The U.S. Dollar rose sharply higher against most major currencies as a slew of negative news hit the markets simultaneously. The day was supposed to have a positive tone as many traders were going to give the benefit of the doubt to President Obama's signing of his financial stimulus package. The optimism surrounding his plan was never allowed to grow as negative news from different parts of the globe trumped the positive nature of the signing.
U.S. Forex traders woke up this morning following a three-day holiday weekend to find that deteriorating emerging markets were threatening the stability of the Euro Zone economy. News that Moody's Investor Service was going to downgrade Euro Zone banks because of their exposure to weakening economies in Eastern and Central Europe pushed the U.S. Dollar sharply higher overnight and throughout the New York trading session.
Not only were Yen traders forced to deal with a huge decline in the Japanese economy, but the Japanese Finance Minister resigned after allegations he was drunk at the G-7 summit. Financial conditions are deteriorating rapidly in Japan and without an experienced finance minister providing guidance traders sold the Yen heavily.
The U.S. markets were not immune to the negative news either. Tuesday was the day that two of the big three automakers were supposed to present their survival plans to Washington. Expectations were for both to say that they need more money in an era where everyone - including the states of California and Kansas - is looking for emergency funding. Chrysler is expected to offer itself up for merger while GM is considering bankruptcy. U.S. economic data released by the Fed also showed that manufacturing fell to a record low.
Despite the negative news regarding the U.S. economy and its trading partners, the fact remains that investors have nowhere to go other than the U.S. Dollar which is regaining its safe haven status. Risk aversion is the theme as investors are parking their money in safe investments such as U.S. treasuries, gold and the U.S. Dollar. The Treasury Department even reported an increase in foreign investment into the U.S.
The U.S. Dollar remains the only currency alternative. Continue to look for a strong Dollar as there is no reason at this time not to hold the U.S. Dollar.
The Euro fell sharply lower overnight and into the New York Forex trading session after two major financial rating services threatened to downgrade Euro Zone banks with significant exposure to the deteriorating economies in Eastern and Central Europe. Euro traders fear that a downgrade from Moody's Investor Service and the S&P Corp. would cause further damage to banks in the Euro Zone.
With the economy continuing to weaken and the threat of bank downgrades, investors are once again calling for the European Central Bank to take a more proactive role in stemming the decline in the economy and in the Euro. This is leading traders to believe that the ECB will announce a drastic rate cut in March along with an aggressive stimulus plan. Some traders are backing comments from George Soros a few weeks back which called for the richer nations of the European Union to help out the poorer nations.
Although the developing banking crisis in the Euro Zone is isolated to Eastern and Central European nations, the crisis can turn worse quickly if Russia gets downgraded or defaults on any of its debt obligations.
The British Pound was also weak on Tuesday as traders flocked to the U.S. Dollar for safety. One can build a case that U.K. banks also face exposure to the growing credit crisis in Eastern and Central Europe. Any banking problems in the Euro Zone are likely to spread to the U.K. as all banks are in bed together.
A weakening economy led by tight credit conditions and the lack of consumer spending is likely to continue to push the U.K. economy deeper into a recession. Growth is slowing to a pace that is going to encourage the Bank of England to pump more money into the economy.
The Japanese Yen traded lower on Tuesday for two reasons: news that the Japanese economy shrank at a record pace in the fourth quarter and the resignation of the Finance Minister encouraged heavy selling throughout the New York trading session.
The main problem in Japan is that it relies on exports and really cannot do anything to fight back. The Japanese economy relies heavily on U.S. consumption of Japanese goods. As long as U.S. consumers are not spending their money on Japanese imports like autos, continue to look for the economy to deteriorate further. Without U.S. consumption there is really no chance of an economic recovery in the short run. Yen traders should brace themselves for more weakness.
The Canadian economy is in the same situation as Japan except it relies on the exportation of raw materials and commodities. With global demand for commodities dropping, especially in the energy complex, downside pressure should continue on the Canadian Dollar. There is a slight ray of hope, however, as the Baltic Freight Index is soaring, indicating that demand for commodities may pick up down the road.
Look for the USD CAD to continue its rally as long as global economies continue to weaken and the demand for commodity-linked currencies remains low.
The Swiss Franc traded lower on Tuesday as traders bought the U.S. Dollar as a safe haven investment. Speculation is growing that Swiss banks face huge exposure to Eastern and Central European economies. If these economies fail to pay back their debt obligations then Swiss banks face the possibility of massive losses from defaults. The economic situation in Russia should also continue to be monitored. Spiraling economic problems in Russia could also spread to Swiss banks.
The Australian Dollar felt downside pressure on Tuesday as trader appetite for higher risk assets fell. Speculators are selling the Aussie on the notion that record low interest rates will take time to revive economic growth in the country. Traders are already factoring in the likelihood of another round of interest rate cuts. The only thing that can stabilize the AUD USD at this time is a commodity rally. Without a rally in the commodity markets, the Aussie could continue to drop sharply lower.
The New Zealand Dollar was also under pressure on Tuesday. Lower demand for commodities and higher yielding assets encouraged selling all day. Speculators are looking for the economy to remain stagnant despite calls for another interest rate cut. It is clear however that the economy needs more than just rate cuts. The NZD USD faces huge exposure to the downside if the Japanese economy continues to deteriorate at its record pace.
Neither the Aussie nor the Kiwi is immune to the situation in Eastern and Central Europe. Banking downgrades in those two areas can spread quickly around the world. Look for a further deterioration in both the AUD USD and the NZD USD over the short-run with big risk to the downside.
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