Tuesday, October 30, 2007

Bob's Currency Focus - 13:00 GMT

Likely to trade within a narrow range ahead of Wednesday's Fed rate announcement. There is the potential for some pullback today if risk aversion levels rise, or if speculation intensifies that the Fed could keep rates on hold. The euro though looks poised for a strike at 1.45 and we could wee see that happen Wednesday, if the Fed meet market expectations for a 25 basis point cut, or surprise with another 50 basis point cut. The Fed will have access to this week’s key economic data (PCE core inflation indicator and ISM manufacturing index, as well as October’s non-farm payrolls number) when it makes its decision, data which is not officially released until Thursday and Friday. Any sharp surprises in this key data, particularly the core inflation indicator or the payroll numbers, could potentially influence the Fed’s rate decision and the content of the statement it subsequently releases. $93 oil also cannot go unnoticed and the Fed will have to seriously consider that a rate cut tomorrow is likely to trigger $100 oil and pose a major inflation risk for the US economy. Runaway oil prices could be the one major obstacle to what would otherwise be a certain rate cut tomorrow, in my view. For Tuesday, the most likely scenario is a drift back towards 1.4350 with the euro rising back up to the highs of 1.4440 before tomorrow’s announcement.

Cable has managed to take out the high at 2.0651 Tuesday and if it breaks above 2.0675 later today, this will be very significant technically and could lead to significant upside potential in the next few days, if we get the expected US Fed rate cut. However with housing data on Monday again reporting on the soft side, sterling’s apparent revival has more to do with US dollar weakness and technical trading than with any new-found underlying fundamental strength. Sterling will be massively vulnerable if the Fed does not cut rates tomorrow and we will probably find ourselves back at 2.0250 before the end of the week. The pound’s technical move against the dollar has helped it appreciate against the euro and the single currency is down 50 points to 0.6770, having hit 0.7020 Sunday night. The pound can potentially push the euro lower but will struggle to gain much beyond 0.6950 in the short-term. Sterling is vulnerable on the Swiss and yen crosses at current price levels, if there is any rise in risk aversion levels.

The yen has just about held its own early Tuesday after two days of significant losses against most currencies, when we had a new wave of carry positions laid ahead of an expected US interest rate cut. The Japanese currency is likely to lose out more than the dollar in the event of a rate cut, as a rally in financial markets will lead to the yen being used as the principal funding currency. The Bank of Japan is expected to leave rates unchanged when it delivers its policy decision early Wednesday and unless Governor Fukui speaks in a hawkish tone, the yen will come under pressure, even before the Fed delivers its rate announcement later Wednesday. However, if the Fed does not cut rates Wednesday, stocks will tumble and the yen will be the principal beneficiary amongst the major currencies. For today, we may well see a sell-off ahead of the Bank of Japan announcement, if stock markets do rally later today, and the US dollar may rise to Y115.50, while the euro could reach Y166.

The loonie was up to its old tricks again Monday, hitting yet another high, this time a 37 year high. USD/CAD yesterday reached its lowest trading price (0.9516) since the Canadian dollar decoupled from the US dollar way back in 1970. When are we ever going to see a bottom in place and a correction higher? The loonie has essentially rallied 13 cents without any correction against the US dollar since the credit crisis shook financial markets in the middle of August. That is an unprecedented level of currency appreciation by any standards and if this is not giving David Dodge and his colleagues in the Bank of Canada some sleepless nights, then it should be. Crude oil revenue has made a paltry contribution to Canada’s economic growth in 2007 and higher oil prices are not a justification for a higher Canadian dollar. The fact is that the rapid rate of the Canadian dollar’s rise in value is at odds with the underlying fundamentals and Canada’s economy will soon pay a very high price for this major disconnect. Speculators continue to ruls and dictate the direction of Canada’s currency. With a Fed rate cut on Wednesday likely to fuel further US dollar weakness, the greenback could find itself trading below 95 CAD cents within the next 2 days. There is the potential for some kind of correction upwards later this week and into next week, once all the risk events are out of the way. Keep an eye on oil prices today because speculators are currently using this as the barometer for deciding where to price the loonie. The euro is a good buy at prices close to 1.37.

Bob T - Oct 30

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