The Dow and Euro Are At Breaking Points

Joined : 23 Dec 2007 Posts : 241 Location : Nigeria

Today's commentary is by Sean Hyman, our Currency Director and editor of The Money Trader.

Good Day Currency Traders!

Right now the Dow Jones Industrial Average and the Euro vs. the Japanese yen (EUR/JPY) currency pair are at crucial levels.

Both the Dow and the popular carry-trade EUR/JPY are hovering in key support areas. Unless both can hold in the black support zone, both the Dow and the EUR/JPY will take a huge fall in the coming weeks affraid

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Let me show what I mean on the charts below... study

The Dow Rides a Crucial Support Line

The Carry-Trade EUR/JPY Is Also Dancing in the Danger Zone

Recession Spells Disaster for the Dow and EUR/JPY
Personally, I believe we're entering a recession. So if the Dow and the EUR/JPY manage to bounce off of these levels initially, I believe the bounce back will be short-lived at best. Then the next time we hit these critical levels, both the Dow and the EUR/JPY will fall through(if both don't fall off a cliff this time).

The earnings momentum simply isn't there to support stocks. Just last week the unemployment rate in America jumped from 4.7% to 5%. Now that may not seem like a lot but if you consider that there are 300 million people in America, a small percentage difference is huge.

In fact, last month there were only 18,000 people hired nationwide. That's not much out of 300 million. It seems hiring has all but dried up in America for the time being

Take a Look at the Hiring & Firing Patterns
When companies aren't hiring and laying off workers instead, then you don't have to wait for the earnings reports to know how these companies are performing. can already get a glimpse at how these companies see the future outlook just by their "hiring and firing" trends.

Right now I see hiring declining and "firing" increasing, so I know that certain company heads feel that the "demand" for their products and services will decrease. This is why I feel that if not now, these levels will be broken very soon on both the Dow and EUR/JPY.

Loans in Yen Have to Be Paid Back
Carry-trades such as EUR/JPY have held a high correlation to the Dow Jones Industrial Average for a while now. When traders feel secure, they're willing to take risks on stocks and carry-trades, so they tend to move together.

However, when traders feel the economy slowing down, then they shun riskier stocks and carry-trades, and look for safer assets instead. That means traders will sell off both at the same time.

Also, many traders borrowed funds in yen between 0% and .5% to buy other higher-yielding assets they felt were going up in value. These riskier assets included Dow stocks (which were a falling dollar play), and high yielding currencies such as the euro, British pound, New Zealand dollar, Australian dollar, etc.

As traders feel the risk of holding these assets increases (due to a slowing economy), they will sell off these riskier trades and "payback" these loans in yen. That will force the yen to increase in value. It will also cause the Dow and the yen to trade in opposite directions for a while. When the yen goes up, it brings the euro down against it and so EUR/JPY goes down right along with the sinking Dow.

As I said before, it's possible there could be a short-term bounce here at the black support zone drawn on the charts. But if it holds this time, I'm looking for the next test of it to breakdown and reflect the fundamentals of the slowing U.S. and global economy.

Sean Hyman, Currency Director

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Making 'Cents' of the Headlines
New Zealand's Trade Balance Gets Worse

What Happened:

Yesterday, New Zealand's Trade Balance got even worse. It went from NZD$-0.47 Billion to NZD$ -0.65 Billion. The Trade Balance measures the difference in value between imported and exported goods and services. A positive Trade Balance indicates that more goods and services were exported than imported over a given period. A rising trend has a positive effect on the nation's currency. When a nation sells more exports to the world, demand for the nation's currency increases. This happens as foreigners convert their native currency to purchase the exports.

How the Markets Reacted :

So the New Zealand dollar took a blow. The very high exchange rate (on NZD/USD) and the high interest rate of 8.25% are both really putting a strain on the country.

A high exchange rate means that their exports are more expensive for foreigners to buy. A high interest rate makes it hard for businesses to grow and expand. The high interest payments cut into their profits. Both of these slow corporate demand.

What I Say:

As countries like the U.S. slow down, it will hurt foreigners' purchasing power to buy goods from New Zealand. This is already starting to take effect. That's why the Trade Balance is getting worse.

As the Dow continues to tumble, the high carry-trades will go down with it. New Zealand's dollar is one of the "poster boys" of the carry-trade. So it will be one of the first to take a hit. As their economy slows, they'll have to reduce interest rates which will also reduce the New Zealand dollar's luster for investors.

On the other hand, another big exporter like Australia (AUD) may actually raise interest rates at least once more as New Zealand starts its first rate cut. So a pair like AUD/NZD starts to look really enticing as New Zealand slows vs. its stronger competition.

The little economy of New Zealand would be crushed in the near-term if it weren't for agricultural commodities beginning to rise. New Zealand deals majorly with agricultural products in New Zealand. So that's their one "saving grace." However, it won't be enough to stop rate cuts from coming as things slow down there.

So look for the New Zealand dollar to weaken against most currencies over the coming weeks to months.