. And, while there demand for return is on the rise, we cannot completely write off risk. After months of stability in the capital and credit markets, we are coming on the next major threat to calm: the Fed Stress Test. Initial reports suggest six of the 19 banks under review will come up short and be forced to raise capital. How will the market react to this? Is another collapse inevitable? Time will tell.

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Risk Indicators:


Definitions:


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What is the DailyFX Volatility Index:



The DailyFX Volatility Index measures the general level of volatility in the currency market. The index is a composite of the implied volatility in options underlying a basket of currencies. Our basket is equally weighed and composed of some of the most liquid currency pairs in the Foreign exchange market.



In reading this graph, whenever the DailyFX Volatility Index rises, it suggests traders expect the currency market to be more active in the coming days and weeks. Since carry trades underperform when volatility is high (due to the threat of capital losses that may overwhelm carry income), a rise in volatility is unfavorable for the strategy.





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What are Risk Reversals:

Risk reversals are the difference in volatility between similar (in expiration and relative strike levels) FX calls and put options. The measurement is calculated by finding the difference between the implied volatility of a call with a 25 Delta and a put with a 25 Delta. When Risk Reversals are skewed to the downside, it suggests volatility and therefore demand is greater for puts than for calls and traders are expecting the pair to fall; and visa versa.



We use risk reversals on AUDUSD as global interest rates have quickly fallen towards zero and the lines between safe haven and yield provided has become blurred. Australia has a historically high and responsive benchmark, making it more sensitive to current market conditions. When Risk Reversals grow more extreme to the downside, it typically reflects a demand for safety of funds - an unfavorable condition for carry.





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How are Rate Expectations calculated:



Forecasting rate decisions is notoriously speculative, yet the market is typically very efficient at predicting rate movements (and many economists and analysts even believe market prices influence policy decisions). To take advantage of the collective wisdom of the market in forecasting rate decisions, we will use a combination of long and short-term, risk-free interest rate assets to determine the cumulative movement the Reserve Bank of Australia (RBA) will make over the coming 12 months. We have chosen the RBA as the Australian dollar is one of few currencies, still considered a high yielders.

To read this chart, any positive number represents an expected firming in the Australian benchmark lending rate over the coming year with each point representing one basis point change. When rate expectations rise, the carry differential is expected to increase and carry trades return improves.





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Additional Information

What is a Carry Trade
All that is needed to understand the carry trade concept is a basic knowledge of foreign exchange and interest rates differentials. Each currency has a different interest rate attached to it determined partly by policy authorities and partly by market demand. When taking a foreign exchange position a trader holds long position one currency and short position in another. Each day, the trader will collect the interest on the long side of their trade and pay the interest on the short side. If the interest rate on the purchased currency is higher than that of the sold currency, the result is a net inflow of interest. If the sold currency’s interest rate is greater than the purchased currency’s rate, the trader must pay the net interest.

Carry Trade As A Strategy
For many years, money managers and banks have utilized the inflow and outflow of yield to collect consistent income in times of low volatility and high risk appetite. Holding only one or two currency pairs would invite considerable idiosyncratic risk (or risk related to those few pairs held); so traders create portfolios of various carry trade pairs to diversify risk from any single pair and isolate exposure to demand for yield. However, even with risk diversified away from any one pair, a carry basket is still exposed to those conditions that render this yield seeking strategy undesirable, such as: high volatility, small interest rate differentials or a general aversion to risk. Therefore, the carry trade will consistently collect an interest income, but there are still situation when the carry trade can face large drawdowns in certain market conditions. As such, a trader needs to decide when it is time to underweight or overweight their carry trade exposure.

EUR/USD: Trading the U.S. ISM Manufacturing Report

Manufacturing activity in the U.S. is expected to contract at a slower pace in April as economists project the ISM index to increase to 38.4 from 36.3 in the previous month, and the data could reinforce an improved outlook for growth as demands pick up however, as the region faces its worst economic downturn in over half a century, economic activity is likely to remain subdued throughout the first half of the year.

Trading the News: U.S. ISM Manufacturing

What’s Expected

Time of release: 05/01/2009 14:00 GMT, 10:00 EST
Primary Pair Impact : EURUSD

Expected: 38.4

Previous: 36.3

Impact the U.S. ISM Manufacturing has had on EURUSD over the last 2 months
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March 2009 U.S. ISM Manufacturing

Manufacturing in the U.S. fell at a slower pace in March as the ISM index increased to 36.3 from 35.8 in the previous month, and the data suggests the downturn in the economy may be reaching a bottom as policymakers take unprecedented steps to steer the region out of a recession. A deeper look at the report showed new orders increased to 41.2 from 33.1 in February, while export demands rose to 39.0 from 37.5, and the employment component rebounded to 28.1 from a record-low of 26.1 in the previous month. Despite the minor improvement in March, economic activity is likely to remain subdued throughout the year as the labor market deteriorates while credit conditions remain far from normal, and conditions may get worse as the U.S. auto industry falters. Moreover, as the downturn in the world economy intensifies, trade conditions are likely to deteriorate further, which reinforces a weakening outlook for growth.


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February 2009 U.S. ISM Manufacturing

The ISM report showed that manufacturing in the U.S. contracted for 13 consecutive months in February, but fell at a slower pace from the previous month as the index increased to 35.8 from 35.6 in January. The breakdown of the report showed new orders ticked lower to 33.1 from 33.2, while the employment component slipped to 26.1 from 29.9, which is the lowest since recordkeeping began in1948, and the data continues to foreshadow a deepening recession in the world’s largest economy as the labor market deteriorates at a record pace. As households continue to face falling home prices paired with fading demands for employment, the outlook for private-spending remains weak, and conditions are likely to get worse as firms continue to cut back on production and investment in response to the downturn in global trade.


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What To Look For Before The Release

Traders with access to market depth information via the FXCM Active Trader Platform may use it to gauge the potency of the economic data release as well as to shed some light on the market’s directional bias. Increasing volume ahead of the announcement will telegraph likely follow-through behind whatever move is to materialize, while an imbalance in available liquidity on the Bid versus the Offer side of the market will tell us the direction major institutions are likely favoring ahead of the announcement:

Bullish Scenario:



If we see substantially deeper available liquidity on the Bid side of the market, this tells us that major price providers in the market are looking to buy the Euro against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bullish bias on EURUSD ahead of the data release.


Bearish Scenario:

If we see substantially deeper available liquidity on the Offer side of the market, this tells us that major price providers in the market are looking to sell the Euro against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bearish bias on EURUSD ahead of the data release.

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How To Trade This Event Risk



Manufacturing activity in the U.S. is expected to contract at a slower pace in April as economists project the ISM index to increase to 38.4 from 36.3 in the previous month, and the data could reinforce an improved outlook for growth as demands pick up however, as the region faces its worst economic downturn in over half a century, economic activity is likely to remain subdued throughout the first half of the year. The advanced GDP reading for the first quarter showed that the world’s largest economy contracted 6.1% from the previous quarter amid expectations for a 4.7% drop in the growth rate as businesses scaled back on spending and production at a record pace, and firms may continue to aggressively cut costs over the year as trade conditions falter. The breakdown of the report showed exports dropped 30.0% in the first quarter to mark the biggest decline in 40-years while imports plunged 34.1% however, the 2.2% increase in personal consumption encouraged an improved outlook for future growth as private-sector spending accounts for more than two-thirds of the economy. At the same time, a report by the Commerce Department earlier this month showed retail sales unexpectedly slipped 1.1% in March, while orders for durable goods fell 0.8% during the same period, and personal consumption may fall in the second quarter as households face a weakening labor market. Non-farm payrolls plunged another 663K in March, which pushed the annual rate of unemployment to a 25-year high of 8.5% from 8.1% in February, while continuing claims for jobless benefits reached a fresh record-high in the week ending April 11, and the outlook for growth and inflation remains bleak as the International Monetary Fund forecasts the annual growth rate to contract 2.8% this year. Meanwhile, after holding the benchmark interest rate at the record low and maintaining its program to drive up the money supply, the Federal Reserve said that ‘the economic outlook has improved modestly since the March meeting,’ and went onto say that the extraordinary efforts taken on by policymakers ‘will contribute to a gradual resumption of sustainable economic growth in a context of price stability.’ The encouraging comments from the central bank sparked expectations for a recovery later this year as the Fed pledged to utilize ‘all available tools to promote economic recovery and to preserve price stability’ however, as policymakers expect economic activity to ‘remain weak for a time’ and sees ‘some risks that inflation could persist for a time below’ the 2% target, the FOMC may continue to step up its efforts to shore up the economy as the region faces a deepening recession. Nevertheless, as risk trends continues to drive price action in the foreign exchange market, a rise in market sentiment could weigh on the reserve currency as investors move into higher risk/reward investments.



