Tuesday, October 16, 2007

Bob's Currency Focus - 12:00 GMT

Currency markets are on a volatile footing Tuesday after stock markets declined overnight and we witnessed a sharp sell-off in the carry trade this morning. This has made the euro more vulnerable, because it has appreciated significantly against the yen in recent weeks. The euro has dropped to 1.4150 against the dollar this morning, a level that has held since the middle of last week and with no key US economic releases Tuesday, direction today will be determined by risk tolerance levels. A further unwinding of carry trades will undermine the euro and the pair could retreat to 1.41, with the outside possibility of sharp return back close to 1.40, if fear intensifies. If equity markets settle, then the current market price should be taken as a buy opportunity and the euro could bounce back to 1.4240. Bernanke’s comments overnight during a speech in New York were not especially positive for the dollar and there is still a strong sense that the Fed will move to cut rates again, possibly at the end of this month. This will keep the US currency on the defensive in the short-term and any dollar rallies should prove to be temporary, so long as market conditions remain stable. October's ZEW business survey index for Germany was unchanged from September and this must be taken as a plus for the euro, given the concerns raging about higher energy costs and the high value of the euro. Euro inflation for September was confirmed at 2.1%, the first time the rate has exceeded the ECB’s guideline rate of 2.0% since August 2006. With the ECB likely to maintain their hawkish stance against this background, there is every opportunity for the euro to take out the lifetime high of 1.4280 this week. For today, I would be inclined to buy around 1.4150 to 1.4160 with a stop at 1.4125 and a target price of 1.4240.

Sterling bulls took a knock this morning when September’s consumer price inflation came in unchanged at a benign 1.8%. It is the third consecutive month that the CPI rate has come in below the Bank of England’s 2% target. With inflation under control the Bank are in a position to lower UK interest rates within the next two months, if a further deterioration is seen in the housing sector or if financial markets encounter another credit crunch. We will find out on Wednesday, when the Bank of England minutes from the October meeting are released, just how dovish or otherwise thinking is on the Monetary Policy Committee. Sterling is certain to come under selling pressure against the euro and the dollar, particularly after it has rallied. Cable again looks like a good sell-down opportunity on levels close to 2.04, while it is difficult to see EUR/GBP breaking significantly below 0.6950 in the short-term, and any price near this level offers an opportunity for a rally back up towards 0.70. Sterling could fall sharply against the yen today, if the carry trade comes under increased pressure.

The yen came through like a train this morning as market panic overnight sent the first layer of carry traders running for the exits. USD/JPY went as low as 116.43 this morning and has currently settled around 116.75. The euro also fell by more than Y1.5 since last evening’s close and it currently at 165.26. We may see further sharp appreciation by the Japanese currency is risk aversions remain high today and traders need to keep a close eye on the performance of US stock markets. If the Dow IA strikes triple digit losses again today, then we could see the dollar fall to at least Y116 and maybe 115.50. te euro could decline back as far as Y164 in the short-term. However, the yen is not a currency traders like to hold for long and if stock markets rebound, then the currency will depreciate sharply, possibly back as far as Monday’s levels of Y117.50 against the dollar and Y167 against the euro. The biggest gains from a major carry unwind should be made on the AUD/JPY and NZD/JPY pairs. The yen is a dangerous currency to be trading in current market conditions and the rewards/losses can be substantial.

This is D Day in many respects for the loonie. With the currency having appreciated by 8% since the last Bank of Canada meeting in September, all eyes today (14:00 GMT) will be on what the Bank has to say about the country’s runaway currency. A rate cut, though unlikely, cannot be ruled out, but at the very least I expect the Central Bank to issue a strongly worded statement in an attempt to rein in a currency that has gained a massive 20% against the US dollar in the past 6 months. A failure to do so will be taken as the Bank effectively turning a ‘blind eye’ and could propel the loonie to further rapid gains, particularly since it is now armed with accelerating oil prices. Today is a stern test of the Bank of Canada’s mettle. The loonie will face a major reversal if rates are cut, or if the Bank’s statement signals a shift to an easing policy. Such a shift could see the dollar return to parity against its Canadian counterpart in the coming days, even in the face of rising commodity prices. Anything less will be taken as the committee being passive towards the currency’s appreciation and we could quickly return to the low at 0.97 for USD/CAD, with the possibility of a slide to 0.95 in the coming days. EUR/CAD and AUD/CAD offer good buy prospects, particularly if markets settle today and the Bank of Canada are dovish on monetary policy.

Bob B - Oct 16

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