Christopher Vecchio from DailyFx shares his views on Euro, Yen, Aussie & Dollar in Forex Interview

By Zac Storella, CountingPips.com

Today, I am pleased to share a forex interview with currency analyst Christopher Vecchio from DailyFx.com on the latest currency market major events and trends. Christopher studies fundamental analysis of the foreign exchange markets by examining the interrelationship between geopolitical events, macroeconomic trends, and finance while also incorporating technical analysis into his research in order paint the most complete picture of what is occurring across various asset classes in the short-term and medium-term.

As the euro crisis deepens and as new developments continue to unfold, what markets and/or indicators are you watching to best anticipate what may be happening next and where things are going?

The Italian bond market has been a good indicator. As the 10-year yield has ticked higher, the EUR/USD has weakened; when there are signs of relief and bond yields trade lower, the EUR/USD has found support. Italy really is the key for Europe: the European Financial Stability Facility is not large enough to save Italy. Given the current course of action, if Italy loses the ability to fund itself at favorable rates, the Euro-zone will enter a terminal tailspin.

Considering all the things happening in Europe and the uncertainty of it all, do you feel that the EUR/USD is overvalued at the moment as it hovers around the 1.38 threshold? How about the EUR/JPY?

I think that the Euro should be lower against the safe haven currencies (including the Swiss Franc, but the Swiss National Bank says otherwise), and the recent rate cut by the European central bank supports this notion. The decreased yield on Euro-denominated assets takes away some of its appeal in terms of interest rate differentials, and the Euro-zone sovereign debt problems – which have in turn raised the question about the future stability of the common market – only compounds the impediments the Euro has to appreciate in value against the other majors.

In terms of the direction of the EUR/USD and EUR/JPY, both pairs are looking lower for the medium-term. Any rallies we’ve seen have been reversed, with good reason: the current measures in place are ineffective and the continued implementation of them has not solved the crisis – it has only gotten worse. The only way the Euro sees a sharp bounce against the Yen in the near-term is if the Bank of Japan or Ministry of Finance intervenes to weaken the Yen again (though these interventions have been unwound in
days if not hours against the majors save the U.S. Dollar).

In terms of the U.S. Dollar, the short-term liquidity issues in Europe have boosted demand for the Greenback, and given the state of the U.S. economy relative to that of the Euro-zone, the U.S. Dollar is poised to strengthen further. The only impediment to a weaker EUR/USD over the near-term would be the Federal Reserve announcing another round of quantitative easing. During the last round of debt monetization, from November 2010 through the end of June 2011, the U.S. Dollar was the worst performing major currency, falling 18.00 percent against the Swiss Franc and 4.38 percent against the Euro. However, given the Federal Reserve’s outlook, another round of easing appears off the table, for now.

The US economy added 80,000 jobs last month with positive revisions for both the September and August numbers (both months now over at least 100,000 jobs created and a 12-month average gain of 125,000 jobs). Do you think the economy is finding its footing and is on a path to some meaningful employment increases or do you feel the economy has more obstacles to overcome?

The recent revisions to labor market data have been positive, but that doesn’t mean the jobs market is actually improving. Beyond the jobs market, there are larger underlying issues that could easily result in the economy deteriorating once more. First and foremost, the Euro-zone crisis threatens to drag under American financial institutions, which would of course pull the global economy back under ala 2008.

Isolating the United States, the most recent gross domestic product reading suggests that growth may have peaked in the third quarter. The key figures to note are the spending figures, as consumption represents approximately 70 percent of the headline growth figure. Consumer spending increased by 2.4 percent in the third quarter, a welcomed development, but the trend is unsustainable: the savings rate dropped to 4.1 percent – its lowest in over two years – while income adjusted for inflation fell by 1.7 percent. If consumers are losing purchasing power and income is eroding, there will be a point in time – likely in the coming quarters – when spending plummets.