Expectations for a rise in the ISM favors a bullish outlook for the greenback as the Fed expects the economy to recover in the second half of the year, and price action following the release could pave the way for a long dollar trade as investors hold long-term expectations for higher interest rates in the U.S. Therefore, an in-line print or a rise above 38.4 would lead us to look for a red, five-minute candle following the event to confirm a sell entry on two-lots of EUR/USD, and once these conditions are met, we will set our initial stop at the nearby swing high (or reasonable distance), and this risk will determine our first target. Our second target will be based on discretion, and we will move the stop on the second lot to breakeven once the first trade trades its target in order to preserve our profits.



On the other hand, fears of a deepening recession paired with the record-drop in exports may lead firms to lower production in April, and a dismal ISM report could weigh on the greenback as the outlook for growth and inflation remains bleak. As a result, if the index unexpectedly falls to 34.0 or lower, we will follow the same strategy for a long euro-dollar trade as the short position mentioned above, just in reverse.
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Euro Weighed By Rising German Unemployment, Will ECB Initiate QE Measures?

The euro reached as high as 1.3388 before the German unemployment report showed the country lost another 58,000 jobs and saw its unemployment rate rise to 8.3% which is the highest since December, 2007. The CPI-estimate holding at 0.6% also added to bearish sentiment as the forecast were for a rise in inflation to 0.7%.

Talking Points
• Japanese Yen: BoJ Leaves Rates Unchanged At 0.10%
• Pound: Consumer Confidence Rises To Highest In a Year
• Euro: German Unemployment Rises To 8.3%
• US Dollar: Personal Income and Spending On Tap

Euro Weighed By Rising German Unemployment, Will ECB Initiate QE Measures?

The euro reached as high as 1.3388 before the German unemployment report showed the country lost another 58,000 jobs and saw its unemployment rate rise to 8.3% which is the highest since December, 2007. The CPI-estimate holding at 0.6% also added to bearish sentiment as the forecast were for a rise in inflation to 0.7%. Although, prices holding steady will help ease some deflation concerns, markets were ready to eliminate the concern if it saw price pressures increasing. Therefore, expectations will remain that he ECB could initiate non-standard measures as soon as their policy meeting next week.

Indeed, we have seen a pick up in rhetoric from the ECB heading into the May 7th decision which has provided conflicting views and led markets to believe that there is division amongst members on the future course of action. Yesterday, Juergen Stark may have cleared up the picture when he stated “we will make a decision about additional non- standard measures, which we will implement when the lower interest-rate limit is reached.” If we examine all the recent rhetoric we come away with a few consistencies in that, many feel that interest rates should not approach zero and that non-standard measure shouldn’t be implemented until the traditional measures have been exhausted. Therefore, we expect the central bank to cut rates by 0.25% next week and leave decisions on quantitative easing efforts until the next meeting as they continue with their measured approach and take stock of past efforts. We could see the Euro find support on such a scenario if the committee signals an end to their accommodative monetary policy. However, if markets believe that the ECB is remaining behind the curve the declining outlook for the region’s economy could lead to euro weakness.

The pound has also seen a reversal of fortunes as it has fallen 100 pips after reaching a two week high of 1.4949. We could be seeing profit taking here as the imminent bankruptcy of Chrysler and the “swine flu” pandemic alert level being raised to the second highest at 5. Regardless, equity markets are still higher on the day ion Europe and U.S> futures are pointing toward a higher open which could continue to provide sterling support. Positive fundamental releases could also add to a bullish case as the Gfk consumer confidence reading rose to -27 which was the highest in a year. Additionally, the 0.4% decrease in the Nationwide house price gauge was les s than forecasts of -1.2% and follows a 0.9% increase the month prior. Stabilization in the housing market will go along way in helping the economy find a bottom which could be a catalyst for increasing support for the pound.

A full economic docket today will provide further insight into the economy and may add to increasing optimism that has been built on the improvements in consumer confidence and personal consumption adding to dollar weakness. However, inline prints of personal income and spending in March which is forecasted to have fallen by 0.2% and 0.1% respectively, would contradict with the 2.2% jump in personal consumption component in the GDP report. Additionally, initial jobless claims are expected to remain at 640,000 as the labor market continues to be negatively impacted by the recession which could weigh on consumer spending going forward, and may extend the current downturn. Conversely, forecasts are for the Chicago PMI reading to improve to 35.0 from 31.4 adding to signs that activity is beginning to pick up as credit markets loosen which could help stem future job losses. This would support the FOMC’s contention that the economy is seeing a slower pace of contraction which led them to refrain from adding additional measures to their current quantitative easing efforts.

Will The EUR/USD Break 1.3000? Join us in Forum

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To discuss this report contact John Rivera Currency Analyst: jrivera@fxcm.com
04-30 MB1

Higher Euro Zone Inflation Unlikely to Signal Recession is Abating (Euro Open)

The Euro Zone Consumer Price Index is expected to show that the annual pace of inflation rose to 0.7% in April. However, it is far too early to say the rebound owes to a pickup in economic activity, and even more so premature to suppose that prices will continue to rise from here.

Key Overnight Developments

• UK Consumer Confidence Rises for Fourth Month in April, Says GfK
• Japan's Manufacturing Sentiment, Industrial Production Improve as Inventories Clear
• Australian Business Confidence Fell at Slower Pace in Q1, Says NAB
• Bank of Japan Holds Interest Rates at 0.10% as Expected

Critical Levels



The Euro was little-changed in the overnight session: prices initially rose to test as high as 1.3338 but retreated back below the 1.33 level ahead of the opening bell in Europe. The British Pound trended higher, adding as much as 0.6% against the US Dollar.

Asia Session Highlights



UK Consumer Confidence continued to advance for the fourth consecutive month in April according to GfK, a market researcher, rising to -27 from -30 in the previous month. The news is hardly encouraging, however, even if we assume that the metric has put in a bottom despite rising unemployment. Looking at a comparable period of low consumer confidence during the 1990-91 recession, we see that the GfK metric reversed upward in March 1990 but GDP follow suit only 6 months later and did not return to positive growth for a full two years down the road. The absence of expanding output will mean that the central bank is likely to maintain a very loose monetary policy, holding the British Pound back against the currencies of countries where economic growth and by extension interest rates will head higher sooner (most notably the US Dollar).

