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Trader's Tip
Risk aversion will shift to risk appetite at some point in 2009. Traders need to be ready for that shift and adjust positions and trades accordingly.
- Kira McCaffrey Brecht | |
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Today's Featured Article
The British pound dropped like a rock last week. The sterling's fast and furious decline represents the lack of faith investors have in the U.K. government's bailout package.
However, last week's decline was really just a continuation of the massive bear trend, which has plagued the sterling for months now. After flirting with the $2.00 mark in mid 2008, the sterling began its steady downtrend in August 2008. From the July 2008 high at $2.01, sterling has fallen to last week's low at $1.36. Looking out on the crosses, October saw an acceleration of the euro/sterling uptrend, in which the euro gained dramatically versus the sterling.
Differentials
Straight growth differentials favor the euro. Bank of New York Mellon is forecasting 2009 gross domestic product (GDP) at an annual 2.0% decline for the U.K. versus a 1.0% decline in 2009 GDP for the euro-zone. Looking at the interest rate differential picture, the Bank of England (BOE) reduced its official bank rate to 1.5% on Jan. 8, a 50 basis point cut. Meanwhile, the European Central Bank (ECB) cut rates by 50 basis points on Jan. 15 to bring its key rate to 2.0%.
Technicals
Looking at a monthly chart of the sterling/dollar, the pair has retreated to multi-year support. The June 2001 low stood at $1.36 and January 2009's retreat has matched that low. The selling in the sterling over the past six months can almost be described as parabolic. In a year, the market retraced 100 percent of six years of gains. Monthly momentum tools have hit oversold levels, but have not yet shown any signs of turning higher. While bottom picking is dangerous business, the market is at a significant monthly low, which could at least spark some consolidation. | |
Run For Parity
Those trading sterling, either versus the dollar, or against the euro, should however keep an eye on parity. At year's end, euro/sterling came within pips of parity. The euro has never seen parity with the sterling, but traders love big round psychological numbers. Early January saw a rush of profit-taking in that pair, but mid January action has seen euro/sterling climb back towards that major level. Another test is fairly inevitable.
Other FX Developments
Shifting out across the forex landscape, risk aversion and fear remain key drivers in trade. As U.S. equities see the Dow consolidating near 8,000 and the S&P near 800, the U.S. dollar and the Japanese yen remain the favored currencies du jour.
Commodity Currencies Consolidate
In the current environment high yielding commodity currencies, such as the New Zealand dollar (aka kiwi) and the Australian dollar (Aussie) are consolidating after seeing brutal declines in the latter half of 2008, amid massive carry trade unwind action.
If U.S. equities can stabilize and perhaps even stage a solid recovery rally, risk appetite could begin to emerge again in the forex arena, which could send traders searching for whatever yield is left. The Reserve Bank of Australia (RBA) along with other global central banks has been on a rate-cutting spree. The RBA slashed its cash rate target by 100 basis points in early December, leaving the rate at 4.25 percent, still much higher than the U.S. zero rate! Meanwhile, the Reserve Bank of New Zealand last cut its official cash rate on Dec. 4 by 150 basis points, which dropped its rate to 5.00 percent. | |
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Risk Appetite Returns?
Kiwi and Aussie still boast some of the highest rates in the industrialized world and a return to risk appetite could see those currencies break out to the upside. Looking at the charts for those currencies, versus the dollar, one can identify key levels to monitor in the weeks ahead.
Key Aussie Level To Watch
A weekly chart of Aussie/dollar reveals the pair falling off a cliff from the July 2008 high at .9849. From there, the pair plummeted to the late October low at .6009, as currency traders around the globe ditched high yielding carry trade positions. Over the past several months, Aussie/dollar has settled into a consolidative base-building type of sideways trade. On the daily chart, key resistance is seen at the .7270 area. A solid push above that ceiling would suggest an upside breakout in Aussie/dollar and could unleash a fresh bullish wave of market action. From there, the next upside target would lie at .8000.
Kiwi Ceiling
The kiwi has settled into a similar sideways trade in recent months. The key ceiling in kiwi/dollar to watch is the .6000/.6125 level. If the bulls can blast through that ceiling it would target a run back toward .6800.
Putting It All Together
While U.S. equity markets continue to trade weakly, risk aversion will likely remain high, which will impact all markets including the foreign exchange markets. Massive and volatile moves have emerged in the forex arena in recent months and some "stories" like the UK banking situation are still playing out and have etched some historic moves on the charts. Nimble forex traders have many opportunities ahead, but players need to use caution and be ready for trends to shift quickly. Once risk appetite returns, a whole new ballgame will be seen with players rushing for yield opportunity.
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About the Author
Kira McCaffrey Brecht is senior editor at SFO Magazine. See her market updates at www.sfomag.com. She has been writing about the financial markets for 18 years. She has passed Level I and Level II of the MTA's CMT exams. | |
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