When this occurs, there will likely be another downturn in employment. The Federal Reserve’s policies haven’t been able to prop up the labor market and injecting further U.S. Dollars into the financial system will weigh heavier on inflation adjusted income, further reducing the consumer spending figure. Fiscal policy is needed to help support job growth, but given the current path Congress has chosen, President Barack Obama’s jobs plan is unlikely to provide the support the labor market desperately needs.

The Bank of Japan intervened in the forex market to weaken the yen and we saw the USD/JPY spike to over 79.52. The USD/JPY has now slid back down under 78 and towards a support level at 77.50. Do you think we could see this pair on its way back to the 80 level without BOJ intervention?

It’s unlikely that we see the USD/JPY rise back to the 80.00 exchange rate figure naturally. Questions over U.S. fiscal and monetary policy have fueled the U.S. Dollar’s decline against the Japanese Yen, even though Japan faces its own mountain of debt and policy issues.

Historically, at least for the past three interventions (March 18, August 4 and October 31), the Yen has gained back all of its losses within a few weeks maximum. For the most recent two interventions, the move to weaken the Yen was unwound within a matter of hours to days against the major currencies, save the U.S. Dollar. That being said, given the deteriorating state of global sentiment, I fully expect the Bank of Japan and/or the Ministry of Finance to step into the markets in the next few weeks, a decision that would easily drive the USD/JPY back above 80.00.

The Reserve Bank of Australia cut its interest rate last week for the first time in two years to 4.25% with the possibility of more rate reductions to come. With yield being an attractive aspect of the Aussie, are you looking for Aussie weakness over the short to medium time horizon?

I expect the Australian Dollar to continue to show signs of weakness in the periods ahead, and the rate cut is only part of the reason why. The shrinking interest rate differential between the Aussie and the other major currencies caps its upside potential in the coming periods, as there is now less incentive to buy Aussie-denominated assets. As such, it would be a shock to me to see the AUD/USD trade near its all-time highs set in July above the 1.1000 figure.

Furthermore, the European debt crisis has boosted demand for liquidity, which translates into demand for the U.S. Dollar. As the European crisis drags on and uncertainty builds, there will be higher demand for the U.S. Dollar, similar to the flight to safety during late 2008 and early 2009; this goes in hand with capital flight from speculative assets, which the Australian Dollar could be considered a part of. All in all, the fundamental forecast for the Australian Dollar is far from ideal.

The Swiss franc/Euro exchange rate has been successfully kept above the the 1.20 mark by the Swiss National Bank since their policy implementation of a minimum exchange rate level. Do you agree with a recent SNB official saying the Swiss currency is still highly overvalued at current levels? And do you feel it is likely the SNB will move the minimum exchange rate level to the 1.30 level that has been mentioned lately?

The Swiss National Bank was ‘forced’ to implement a currency floor on the EUR/CHF back on September 6, after the Swiss Franc rallied to near-parity against the Euro in early August. The SNB cited a severely damaged export sector due to Franc strength as the reason to intervene in the markets, and officials continue to cite the Franc’s strength as a reason the economy is slowing.

There has been chatter that another hike could be in store, and while in the near-term that looks unlikely, as the 1.2000 floor hasn’t really come under that much pressure. If the Euro-zone debt crisis accelerates faster-than-expected, however, without question the SNB will raise the floor to a minimum of 1.2500 EUR/CHF to prevent speculative investments in the Franc.

It’s worth noting that unlike the British Pound peg in the early 1990s, in which the Bank of England was forced to prop up the value of the Sterling, the SNB is trying to devalue its currency. This means that all they need to do is print more currency. The SNB has the ability to print a theoretically unlimited number of Francs, so holding the floor at 1.2000, 1.3000 or even higher should be no problem going forward.

Thank you Christopher for taking the time for participating in this week’s forex interview. To read Christopher’s latest currency analysis and trading strategies you can visit DailyFx.com.