Wednesday, October 17, 2007

Bob's Currency Focus - 12:00 GMT

We failed to see any real move upwards Tuesday and most of the price action was to the downside. 1.4150 was beached but not convincingly and immediate support for the euro is now found around 1.4140. US data yesterday was rather poor and with the international net capital flows coming in at a negative $163 billion in August, this should raise concerns within the US Treasury Department, as doubts amongst foreign investors intensify over the outlook for the US economy and by consequence dollar-denominated assets. August was the month when financial markets endured a major credit squeeze and this will have distorted the capital flow numbers and we will have to wait until next month to see if yesterday’s shock report was a one-off, or the beginning of a worrisome trend. Wednesday sees key inflation and housing data released and the best outcome for the dollar will be a bigger rise than expected in inflation and a better than expected set of housing figures. The core inflation rate is expected to remain unchanged at 2.1%. but should this rise to 2.3% or more, the Fed’s hands may be tied on interest rates later this month and it should give the dollar a much-needed lift. The housing data is expected to be poor – housing starts are forecast at a 1.285 million annual rate. If the number comes in sharply lower than this, then expect risk aversion levels to rise and currency markets to become more volatile. The euro’s prospects of hitting the lifetime high of 1.4280 this week are reducing with each day, as we get closer to the G7 meeting at the weekend. With European politicians expected to raise the issue of the strong euro Vs the dollar and the yen at the weekend (unofficially), many would-be euro supporters will remain on the sidelines for fear of some form of intervention, thus curtailing the scope of immediate euro gains. The dollar does therefore have the potential to break to the downside, if the US inflation data is robust and we could possibly see a retreat to 1.41, or below, later on. If stock markets fall again, it will tend to hamper the euro. On balance, I would rather sell down Wednesday on any price advances towards 1.4240, presuming 1.4242 stays intact. Even if the euro does rally, it will find it difficult to hold its gains, given the wider risks at play.

Good old David Blanchflower didn’t let the side down at October’s MPC meeting, when being the only member of the committee to vote for a rate cut. The solitary vote is significant in market terms because it means a rate cut is now at least in the mindset of committee members and a cut is likely to command a more heated debate at the next Bank of England meeting in November, particularly following yesterday’s soft inflation report and recent housing data that points to a slowdown in that sector. September's favourable employment report didn’t reveal any new inflation concerns on the wage front and will have little impact on interest rate policy. Cable has managed to hold above the 2.03 line again today but it looks good value for a sell-down on any advances close to 2.04, with the possibility of a return to 2.0250 within the next few days. The pound will continue to struggle to make much progress against the euro, but should be able to prevent any immediate moves by the single currency to retake the 0.70 price level. Sterling will come under pressure on the yen and swiss franc crosses, if risk aversion levels rise again later.

The yen has given back nearly all of yesterday’s gains this morning, as a bounce in European markets Wednesday has attracted a flood of carry trades. There is plenty of high risk data scheduled for release in the US though and any further sharp deterioration in US housing data could spark another sell-off in US equities and see the yen come back into favour. It is difficult to see the US dollar advancing beyond Y118 in the short-term, given the current level of negative sentiment, while any yen advances are likely to occur in bouts of sporadic attacks, similar to what we have seen in the past two days. A significant decline in stocks could see the yen push the dollar back below Y116, with the potential to spike lower towards Y115, if the trend continues into the tonight's session. The euro could rally back up to Y167 against the Japanese currency, if markets manage to stabilise.

The Bank of Canada issued a broadly neutral statement Tuesday, when voting to keep rates unchanged, as expected. They were not as vociferous in their language about the currency’s high value as they might have been and many market players who are currently long on the CAD may see this as a let-off. At the same time, the statement did see inflation risks as tilting to the downside and have at least left the door slightly ajar for a cut, should events point to any deterioration in the economy. While oil prices are generally supportive of the loonie, the fact that prices are rising on the back of a weak US dollar and a slowing US economy should cause some alarm and the loonie will struggle to penetrate the 0.97 31-year low in the short-term. If US inflation data proves to be soft and US housing data is in line with expectations, the loonie should be able to hold its own. High US inflation data coupled with a rise in risk aversion levels could see the US dollar advance to 0.9850, if only temporarily. The euro is again a good buy at levels close to 1.38. A sharp fall in oil prices might also be seen as a reason to sell the CAD.

Bob B - Oct 17

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