Currency Markets Term Paper

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Currency Markets

The currency exchange market is an inter-bank or inter-dealer market that was established in 1971 when floating exchange rates began to materialize. Trading is not centralized, as is the case with many stock markets (i.e. NYSE, ASE, CME) or as the case for currency futures and currency options, which trade on special exchanges. Dealers often "advertise" exchange rates using a distribution network, then use the information "agree" to a rate and a trade.

Considering trading volume, the currency exchange market is the worlds largest market, with daily trading volumes in excess of $1.5 trillion U.S. dollars, which makes it is by far the most liquid market in the world today. Because of the volume in trading, it is impossible for individuals or companies to affect the exchange rates and even central banks and governments find it increasingly difficult to affect the exchange rates of the most liquid currencies, such as the U.S. dollar, Japanese Yen, Euro, Swiss Frank, Canadian Dollar or Australian Dollar.

The currency exchange market is a true 24-hour market, 5 days a week. There are dealers in every major time zone. Trading begins Monday morning in Sydney (which corresponds to 3pm EST, Sunday) and then daily moves around the globe through the various trading centers until closing Friday evening at 4:30pm EST in New York.

Today, over 85% of all currency exchange transactions involve a few major currencies: the U.S. Dollar (USD), Japanese Yen (JPY), Euro (EUR), Swiss Frank (CHF), British Pound (GBP), Canadian Dollar (CAD), and Australian Dollar (AUD). In the currency exchange market, most of the currencies are traded only against the U.S. Dollar. Trading between two non-dollar currencies usually occurs by first trading one against the U.S. Dollar and then trading the U.S. Dollar against the second non-dollar currency. Because of this, the spread in the exchange rate between two non-dollar currencies is often higher. (There are a few non-dollar currencies that are traded directly, such as GBP/EUR or EUR/CHF.) The following directly traded currency pairs make up the vast majority of the trading volume and are thus considered to be the most important ones: EUR/USD, USD/JPY, EUR/JPY, USD/CAD, EUR/GBP, GBP/USD, USD/CHF, AUD/USD, and AUD/JPY.

Currency trading is always done with currency pairs, such as EUR/USD, and so it is useful to consider the currency pair as an instrument, which can be bought or sold."

2-8 August

EUR/USD: For the second consecutive week, EUR/USD dealers sent the pair to highs of 0.8340, finally closing nearby at 0.8318. The dealers may even try to go higher in the near future.

USD/JPY: USD/JPY bulls took in the 2-8 August week by sending the pair to 2-month highs (112.46) while closing on a very strong note (111.17) above the 38.2% fibs drawn from 103.42-114.85. The chart in Annex 1 shows a potential "head and shoulders" pattern taking shape

USD/GBP: Bears were busy this week offering the USD/GBP to 1-month highs (0.5530), but the pair closed slightly lower at 0.5492

The main event of the 2-8 August week was the release of the U.S. gross domestic product. U.S. Q2 GDP growth went at the slowest pace in over a year at 3.0%. Consumer spending unexpectedly slumped and caused most of the weakness in economic expansion. Consumption grew at its slowest pace in 3 years. Durable goods dropped 2.5% with auto production falling 5.2%. Persistently high energy costs are at he bottom of this slow growth. Gas prices on average held above the $2.00 level in June and the consumption release showed that in June, Personal Spending declined by 0.7% over May as consumers had to cope with higher energy bills. Greenspan stated that June would only to be a temporary lag in the U.S.'s economy. With that period behind, the economy has already showed signs of speeding up. Manufacturing activity also went up, as the Fed's beige book reported production increases in all 12 of the Fed's Bank districts.

June's preliminary releases of retail data in Japan continues to show a contracting trend in sales. Retail sales fell by 2.9% in June over the last year, further adding to its -2.2% growth in May. June's levels dropped 0.6% from May, with lower sales with food, autos, and electronics causing the fall. Department stores were severely hit as sales dropped by 5.7% over a year ago in June and by a -2.4% reading from May. Despite a small lift in Q1, the low levels of consumption strongly influence the economic conditions. The spike in energy prices has also undoubtedly afflicted retail by diminishing consumer spending. However, the overall picture is not so bad, notwithstanding the disappointing performance in the retail sector, because retail figures only account for less than two-fifths of total consumer spending.

