FOREX TRADING

EUR/USD closed higher on Wednesday before a short covering rally tempered some of this year’s decline. The high-range close sets the stage for a steady to higher opening on Thursday. Stochastics and the RSI are oversold but remain neutral to bearish signalling that additional weakness is possible near-term. If June extends this year’s decline, monthly support crossing is the next downside target. Closes above the 20-day moving average crossing are needed to confirm that a short-term low has been posted.

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At earlier this week, President Obama formally nominated Ben Bernanke to a second four-year term as Chairman of the Federal Reserve Bank’s Board of Governors. The response was comparatively quiet, maybe because most pundits had already expected the news. Bernanke himself likely sealed his own re-appointment with the public relations campaign he embarked on last month, ostensibly to offer a rationale for his response to the credit crisis. “In a profound departure from the central bank’s tradition as an aloof and secretive temple of economic policy, Mr. Bernanke has plunged into the public spotlight to an extent that none of his predecessors would have contemplated.” (more…)

The US Dollar avoided a breakdown in overnight trading despite sharp gains across Asian stock exchanges as the market continued to look ahead to this week’s record-setting $115 billion US Treasury bond auction that promises to boost long-term interest rates and spur demand for the greenback. Germany’s GfK Consumer Confidence report is on tap in European hours.

Key Overnight Developments

• Bernanke Defends Fed’s Independence, Supports “Strong Dollar Policy”
• Buyers Returning to UK Housing Market, Reveals Hometrack Survey
• US Dollar Avoids Breakdown Despite Stock Rally, Bond Auction Looms Ahead

Critical Levels

The Euro and the British Pound traded near familiar levels against the US Dollar despite a sharp rally across Asian stock exchanges that would have been expected to weigh on the safety-linked greenback. The MSCI Asia Pacific added over 1% overnight, putting in 10 consecutive days of gains for the first time since 2004. We noted last week that the majors were showing signs of diverging from risk trends following the US Treasury’s announcement of a record-setting $115 billion bond auction that stands to boost long-term interest rates and spur US Dollar demand.

Asia Session Highlights

US Federal Reserve Chairman Ben Bernanke defended the central bank’s independence at the taping of a “town hall”-style meeting for PBS, saying the Fed is already “very accountable” to Congress and stressing that citizens don’t want Congress running monetary policy. On the economy, Bernanke said that credit markets are still “very constrained” and warned that employment won’t recover for “a while”, forecasting that the jobless rate will likely exceed 10%. Regardless, the Fed chief said he has “tremendous confidence” in the US economy, saying output will be “growing strong” within a few years. Answering critics that have argued policymakers’ actions would stoke future inflation, Bernanke said the Fed does not want to “over-stimulate” the economy and is “very confident” it has the tools to unwind the emergency liquidity-boosting measures put in place amid the financial crisis. Bernanke added that it was too early to judge the impact of the government’s stimulus plan, but stressed that Congress needs to come up with a plan to restore fiscal balance by trimming the burgeoning budget deficit. Commenting on currencies, Bernanke echoed the Treasury’s mantra of support for a “strong Dollar policy” and said a stronger US economy will bolster the greenback.

In the UK, the Hometrack Housing Survey revealed that real estate prices fell -7.7% in the year to July, the slowest pace of decline since October 2008. Details of the report revealed that property sellers were able to secure 91.5% of their initial asking price in the final transaction, marking the eighth consecutive month that their bargaining power has improved; meanwhile, the average time a property spent on the market before being sold fell to 9 weeks, the lowest in over a year. On balance, the survey reinforces reports of a rebound in buying interest that has been noted in other recent data. That said, rising unemployment may prove to be a barrier to a near-term rebound in real estate prices: the jobless rate is expected to top approach a whopping 9% by the end of this year, trimming incomes and hindering Britons’ ability to pay their mortgages. This is likely to boost repossessions, flooding the market with fresh supply and sending property values downward.