Japan’s Nomura/JMMA Manufacturing Purchasing Manager Index rose for the fourth consecutive month in April, printing at 41.4 from 33.8 in the previous month. The reading is still below the “boom-bust” 50 level, meaning the manufacturing sector is still contracting, albeit at the slowest pace since October of last year. The improvement reflected expectations that the breakneck pace of decline in output will begin to slow as firms deplete existing stocks of products and are required to replenish. Indeed, Industrial Production rose for the first time in five months in March, rising 1.6%, while inventories shrank for the third consecutive month and the inventory-to-shipments fell -4.9% from a record high. Still, the news is far from rosy: overseas sales remain lackluster as Japan’s top trading partners suffer acute economic slowdown, so any pickup in production can be expected to be shallow. This means firms are unlikely to re-hire labor en masse, keeping the lid on spending and thereby overall economic growth for some time to come. Japan’s Trade Ministry was reasonably unimpressed, calling output “stagnant”.

Australian Business Confidence improved as expected in the first quarter from the three months to December 2008 according to National Australia Bank (NAB). Importantly, the metric continues to show contraction with a print in negative territory. Indeed, NAB chief economist Alan Oster remained cautious after seeing an uptick in the March result, saying, “While an element of fear appears to be abating, the index is still quite low [and] points to falling demand in the first quarter.”

The Bank of Japan kept interest rates on hold at 0.10% as expected. The decision was unanimous and policymakers said they will leave their current 1.8 trillion yen government bond purchasing program unchanged. The Japanese Yen was little changed after the announcement with the outcome widely priced into the exchange rate for some time.

Related Article: New Zealand Dollar Plummets as RBNZ Cuts Rates to 2.50%, Signals Low Rates Through Late 2010


Euro Session: What to Expect



The initial estimate of the Euro Zone Consumer Price Index are expected to show that the annual pace of inflation rose to 0.7% in April from a record low of 0.6% in the previous month. As with the analogous metric from Germany earlier this week, it is far too early to say the rebound owes to a pickup in economic activity, and even more so premature to suppose that prices will continue to rise from here. Currency depreciation may account for the increase, making imported goods comparatively more expensive for European consumers. Indeed, the Euro slipped -1.4% on average against the currencies of the regional bloc’s top trading partners to date this month. Travel and leisure spending linked to Easter may have also helped considering the holiday break fell in April this year rather than its usual time in March. The fallout in commodity prices (particularly oil) and slowing economic activity are likely to weigh on price growth in coming months. In fact, French Producer Prices are expected to fall by a record -5.3% in the year to April, suggesting lower consumer prices ahead as firms pass on lower manufacturing costs via cheaper finished products. The analogous metric in Germany also tumbled during the same period, bolstering the downside scenario for the Euro region as a whole.

If the economy is indeed showing signs of life, this likely owes to a slew of government spending packages put in place across the currency bloc. The ability of these measures to spur a sustainable return to economic growth looks questionable at best, however. Bruegel, a think tank, has estimated that European countries will spend an average of 0.9% of GDP on fiscal stimulus, as compared to 2% being spent in the US. On the monetary front, the European Central Bank seems intent on continued waffling, signaling rate cuts will end with borrowing costs at 1% and seemingly failing to reach a workable consensus on “unconventional measures” (meaning quantitative easing, a policy in place in the US, UK and Japan). This half-hearted approach means that private demand will likely be slow to step in to pick up the baton after the government’s boost is exhausted, keeping unemployment at elevated levels, holding back spending and bolstering expectations for a comparatively slower recovery. Indeed, the Unemployment Rate is expected to rise to 8.7% in March, the highest in 3 years, and is forecast to approach 10% by the end of this year. In Germany, the Euro area’s largest economy, the ranks of the unemployment are expected to jump by another 65,000 people to bring the jobless rate to 8.2%, the highest since January 2008.

New Zealand Dollar Plummets as RBNZ Cuts Rates to 2.50%, Signals Low Rates Through Late 2010

The New Zealand dollar plunged across the majors at 21:00 ET on Wednesday after the Reserve Bank of New Zealand cut their official cash rate target by 50 basis points to 2.50 percent, as the "world economy deteriorated more than expected" during Q1.

The reduction was in line with forecasts published by Bloomberg News, but differed from what Credit Suisse overnight index swaps were pricing in, as they only fully reflected a 25 basis point cut. Looking to the RBNZ Governor Alan Bollard’s policy statement, it is clear that the central bank has cut back their inflation expectations due to weaker global growth and tight financial conditions. Furthermore, the RBNZ anticipated that the “adverse economic forces generated by the crisis to remain dominant throughout 2009,” with the “timing and extent of recovery” remaining “highly uncertain.” While all of this was negative for the New Zealand dollar, NZD/USD was able to break below 0.5700 on comments that the RBNZ expected to leave the OCR at or below current levels through the end of 2010. This leaves additional downside risks for the New Zealand dollar, especially if risk aversion remains a lingering issue.


Source: FXTrek Intellicharts

New Zealand Dollar Outlook Hinges Upon RBNZ Rate Decision, Outlook

The New Zealand dollar has been gaining steam today as improved investor sentiment has sent “risky” assets rocketing higher. Adding to the mix, NZD/USD will face high event risk at 17:00 ET: According to a Bloomberg News poll of economists, the Reserve Bank of New Zealand (RBNZ) is forecasted to cut rates by 50 basis points to 2.50 percent.

However, Credit Suisse overnight index swaps are fully pricing in a 25 basis point cut, and are only pricing in a 36 percent chance of a 50 basis point reduction, and the divergence between these forecasts creates potential for the New Zealand dollar to respond to a “surprise.”

Based on the RBNZ’s policy statement from March, the central bank is still open to making monetary policy more accommodative, but they will not seek to implement the same aggressive cuts they’ve applied in the past as they said that they said “future cuts will be much smaller than observed recently.” With growth still slowing, the financial markets not yet stable, and inflation pressures receding, the odds seem to be in favor of a reduction. The NZD/USD will initially respond to actual rate decision, with a 25 basis point cut likely to provide a brief boost to the pair in light of the Bloomberg News forecast, while a 50 basis point (or larger) cut would weigh on the pair.

Whether the NZD/USD response can be sustained will hinge upon the RBNZ’s policy statement, as indications that they see the need to cut rates further, or signs that economic or financial market conditions have become worse than anticipated could push the pair lower. However, if the RBNZ suggests in their policy statement that they will leave monetary policy unchanged going forward, the New Zealand dollar could actually rally toward, or above, a region of resistance at 0.5792/0.5800.

Euro Pushes Higher As Pandemic Fears Ease and Economic Confidence Improves, Will US GDP Add To Bullish Sentiment?

The euro reached as high as 1.3240 on the back of improving confidence and increasing risk appetite now that fears from the “swine flu” pandemic have eased. Economic confidence in the region improved to 67.2 from 64.7 which was the highest in almost a year.

Talking Points
• Japanese Yen: Weakens As Health Fears Ease
• Pound: Finding Support On Improving Risk Appetite
• Euro: Higher On Improving Economic Confidence
• US Dollar: GDP and FOMC Rate Decision On Tap

Euro Pushes Higher As Pandemic Fears Ease and Economic Confidence Improves, Will US GDP Add To Bullish Sentiment?

The euro reached as high as 1.3240 on the back of improving confidence and increasing risk appetite now that fears from the “swine flu” pandemic have eased. Economic confidence in the region improved to 67.2 from 64.7 which was the highest in almost a year. Government stimulus plans and easing inflation has helped improve consumer’s purchasing power and their outlook. This was evident in the improvement in the Bloomberg retail PMI gauge which rose to 48.4 from 44.1. Although Easter spending helped boost the consumption numbers, there are clear signs that consumers are starting to open up their wallets.