26 July - 1 August

USD/EUR: EUR longs bid the currency pair to one-month lows. Current trading approaches the lower limits of the channel used in the previous 4 months. Impatient traders may "hit the bid" as lower limits are tested.

USD/JPY: Dollar bulls sent the pair to one-month highs (110.30), closing near weekly highs at 110.10, while the moving averages remained at lower levels. The long-term upward trending channel shows that support has moved ahead of the 108.00 figure; resistance remains at 114.85.

USD/GBP: The market closed near weekly highs (0.54653 / 0.5458). The moving averages indicate long-term upward strength, but short-term weakness.

US Consumer Confidence surprised markets this week by going to a two-year high of 106.1 although expectations were modest, at 102.00. The hope that June's disappointing economic data was a temporary thing is now realized, with growth continuing in July. The boost reflects improving employment conditions Home sales are also in good shape this week and more people seem to be willing to try their luck on the housing market. Consumer confidence is widely expected to grow in the upcoming months although gas prices are still relatively high.

The UK GDP report released during the 26 July - 1 August week shows that the kingdom's economy is widely expected to continue growth through the second quarter. Q2 economic expansion met the expectations by going up 0.9%, while annual growth is estimated at 3.7%. Slow growth of only 0.7% in Q1 is now a memory, as UK's manufacturing sector is steadily recovering. After a slump in the first quarter, production expanded at its fastest rate in over 2 years by 0.9%. Retail sales continue to sustain the economy and even manage to take it past the Euro-zone average. However, investors were not impressed as the retail sales report a day earlier brought enough information to make the Q2 GDP report predictable. June's retail sales went up 1.1% despite analysts' forecasts of a slowdown to 0.4% from the previous 0.8%. This was partly attributed to spending on soccer merchandise, as a consequence of the summer's European Cup. Despite the GDP report release, the pound suffered a severe sell-off, which pushed it at the 1.8300 level against the dollar on Friday.

Thin summer markets have again caused some sharp and sudden moves. The U.S. dollar strengthened until Thursday, the 22nd, pushing the Yen to 112.50 (its weakest since late May) and the Euro to 1.1990. Weaker-than-expected U.S. Q2 GDP at 3.00% reversed most of this move, and now the dollar is practically unchanged on the week. Interest rates have moved in a similar fashion, rallying until Wednesday then reversing to end almost unchanged. Headlines are all about oil prices, as they have risen to disturbing heights. NYMEX Crude for September delivery hit an all-time high of $43.22 on the 30th of July. Commodities had a mixed evolution: metals went up, while grains drifted down. Equity indices, which were in the critical area early this week, went up, to the relief of the investment community.

British debt in June was in total value of one thousand-billion pounds, the highest ever amount, and Bank of England chief economist Charles Bean pointed to reasonable debt servicing costs and said that the Bank would not 'clobber' borrowers with a single large rate rise. In the mean time, policymakers try encouraging the nation to put much more aside for retirement.

John Kerry tried at the Democrat National Convention to clearly emphasize the difference between himself and George Bush by stating that 'We need a president who has the credibility to bring our allies to our side... That won't happen until we have a president who restores America's respect and leadership'. Analysts feel his speech might just result in a small gain in the opinion polls, which have held stubbornly neck-and-neck at 48% for both candidates.

19-25 July

The highlight of July 19-25-week was Federal Reserve Chairman Alan Greenspan's semi-annual testimony on the economy, Greenspan was optimistic about economic recovery and stated that the recent decline in consumer spending (-1.1% in June) is a result of transitory higher energy costs. Greenspan made a negative comment regarding the U.S. trade deficit, which, in his opinion needs to decrease, and mentioned there is a risk that foreigners may stop buying…[continue]

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