Euro Session: What to Expect

Germany’s GfK Consumer Confidence gauge is expected to stall at 2.9 in August after rising for two consecutive months in June and July. Last month, the market research firm commented that, “Reports that the inflation rate stood at zero percent in May are having a positive effect on income expectations and the propensity to buy.” Although falling prices stand to boost spending in the short term, entrenching expectations of deflation will work against consumption, encouraging people to wait for the best possible bargain and perpetually put off purchases. Clearly, this threatens firms’ revenues and darkens the outlook for employment, which in turn can reasonably be expected to put the brakes on any rebound in consumer sentiment. Most worryingly, the onset of deflation may already be at hand, with Germany’s Consumer Price Index set to show later this week that the annual pace of inflation turned negative for the first time in 23 years.

Written by Ilya Spivak, Currency Analyst
Article Source – US Dollar Avoids Breakdown Despite Stock Rally, Bond Auction Looms Ahead (Euro Open)

After a brief pause, China’s foreign exchange reserves have resumed their blistering pace of growth: “The reserves rose a record $178 billion in the second quarter to $2.132 trillion, the People’s Bank of China said today on its Web site. That dwarfs a $7.7 billion gain in the previous three months.” Considering that the global economy remains embroiled in the worst recession in decades, this is frankly incredible. [Chart below courtesy of WSJ].

As far as currency traders are concerned, this development has two important implications, the first of which concerns the Chinese Yuan (also known as RenMinBi or RMB). A quick parsing of trade and capital flows data reveals that the majority of the $178 Billion came from unconventional sources. “The trade surplus was $34.8 billion in the second quarter and foreign direct investment was $21.2 billion.” Currency fluctuations (i.e. the depreciation in the Dollar relative to other major currencies) can explain a small portion, “leaving the bulk of the increase in the reserves unaccounted for.”

In short, most of the capital now flowing into China is so-called “hot money,” chasing a piece of the action in China’s surging property and stock markets. The benchmark stock index has risen 75% this year, making it the world’s best performer. In short, China is once again “caught in a squeeze similar to the one that bedevilled policymakers earlier this century, with a flood of hot money trying to force the government’s hand on the currency.” Either it allows the RMB to resume its upward path against the Dollar, or it raises interest rates rapidly to head off inflation. With the money supply now growing at an annualized rate of 30%+, the government is running out of time on this front.

The second implication concerns the composition of China’s reserves. You can recall that in recent months, Chinese officials have become more vocal about ending the Dollar’s role as the world’s reserve currency, and have even taken token steps towards achieving that goal. But the latest analysis suggests that when push comes to shove, China is still firmly behind the Dollar: “Estimates suggest around 65% of China’s official holdings are in U.S. dollar assets, and the remainder are denominated in euro, yen, sterling and other currencies. This mix has been relatively stable as the Chinese government continues to place the bulk of its reserves in U.S. Treasury securities.”

In fact, “stable” is an understatement. While other Central Banks are gradually paring their holdings of US Treasuries, China is adding to its own stockpile. Already the world’s largest holder of Treasuries, China added another $38 billion in May, for a total of $800 Billion. “On the contrary, Japan, Russia and Canada were sellers of US assets in May. Japan, the second-biggest international investor, reduced its total holdings by $8.7 billion to $677.2 billion.” Meanwhile, Zhou XiaoChuan, governor of China’s Central Bank has endorsed the current composition of reserves: “Despite the $800 billion in U.S. Treasuries, it is a diversified portfolio overall.” This certainly represents a step backwards for Mr. Zhou, who only a couple months ago was leading the charge for a global reserve currency.

Perhaps over the longer-term, it can begin to take steps to dislodge the Dollar, but for now, it appears that China has accepted the status quo. As one analyst observed, “We do expect China to increase its purchase of gold and other commodities over time, but these markets are just not big enough to make a meaningful dent in the structure of the overall FX holdings. For example, if China decided to hold 5 percent of its current $2 trillion reserves in gold, it would need to buy …the equivalent to about one year of world production. For other hard commodities, the cost of storage is high and prices fluctuate wildly.”

China did recently appoint a new official (an economist trained in the US) to manage its reserves. “The move isn’t likely to fluster foreign-exchange markets or herald any change in China’s exchange-rate policy and reform.” Still, Chinawatchers are advised to continue to monitor the situation closely for any signs of discontinuity.