The improving fundamental data will decrease the chances that we will see the ECB embark on quantitative easing measures, as they have been reluctant to take that route. However, we have been receiving conflicting rhetoric from members with Bini Smaghi stating that buying government bonds would be problematic for the central bank. The comments come on the heels of remarks from committee member Nowotny who said that the ECB stands ready to use unconventional measures. Therefore, markets will begin to scrutinize any additional rhetoric the may come from members as the central bank appears to be divided on the issue. Nevertheless, a 25 bps reduction over the next two meetings is very likely but if that is seen as the end of the easing cycle then we could see the Euro start to gain additional support. The EUR/USD has pushed above the 100-Day SMA at 1.3222 but unless we see a clear break of the resistance level, we could see it limit future gains. The April 14th high of 1.3382 is the next level of resistance.

Further evidence of improving risk appetite is the current yen weakness which had been the strongest performing currency during the heightened fears from the health crisis. The dollar/yen has rallied nearly 200 pips from yesterday’s low of 95.62, but the 50-Day SMA at 98.00 is ahead as possible resistance. Meanwhile, the pound has also benefitted from the improving optimism with sterling/dollar breaking above the 20-Day SMA at 1.4739. The pound may continue to find support if we see risk appetite continue as there is very little event risk on the economic docket which could lead to a test of April 16th high 1.5070.

The dollar has been under pressure during overnight trading as markets have started to look past the “swine flu” and bank stress tests and focus on the improving fundamental data. Indeed, yesterday’s jump in consumer confidence was a catalyst to reverse sentiment which has carried through to today as markets prepare for a U.S. GDP report which is expected to show the pace of contraction for the economy has slowed from 6.3% to 4.7%. The slew of stimulus and availability of cheap credit has raised optimism that the economy will regain its footing and return to positive growth by 2010. The FOMC policy decision is also ahead with expectations that the central bank will leave their benchmark rate at 0.25%. However, we could see the Fed announce additional quantitative easing measures or at the very least give an update on the impact of current efforts which will provide potential event risk. A better than expected growth report and an upbeat central bank could add to current risk appetite and dollar weakness.

Will The EUR/USD Break 1.3000? Join us in Forum

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Fed Likely To Announce More Quantitative Easing

To discuss this report contact John Rivera Currency Analyst: jrivera@fxcm.com
04-29 MB1

EUR/USD: Trading the U.S. Gross Domestic Product Report

The advanced GDP reading for the U.S. is likely to reinforce a dour outlook for the world’s largest economy as economists forecast the annual rate of growth to contract 4.7 the first quarter, and economic activity is likely to remain subdued throughout the year as businesses continue to scale back on production and employment in an effort to reduce costs.

Trading the News: U.S. Gross Domestic Product (Annualized)

What’s Expected

Time of release: 04/29/2009 12:30 GMT, 08:30 EST
Primary Pair Impact : EURUSD

Expected: -4.7%

Previous: -6.3%

Impact the U.S. GDP has had on EURUSD over the last 2 quarters
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4Q 2008 U.S. Gross Domestic Product

The advance GDP reading for the U.S. showed that the world’s largest economy contracted at an annual pace of 3.8% in the fourth quarter to mark the biggest drop since 1982, and conditions are likely to get worse as the region faces its worst economic downturn in over a quarter century. A deeper look at the report showed personal consumption, which is one of the biggest drivers of growth, slipped 3.8% during the three-months to December, while business investments plunged 19.1% from the third quarter to post the biggest drop since 1975, and the data foreshadows a deepening recession in the U.S. as private-sector spending falters. As a result, the Federal Reserve is widely expected to hold the overnight lending rate at the record-low of 0.25% for some time, and announced that the central bank will utilize policy tools beyond the interest rate in an effort to stem the downside risks for growth and inflation.


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3Q 2008 U.S. Gross Domestic Product

Economic activity in the third quarter fell less than expected as the advanced GDP reading showed that the economy contracted 0.3% amid expectations for a 0.5% decline. The breakdown of the report showed that personal consumption slipped 3.1% from the previous quarter, which foreshadows a dour outlook for growth as private spending accounts for nearly two-thirds of the economy. As growth prospects deteriorates at a rapid pace, the U.S. economy may face its longest recession in over a quarter century, and may lead the FOMC to ease policy further in an effort to avoid a deep and severe downturn in the economy. Despite the enhanced reading for growth, the outlook remains bleak as credit conditions remain far from normal, and consumers are likely to curb spending in the months ahead as they continue to face falling home prices paired with financial uncertainties.


004-28 TTN3


What To Look For Before The Release

Traders with access to market depth information via the FXCM Active Trader Platform may use it to gauge the potency of the economic data release as well as to shed some light on the market’s directional bias. Increasing volume ahead of the announcement will telegraph likely follow-through behind whatever move is to materialize, while an imbalance in available liquidity on the Bid versus the Offer side of the market will tell us the direction major institutions are likely favoring ahead of the announcement:

Bullish Scenario:



If we see substantially deeper available liquidity on the Bid side of the market, this tells us that major price providers in the market are looking to buy the Euro against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bullish bias on EURUSD ahead of the data release.


Bearish Scenario:

If we see substantially deeper available liquidity on the Offer side of the market, this tells us that major price providers in the market are looking to sell the Euro against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bearish bias on EURUSD ahead of the data release.

004-28 TTN4


004-28 TTN5

How To Trade This Event Risk



The advanced GDP reading for the U.S. is likely to reinforce a dour outlook for the world’s largest economy as economists forecast the annual rate of growth to contract 4.7 the first quarter, and economic activity is likely to remain subdued throughout the year as businesses continue to scale back on production and employment in an effort to reduce costs. Manufacturing and service-based activity fell throughout the first quarter, while industrial outputs slid for the fifth consecutive month in March, and as the capacity utilization rate remains at a record-low of 69.3%, the slump in production is likely to drag on the economy throughout the first half of the year. Moreover, stockpiles held by businesses dropped for the sixth month in February, while wholesale inventories plunged 1.5% during the same period to mark the biggest drop since recordkeeping began in 1992, and the data foreshadows a deepening downturn in the region as private-sector demands falter. Retail spending unexpectedly fell 1.1% in March, which was followed by a 0.8% drop in durable goods orders, while consumer credit fell $7.5B in February to an annual pace of $2.56T, and conditions are likely to get worse as households face a weakening labor market paired with tightening credit conditions. A report by the Labor Department showed that non-farm payrolls slipped another 663K in March, which pushed the annual rate of unemployment to a 25-year high of 8.5% from 8.1% in February, while continuing claims for jobless benefits reached a fresh record-high in the week ending April 4, and the outlook for growth and inflation remains bleak as the International Monetary Fund forecasts the growth rate to contract 2.8% this year. At the same time, Fed Vice Chairman Donald Kohn reinforced the improved outlook held by Chairman Ben Bernanke, stating that he expects economic conditions ‘to stabilize later this year’ as policymakers continue to take unprecedented steps to shore up the ailing economy, but went onto say that ‘a wide range of uncertainty surrounds that outlook’ as financial conditions remain far from normal. As the central bank holds the overnight lending rate at a record-low and expands its balance sheet at a rapid pace to soften the landing of the economy, the extraordinary efforts should help to stem the downside risks for growth and inflation however, as the downturn in the world economy intensifies, the downturn in global trade may continue to weigh on the economy going forward. Meanwhile, as investors continue to weigh the viability of the financial institutions in the U.S., a dismal GDP reading could weigh on the exchange rate as growth prospects deteriorate but nevertheless, as risk trends continue to dictate price action in the foreign exchange market, a drop in risk sentiment could boost the appeal of the U.S. dollar as the reserve currency continues to benefit from safe-haven flows.



