Monday, October 22, 2007

Bob's Currency Focus - 15:30 GMT

What a turnaround this morning. We saw the euro hit 1.4349 last night on the Asian session and then go as low as 1.4134 this morning, as the pair crashed when the European session got properly underway. The market is incredibly volatile at present and we have seen a significant rise in risk aversion levels, as demonstrated by major losses on stock markets Monday that in turn follows an average 2.6% loss on the major US stock indices last Friday. Major doubts persist about the outlook for the US economy and futures markets have now priced in 90% probability of a further rate cut from the Fed when they meet next week. While fundamentally this is not good news for the dollar, a flight to safety Monday triggered a major unwind of carry trades and a major scramble for US treasurys which saw the dollar catapulted higher across the board. As to whether or not this trend will continues very much depends on the performance of financial markets over the next day or two. Any rebound in equities is certain to spark a fresh wave of dollar selling which will see the euro bounce strongly. The G7 meeting at the weekend failed to generate any official response from officials of the world’s most developed nations on current US dollar weakness. It remains to be seen as to whether there were any behind-the-scenes discussions of possible market intervention to protect the dollar, but this morning’s euro reversal can probably be put down to profit-taking and a temporary movement into dollar-denominated bonds. There is no economic data today or tomorrow that is going to influence the market much, one way or the other. It is a highly dangerous market to trade at present, particularly when currencies are following the fortunes of stock markets. The euro offers good value on levels close to 1.4150 and if stock markets stabilise, then there is every chance of a return to 1.43 over the next few days. If stock markets fall sharply again Monday, then there is every chance that the dollar could send the euro tumbling towards 1.40 by tomorrow.

Cable went through the floor Monday, helped in a large way by a major liquidation of GBP/JPY carry positions. Having come off an impressive high of over 2.0550 Sunday night, the pound fell to as low as 2.0265 Monday. Cable has fallen victim to the same rise in risk aversion that has afflicted EUR/USD. Sterling has consistently been susceptible to sell-offs on any significant rallies it has mustered in the past two weeks and that trend is likely to continue. There is no economic data of note out of the UK currency this week, but the pound should in part be protected by last week’s strong GDP and employment data which has reduced the prospects for an imminent rate cut from the Bank of England. Cable could test recent lows in the 2.0240 and 2.0190 price regions before we see a meaningful bounce. Sterling again offers good value against the euro on prices close to 0.70, although there appears little scope for progress much below 0.6950 for EUR/GBP in the current market environment.

The yen powered its way forward Monday against all currencies as the G7’s official calls for an appreciation on the Chinese Yuan was seen as supportive of the Japanese economy. Friday’s collapse on Wall Street saw many traders lower their risk tolerance levels and a reduction in carry trades also helped propel the yen higher. The dollar fell as low as 113.23 overnight before recovering to 114 by the time the US session opened. The euro, which hit a high of over Y167 last week, plummeted to below Y161 this morning, before bouncing back to 161.50. If stock markets continue their sharp decline, we could see the USD/JPY challenge the lows hit back in August (below Y112), while the euro could potentially decline back as far Y155 over the course of this week. It is a high risk trading approach though because if stock markets recover Monday, the dollar could quickly advance to Y115, while the euro could return to 1.64 by tomorrow evening. The yen made big inroads on the other crosses Monday, against the pound, the Canadian dollar and the Swiss Franc.

The loonie fell off its pedestal Monday, losing more than 1 and a half cents from Friday’s high (USD/CAD low) against its US counterpart. It is possible that Friday’s low of 0.9633 is now a significant anchor and what we are seeing today could be the commencement of a more meaningful correction upwards for the USD/CAD pair. Bank of Canada Governor David Dodge stated Sunday that the rapid appreciation of the loonie in the past few weeks was not fundamentally based and with Finance Minister Jim Flaherty commenting at the weekend that Canada is carrying the burden of 33% of the US dollar’s weakness (the same as the entire euro area), it could be that Canada’s establishment figures are finally realising that the runaway currency has the potential to bring the entire Canadian economy to its feet, if the loonie is not brought down to earth some time soon. The US dollar has risen to 0.98 Monday and there is know resistance in the 0.9830 price region which could halt the greenback’s assault. We have seen too many failed rallies by the dollar over the course of the past 6 months to know that it would be premature as of now to even consider this a possible trend reversal. Rallies on the back of increased market volatility (when temporary funds find their way into US dollars) are not in themselves convincing. The US dollar needs to hold above 0.9750, if any further genuine progress is to be made. The euro remains the value trade against the loonie on the crosses, on any price close to 1.38.

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