Expectations for a 4.7% drop in 1Q GDP favors a bearish forecast for the greenback but nevertheless, an enhanced growth report could set the stage for a bullish dollar trade as the Federal Reserve expects economic activity to improve later this year. Therefore, if the annualized growth rate falls less that 4.0% in the first quarter, we will look for a red, five-minute candle following the release to confirm a sell entry on two-lots of EUR/USD, and once these conditions are met, we will set our initial stop at the nearby swing high (or reasonable distance taking volatility into account), and this risk will establish our first target. Our second target will be purely based on discretion, and we will move the stop on the second lot to breakeven once the first trade reaches its target in an effort to preserve our profits.



On the other hand, as firms reduce outputs and cut stockpiles at a record pace, economic activity is likely to weaken further, and price action following a dismal first quarter growth reading may call for a short dollar trade as the region faces a deepening recession. As a result, an in-line print or a drop of more than 4.7% in GDP would lead us to sell the greenback, and we will follow the same strategy for a long euro-dollar trade as the short position revealed above, just in reverse.
004-28 TTN6

US Dollar, Japanese Yen Remain on Edge Ahead of Key US GDP Report, FOMC Rate Decision

- British Pound Contained to Range Versus US Dollar of 1.4525 - 1.4685
- Euro Gains as ECB’s Bini Smaghi Writes Off Quantitative Easing, Zero Interest Rates
- New Zealand Dollar Outlook Hinges Upon RBNZ Rate Decision, Outlook

US Dollar, Japanese Yen Remain on Edge Ahead of Key US GDP Report, FOMC Rate Decision
The US dollar and Japanese yen ended Tuesday on a mixed note, but risky assets remain on edge, which may leave the odds in favor of further gains for the low-yielders. US economic data was generally better-than-expected this morning, as the pace of declines in the S&P Case-Shiller house price index slowed to -18.63 percent in February from a year earlier, up from a record low of -19.00 percent. Meanwhile, the Conference Board's consumer confidence index surged to 39.2 in April from an upwardly revised 26.9, which was significantly more optimistic than forecasts for an increase to 29.7. A breakdown of the index shows that sentiment on economic expectations improved far more than opinion on the present situation, suggesting that if consumers do not see signs of recovery for themselves in coming months, broad sentiment could fall lower once again. Finally, the Richmond Fed's manufacturing index jumped to -9 in April from -20, as shipments, new order volume, number of employees, the average workweek all contracted at a slower pace.

Looking ahead to Wednesday, there will be two big economic releases. First, the 08:30 ET advanced reading of Q1 GDP for the US is forecasted to contract for the third straight quarter at a rate of -4.7 percent, following the Q4 contraction of 6.3 percent. The National Bureau of Economic Research (NBER) has already declared that the US has been in recession since December 2007, but a plunge in GDP that is sharper than expectations will only suggest that the contraction in growth will continue to worsen. The Federal Reserve really has no room to make monetary policy more accommodative, so traders should watch for the impact of this report on equities, as a surge in risk aversion may only lead the US dollar higher despite the disappointing fundamental scenario. That said, with the Fed scheduled to announce their latest policy decision later in the day, the markets may not show any response whatsoever.

At 14:15 ET, the Federal Open Market Committee (FOMC) is widely expected to leave the fed funds target range at 0.0 percent - 0.25 percent, and this should remain the case throughout much of the year. In fact, the FOMC started saying in January that they continue “to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time,” and they went on to say something similar in March. Furthermore, the last statement highlighted that the Committee's policy focus is to support the functioning of financial markets via measures that are likely to keep the size of the Federal Reserve's balance sheet at a high level. As long as we see these sorts of statements continue to be published, the news shouldn’t be too market-moving. However, the statement could send the US dollar spiraling lower if the FOMC announces an expansion of their quantitative easing efforts, and ultimately, any news that is positive for the stock markets may be negative for the greenback (which has been trading solely as a safe-haven asset lately), and vice versa.

Related Articles: US Dollar Weekly Trading Forecast, Japanese Yen Weekly Trading Forecast

British Pound Contained to Range Versus US Dollar of 1.4525 - 1.4685
The British pound generally lagged against many of the majors, with the exception of the ultra-weak Australian and New Zealand dollars, but for what it’s worth, GBP/USD has simply stuck to a tight trading range of 1.4525-1.4685. In UK economic news, the CBI retail survey showed that retailers surprisingly saw positive sales, as the index rocketed up to 15-month high of +3 in April from -44 in March. The data comes on the tails of last week’s news that the UK economy contracted 1.9 percent during Q1, and suggests that while GDP results are likely to remain weak through the rest of the year, they may not reflect the drastic drops we’ve seen in recent quarters.

Related Article: British Pound Weekly Trading Forecast

Euro Gains as ECB’s Bini Smaghi Writes Off Quantitative Easing, Zero Interest Rates
The euro was actually one of the stronger currencies on Tuesday, falling only against the Swiss franc, as data showed that German inflation picking up during April. According to the latest figures, the annual rate of CPI growth rose to 0.7 percent from 0.5 percent, though the monthly rate went unchanged after falling 0.1 percent in March. Meanwhile, European Central Bank (ECB) Executive Board member Lorenzo Bini Smaghi signaled that the bank may be nearing the floor for interest rates as “Bringing the main policy rate too close to zero would risk hampering the functioning of the money markets as it would reduce the incentives for interbank lending.” Bini Smaghi also said that quantitative easing would “make sense only when the interest rate is at zero or very close to zero,” and noted that buying corporate securities may prove a “difficult endeavor.” As a result, an increasing amount of attention is going to be paid to the ECB’s next meeting on May 7, not only because they could cut their benchmark lending rate by 25 basis points to 1 percent, but also because they’ve said that they will announce “unconventional” measures. Ultimately, there are substantial downside risks for the euro, but the EUR/USD outlook in the near-term hinges upon US dollar trends, which could be shaken up by US-related event risk.

Related Articles: Euro Weekly Trading Forecast, Euro/US Dollar Loses Correlation to S&P 500 - Time for Turn Lower

New Zealand Dollar Outlook Hinges Upon RBNZ Rate Decision, Outlook
The New Zealand dollar was the weakest of the majors on Tuesday, as the high-yielding currency may face a rate cut on Wednesday afternoon. According to a Bloomberg News poll of economists, the Reserve Bank of New Zealand (RBNZ) is forecasted to cut rates by 50 basis points to 2.50 percent. Meanwhile, Credit Suisse overnight index swaps are pricing in at least a 25 basis point cut, but are also pricing in a 40 percent chance of a 50 basis point reduction. Based on the RBNZ’s policy statement from March, the central bank is still open to making monetary policy more accommodative, but they will not seek to implement the same aggressive cuts they’ve applied in the past as they said that they said “future cuts will be much smaller than observed recently.” With growth still slowing, the financial markets not yet stable, and inflation pressures receding, the odds are in favor of a 25 or 50 basis point cut at 17:00 ET on Wednesday. That said, the outlook for the New Zealand dollar will hinge upon their policy statement, as indications that they are open to further cuts could weigh on the currency. However, if the RBNZ suggests in their policy statement that they will leave monetary policy unchanged going forward, the New Zealand dollar could actually rally.

Related Article: New Zealand Dollar Weekly Trading Forecast


**For a full list of upcoming event risk and past releases, go to www.dailyfx.com/calendar

ECONOMIC DATA

042809_fund_1

SUPPORT AND RESISTANCE LEVELS

042809_fund_2

US Dollar, New Zealand Dollar to Face Fed, RBNZ Rate Decisions This Week

The US dollar and New Zealand dollar are the two major currencies to face the highest event risk this week, as both the Federal Reserve and the Reserve Bank of New Zealand will announce rate decisions. Adding to the mix, US consumer confidence, Q1 GDP, and ISM manufacturing all have the potential to shake up risk trends.

• US Consumer Confidence (APR) – April 28
The Conference Board’s consumer confidence index for the month of April is forecasted to continue creeping higher from its record low of 25.3 reached in February up to 29.9. With record keeping having begun in 1967, the steady plunge in sentiment from the 2007 highs of 111.90 makes the extent of the recession especially clear. Nevertheless, a surprisingly strong result could provide a boost to risky assets, as the move would indicate that sentiment may have bottomed out. However, if consumer confidence goes little changed or rises right in line with expectations, the news is unlikely to evoke any reaction from the markets.

• US Gross Domestic Product (1Q A) – April 29
The 08:30 ET advanced reading of Q1 GDP for the US is forecasted to contract for the third straight quarter at a rate of -4.7 percent, following the Q4 contraction of 6.3 percent. The National Bureau of Economic Research (NBER) has already declared that the US has been in recession since December 2007, but a plunge in GDP that is sharper than expectations will only suggest that the contraction in growth will continue to worsen. The Federal Reserve really has no room to make monetary policy more accommodative, so traders should watch for the impact of this report on equities, as a surge in risk aversion may only lead the US dollar higher despite the disappointing fundamental scenario.

• Federal Open Market Committee Rate Decision – April 29
The Federal Open Market Committee (FOMC) is widely expected to leave the fed funds target range at 0.0 percent - 0.25 percent, and this should remain the case throughout much of the year. In fact, the FOMC starting saying in January that they continue “to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time, ” and they Committee said something similar in March. Furthermore, the last statement highlighted that the Committee's policy focus is to support the functioning of financial markets via measures that are likely to keep the size of the Federal Reserve's balance sheet at a high level. As long as we see these sorts of statements continue to be published, the news shouldn’t be too market-moving. However, the statement could have an impact on risk trends if the FOMC announces an expansion of their quantitative easing efforts, and utimately, any news that is positive for the stock markets may be negative for the greenback (which has been trading solely as a safe-haven asset lately), and vice versa.

• Reserve Bank of New Zealand Rate Decision – April 29
According to a Bloomberg News poll of economists, the Reserve Bank of New Zealand (RBNZ) is forecasted to cut rates by 50 basis points to 2.50 percent. Meanwhile, Credit Suisse overnight index swaps are pricing in at least a 25 basis point cut, but are also pricing in a 48 percent chance of a 50 basis point reduction. Based on the RBNZ’s policy statement from March, the central bank is still open to making monetary policy more accommodative, but they will not seek to implement the same aggressive cuts they’ve applied in the past as they said that they said “future cuts will be much smaller than observed recently.” With growth still slowing, the financial markets not yet stable, and inflation pressures receding, the odds are in favor of a 25 or 50 basis point cut at 17:00 ET on Wednesday. That said, the outlook for the New Zealand dollar will hinge upon their policy statement, as indications that they are open to further cuts could weigh on the currency. However, if the RBNZ suggests in their policy statement that they will leave monetary policy unchanged going forward, the New Zealand dollar could actually rally.

• US ISM Manufacturing (APR) – May 1
Unlike the releases of personal income and personal spending on April 30, the 10:00 ET release of the ISM Manufacturing index will give a more timely view of conditions in the economy. The April reading of the index is anticipated to rise to 38.5 from 36.3, and while this would mark a slight improvement, the index would ultimately still be close the nearly 29-year low of 32.9 reached in December. This would also mark the fifteenth straight month of contraction in business activity, suggesting that the recession remains in full force. Weaker than expected results could lead flight-to-safety to push the US dollar higher, while surprisingly strong numbers could weigh the currency down.

See the DailyFX Calendar for a full list, timetable, and consensus forecasts for upcoming economic indicators.
Send questions or comments to tbelkas@dailyfx.com

Dollar, Yen Find Support On 'Swine Flu' Pandemic Fears, Adding To Concerns Over Bank Stress Tests

The Yen has been the main story overnight as the currency has re-established its safe-haven status with the potential “swine flu” pandemic sending cautious investors to the sidelines. The fact that the health concerns are based in the Western hemisphere has heightened concerns as it could negatively impact the U.S. economy where the most stimulus has been enacted and is the expected source of growth to help stem the current global downturn.

Talking Points
• Japanese Yen: Finds Support On “Swine Flu” Fears
• Pound: Housing Markets Continues to Show Weakness
• Euro: Deflation Concerns Remain
• US Dollar: Durable Goods Orders On Tap

Dollar, Yen Find Support On “Swine Flu” Pandemic Fears, Adding To Concerns Over Bank Stress Tests

The Yen has been the main story overnight as the currency has re-established its safe-haven status with the potential “swine flu” pandemic sending cautious investors to the sidelines. The fact that the health concerns are based in the Western hemisphere has heightened concerns as it could negatively impact the U.S. economy where the most stimulus has been enacted and is the expected source of growth to help stem the current global downturn. USD/JPY reached as low as 96.46 leaving the March 30th low of 95.94 as the next support level. There is a risk that market sentiment could return their focus back toward fundamentals, but that may not change sentiment as the pending results of the bank stress test and the gloomy outlook painted by the IMF for the global economy may still lead traders to avoid risky assets.

The Euro continues to remain under pressure as traders continue to unwind risk positions sending it back below the 100-Day SMA at 1.3219 to an intraday low of 1.3119. The economic docket demonstrated the two themes that are currently prevalent in the economic region growing confidence and declining prices. The German Gfk consumer confidence reading held steady at 25 for a third month as it beat estimates for a decline to 23. The sentiment reading follows improvement in the PMI and IFO business gauges as confidence is starting to improve on the back of the ECB’s increasingly accommodative monetary policy and the individual stimulus packages by the various countries. Meanwhile, the German import price index to -7.1% from -6.4% in February as declining oil costs continues to drive down inflationary pressures. Deflation concerns will remain as longs as price continue to fall and the economy lacks clear signs of growth returning. Therefore, expectations are t hath e central bank will lower their benchmark rate by another 25 bos and initiate non-standard measures over their next two policy meeting, which could become a weighing factor for the single currency. The 50-Day SMA is the next possible support level at 1.3059, but the April 20th below of 1.2889 will be the key level to watch.

The pound has also continued to remain under pressure as it fell to an intraday low of 1.4514, but we are starting to see support from the 100-Day SMA which stands at 1.4521. The hopes of a recovery in the U.K. housing market were put on hold when Hometrack reported that home prices fell for a 19th month by 0.3% bringing the annualized reading to -10.1%. Additionally, the BBA loans for home purchases measurement declined to 26,097 from 28,024 in March. The BoE continues to purchase debt in hopes of loosening credit markets, but if those results don’t begin to start to show results we may see fears grow that more downside risks remain for the country’s economy which could start to weigh on sterling. The 50-Day SMA at 1.4421 remains a key level of support since mid-March, and a failure there could lead to a significant move lower for the pound.

The dollar traded higher throughout the majority of the overnight session, except against the yen as the unknown attached to the “swine flu” has fueled risk aversion. We have started to see the greenback give back some of its gains as the extra-ordinary factor may have limited impact on broader sentiment. However, concerns over growth and the bank stress test may keep traders cautious going forward. A light fundamental calendar will leave the dollar at the mercy of the broader themes today but the FOMC meeting and the first quarter GDP report will provide event risk latter in the week. The Dallas Fed manufacturing report is the only release scheduled to hit the wires and it is expected to show a mild improvement to -46.0% from -49.0%. Dow futures continue to trade down over 100 points, and a weak day on Wall St could continue to lend support for the dollar.

Will The EUR/USD Break 1.3000? Join us in Forum

Related Articles:

Forex Trading Weekly Forecast - 04.27.09


To discuss this report contact John Rivera Currency Analyst: jrivera@fxcm.com
4-27 MB1

US Dollar Pushes Higher as Traders Bet on Wall St Weakness (Euro Open)

The US Dollar advanced to start the trading week as US stock index futures slipped over 1% in overnight trading, suggesting risk aversion may be returning to financial markets. An uneventful calendar in European hours will likely see risk sentiment remain the principal driver for forex price action.

Key Overnight Developments

• US Dollar Rises as Dow Jones, S&P 500 Futures Slip Over 1%
• Euro, British Pound Follow Risky Assets Lower

Critical Levels



The Euro trended lower against the US Dollar, losing as much as -0.7%. The British Pound followed suit, shedding as much as -0.6% against the greenback. Technical positioning favors a bearish outlook on both EURUSD and GBPUSD.


Asia Session Highlights



With little of note on the economic calendar, markets fell back on risk sentiment as the principal driver for forex price action. Futures on the Dow Jones and S&P 500 stock indices slipped over 1%, suggesting investors are betting that Wall St. stocks will move lower to start the trading week. The MSCI Asia Pacific Index erased initial gains after Hong Kong stocks dropped over 2% in early trading as Financial Times reported that American Express Co. and Allianz SE will sell their stakes in ICBC, China’s biggest bank, for a combined $2 billion. Asian exchanges initially moved higher following Friday’s Wall St. rally on news that the US Federal Reserve’s stress tests revealed most banks are adequately capitalized.

The retreat in risky assets boosted US Dollar – an index of the greenback’s average value against six top global currencies gapped higher to start the week and rose as much as 0.5% ahead of the opening bell in Europe. The US Dollar has been seen as a safe-haven asset amid falling stock markets, showing a -84% inverse correlation with global stock performance (based on a 90-day rolling correlation study).


Euro Session: What to Expect



An uneventful economic calendar is likely to yield to risk sentiment as the principal driver for forex price action in European hours. If stock markets continue to slip into negative territory, the US Dollar is likely to extend gains against the spectrum of major currencies.

A brief scan of European data is set to reveal deepening recession – the Import Price Index is set to drop -6.5% in the year to March, the most in over a decade; meanwhile, the GfK Consumer Confidence Survey is expected to print at 2.3 in May, the lowest since February.

Dollar, Yen And Risk Appetite Await G20 Meeting And US GDP

Market sentiment has stabilized over the past week as traders wait for fundamentals to either catch up to optimism or draw the budding recovery to a grinding halt. Ongoing earnings releases, first quarter growth reports from the world’s largest economies and a series of meetings attended by global policy makers can decide the fate of growth and optimism for months to come.

• Dollar, Yen And Risk Appetite Await G20 Meeting And US GDP
• Do Better Than Expected Earnings Signal A Turn For The Economy?
• Where Will Optimism Develop Without Confirmation Of A Recovery?

Market sentiment has stabilized over the past week as traders wait for fundamentals to either catch up to optimism or draw the budding recovery to a grinding halt. Ongoing earnings releases, first quarter growth reports from the world’s largest economies and a series of meetings attended by global policy makers can decide the fate of growth and optimism for months to come. Heading into this pervasive fundamental wave, traders from all asset classes have taken to caution. Reflecting the more speculative side of the market, the benchmark Dow Jones Industrial Average has curbed its most aggressive rally in two years. On the other side of the coin, interest in Treasuries has recovered while risk premiums through credit default swaps and other financially sensitive securities have curtailed their slow improvement. Unsurpassed liquidity makes the currency market the most discerning gauge of risk appetite versus risk aversion though. The Carry Index has extended the timid decline that began at the beginning of this month. However, looking beneath the surface of this complex measure, panic is further subsiding while expectations for returns slacken. Volatility for the broader currency is the lowest it has been since before the October market crash and credit seizure (despite the presence of event risk). In contrast, the scales of risk/reward have been balanced by shrinking yield forecasts (the interest rate outlook) and souring expectations for capital returns (risk reversals).

A sort of equilibrium has been struck between the potential for limited rates of return and the fading sense of fear that has encouraged reinvestment into the speculative areas of the market. However, as we have said many times before, this should not be considered a genuine recovery. Rather than a reduced pace of recession, a natural return to optimism and sentiment must come from positive forecasts for economic activity rather than a diminished pace of contraction. The round of event risk scheduled over the coming weeks provides the most comprehensive measure for health that we have been presented in months. The most pressing burden on sentiment are the gatherings of policy officials in Washington DC. On Friday, the G7 and G20 will convene; but the topics for discussion are not certain. The most meaningful outcome to the gathering of finance ministers would be a list of definitive steps and responsibilities aimed at turning individual and national rescue plans into a global one. This was the aim of the last summit in London; but so far, there has been little in the way of remarkable progress towards this goal. Whereas government policies for economic and financial aid support risk and reward equally, earnings activity and scheduled GDP releases will impact one or the other. The UK and US growth reports have obvious implications; but the accounting data is a more nuanced measure of risk through delinquencies and writedowns.

Risk Indicators:	Definitions:
	What is the DailyFX Volatility Index: The DailyFX Volatility Index measures the general level of volatility in the currency market. The index is a composite of the implied volatility in options underlying a basket of currencies. Our basket is equally weighed and composed of some of the most liquid currency pairs in the Foreign exchange market. In reading this graph, whenever the DailyFX Volatility Index rises, it suggests traders expect the currency market to be more active in the coming days and weeks. Since carry trades underperform when volatility is high (due to the threat of capital losses that may overwhelm carry income), a rise in volatility is unfavorable for the strategy.
	What are Risk Reversals: Risk reversals are the difference in volatility between similar (in expiration and relative strike levels) FX calls and put options. The measurement is calculated by finding the difference between the implied volatility of a call with a 25 Delta and a put with a 25 Delta. When Risk Reversals are skewed to the downside, it suggests volatility and therefore demand is greater for puts than for calls and traders are expecting the pair to fall; and visa versa. We use risk reversals on AUDUSD as global interest rates have quickly fallen towards zero and the lines between safe haven and yield provided has become blurred. Australia has a historically high and responsive benchmark, making it more sensitive to current market conditions. When Risk Reversals grow more extreme to the downside, it typically reflects a demand for safety of funds - an unfavorable condition for carry.
	How are Rate Expectations calculated: Forecasting rate decisions is notoriously speculative, yet the market is typically very efficient at predicting rate movements (and many economists and analysts even believe market prices influence policy decisions). To take advantage of the collective wisdom of the market in forecasting rate decisions, we will use a combination of long and short-term, risk-free interest rate assets to determine the cumulative movement the Reserve Bank of Australia (RBA) will make over the coming 12 months. We have chosen the RBA as the Australian dollar is one of few currencies, still considered a high yielders. To read this chart, any positive number represents an expected firming in the Australian benchmark lending rate over the coming year with each point representing one basis point change. When rate expectations rise, the carry differential is expected to increase and carry trades return improves.

Additional Information

What is a Carry Trade
All that is needed to understand the carry trade concept is a basic knowledge of foreign exchange and interest rates differentials. Each currency has a different interest rate attached to it determined partly by policy authorities and partly by market demand. When taking a foreign exchange position a trader holds long position one currency and short position in another. Each day, the trader will collect the interest on the long side of their trade and pay the interest on the short side. If the interest rate on the purchased currency is higher than that of the sold currency, the result is a net inflow of interest. If the sold currency’s interest rate is greater than the purchased currency’s rate, the trader must pay the net interest.

Carry Trade As A Strategy
For many years, money managers and banks have utilized the inflow and outflow of yield to collect consistent income in times of low volatility and high risk appetite. Holding only one or two currency pairs would invite considerable idiosyncratic risk (or risk related to those few pairs held); so traders create portfolios of various carry trade pairs to diversify risk from any single pair and isolate exposure to demand for yield. However, even with risk diversified away from any one pair, a carry basket is still exposed to those conditions that render this yield seeking strategy undesirable, such as: high volatility, small interest rate differentials or a general aversion to risk. Therefore, the carry trade will consistently collect an interest income, but there are still situation when the carry trade can face large drawdowns in certain market conditions. As such, a trader needs to decide when it is time to underweight or overweight their carry trade exposure.

US Dollar, Japanese Yen Trading Above Key Support Levels - Watch Status of Risk Appetite

- British Pound Dominates - UK Q1 GDP Could Weigh Heavily on Friday
- Euro Gains as Euro-zone PMI Reflects Surprisingly Strong Results - What About Deflation?
- Canadian Dollar Surges as Bank of Canada Leaves Door Open to QE If Nominal Interest Rates Fall Negative

US Dollar, Japanese Yen Trading Above Key Support Levels - Watch Status of Risk Appetite
The US dollar and Japanese yen both came under pressure on Thursday as demand for “risky” assets increased. From a technical perspective, we saw the DXY index end the day just above a trendline connecting the March and April lows, as well as the 38.2 percent fib of 82.64-86.86 at 85.26. Likewise, almost all of the Japanese yen crosses, such as USD/JPY, EUR/JPY, and GBP/JPY, are trading just above critical support at trendlines connecting the 2009 lows. As a result, the status of investor sentiment over the next 24 hours is incredibly important, as a return to risk aversion could send both the US dollar and Japanese yen spiraling higher.

On Friday, signs that domestic demand is showing no sign of recovery should continue to emerge as US Durable Goods Orders are forecasted to have dropped 1.5 percent in March and even excluding transportation is anticipated to fall 1.2 percent. All told, this would mark a return to disappointing results after the index surprisingly rose 3.5 percent in February, and while this will have the most impact on forex trading, the markets should keep an eye on non-defense capital goods orders excluding aircraft, as this number serves as a leading indicator for business investment. The 3-month annualized figure has fallen sharply over the past few months, and combined with the weak outlook for the headline reading, the news could weigh on risk appetite and subsequently provide a boost to the US dollar, thanks to increased flight-to-quality. On the flip side, surprisingly strong results could provide a boost to carry trades, and thus weigh the greenback down.

British Pound Dominates - UK Q1 GDP Could Weigh Heavily on Friday
The British pound was the biggest gainer on Thursday, helping GBP/USD to break above 1.4700. However, the tide could turn for the currency on Friday as the 04:30 ET advanced reading of Q1 GDP for the UK is forecasted to contract for the third straight quarter at a rate of -1.5 percent, the worst drop in nearly 29 years, which could drag the year-over-year rate down to match the Q1 1981 low of -3.8 percent. The UK has been hit particularly hard by the credit crunch, especially since the country became one of the biggest financial centers in the world. This has translated into a full-on collapse of the housing market, climbing job losses, and weak consumption. Furthermore, with growth slowing around the world, demand for British exports has declined as well, putting a large burden on manufacturers. Overall, a greater-than-expected decline could lead the British pound lower as the data would raise the odds that the Bank of England will expand their quantitative easing efforts. On the other hand, if GDP is a bit better than forecasts, the currency could surge.

Euro Gains as Euro-zone PMI Reflects Surprisingly Strong Results - What About Deflation?
The euro made solid headway against the US dollar and Japanese yen on Thursday, but fell against the British Pound, commodity dollars, and Swiss franc. Economic news provided a positive surprise, for once, as the Purchasing Managers’ Index (PMI) for the Euro-zone’s services and manufacturing sectors improved more than anticipated in April, rising to 43.1 from 40.9 and to 36.7 from 33.9, respectively. All told, these moves pushed the composite measure up to a six-month high of 40.5 in April from 38.3. While this is a positive development, this marked the eleventh straight month that PMI held below 50, signaling a further contraction in activity, albeit at a slower pace.

The outlook for the Euro-zone otherwise remains relatively bleak, and while European officials have consistently said that they don’t see a risk for deflation in the region, evidence may suggest the opposite. In Spain and Portugal the annual rate of CPI growth fell negative during March, and in Ireland, the annual rate has held negative for the past three months. However, with inflation growth still holding positive in larger member countries like Germany and France, headline CPI numbers for the Euro-zone as a whole have held positive as well. The ECB has said in the past that they expect CPI to fall negative later in the year, and once those figures come to fruition, deflation concerns may become more widespread.

Related Article: Euro/US Dollar Loses Correlation to S&P 500 - Time for Turn Lower

Canadian Dollar Surges as Bank of Canada Leaves Door Open to QE If Nominal Interest Rates Fall Negative
The Canadian dollar was the second strongest of the majors, leading USD/CAD to fall sharply from a region of resistance at 1.2379-1.2495. Canadian retail sales unexpectedly rose 0.2 percent in February, suggesting that consumers haven't been entirely deterred by soaring job losses and slowing business activity. The bigger market-mover, though, was the Bank of Canada's Monetary Policy Report, as they left the door open to quantitative easing (QE) and credit easing if nominal interest rates start to fall below zero. Indeed, the Bank stated that while they could cut rates to zero in theory, it would ultimately "eliminate the incentive for lenders and borrowers to transact in markets, especially in the repo market." As a result, inflation reports will be key to gauging whether or not the Bank of Canada will go the route of QE, but with total CPI at 1.2 percent (YoY) and the Bank's core CPI at 2.0 percent (YoY), there doesn't seem to be potential for such measures in the near-term.

Related Article: Canadian Dollar Tumbles as Bank of Canada Surprises with 25bp Cut to 0.25%


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ECONOMIC DATA

042309_fund_1

SUPPORT AND RESISTANCE LEVELS

042309_fund_2

Bank of Canada Holds Off on Immediate QE Measures (Midday Snapshot)

Price action in the US morning has been relatively quiet with the market content on some consolidation ahead of the next moves. The big news has come out of Canada where the Bank of Canada announced in its monetary policy report that it would hold off on the immediate implementation of formal QE measures.

MIDDAY SNAPSHOT & ANALYSIS OF SELECTED RATES

Price action in the US morning has been relatively quiet with the market content on some consolidation ahead of the next moves. We have however been hearing of good London fix related demand for Euro and Cable. US equities have been trading marginally lower while on the commodity front, both gold and oil trade higher, up 1.90% and 0.80% respectively. The as expected initial jobless claims data has taken a backseat to the weaker existing home sales and a Fitch report which forecasts an additional weakness in US house prices. Fitch also expects housing declines into late 2010. In Canada, retail sales managed to come in better than expected but the big news was the Bank of Canada announcement in its monetary policy report that it would hold off on the immediate implementation of formal QE measures. Usd/Cad has been sold off heavily on the news with the Loonie jumping up to the second best performer on the day. Elsewhere, the expansion of the Fed TALF is now being questioned on lack of progress to purchase CMBS. This has shaken some investor confidence on Thursday. The Norwegian krone is the strongest currency on the day, while the South African rand underperforms. Looking ahead, Fed Stern is slated to speak at 15:45GMT on new policies for financial stability.

ANALYSIS OF SELECTED RATES



Aud/Nzd: Price action on the cross has been quite constructive of late with the market now in the process of consolidating ahead of the next push higher through 1.2770 (20Apr high) and back towards the yearly highs at 1.2935 from early March. However moves towards the 1.3000 area have been met with solid resistance and any rallies over the coming days towards the psychological barrier should be used as a formidable sell opportunity. Daily studies are approaching overbought levels and a push towards 1.3000 over the near-term will officially put the RSI above the critical 70 level to reaffirm bearish outlook by 1.3000.

Written by Joel Kruger, Technical Currency Analyst for DailyFX.com
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