Thursday, November 1, 2007

Bob's Currency Focus - 12:00 GMT

Well, we managed to hit the magical 1.45 line Wednesday shortly after the Fed rate cut. The market is still unsure what to make of the actual accompanying statement, which on balance, was broadly neutral. We need to see the key data over the next few days (which the Fed would have had exposure to during their deliberations) to know whether a further cut in December is likely or not. If Thursday’s core PCE inflation indicator registers above last month’s 1.8% reading, then it will a signal that inflation is beginning to creep up again. In fact with oil prices hitting a ridiculous $96 a barrel level overnight, it is difficult to see how inflation is not going to become a major problem for the US, particularly given the weak dollar. The euro dropped to 1.4406 this morning because of profit-taking and if the US data today is broadly supportive of the dollar, then we could see price return towards 1.4350 ahead of Friday’s non-farm payroll data. A weak set of data results (including a soft PCE core reading) may well reinforce the view that the Fed will be cutting again in December and the dollar could retreat sharply once again. Keep a close eye on the ISM manufacturing index at 14:00GMT because it comes a day after the Chicago PMI revealed a contraction in October (a story which rather slipped under the radar because of the preoccupation with the Fed meeting). A contraction in the ISM index (<50) for October would be a very bad sign for the US economy, particularly as exports should be significantly on the up because of the weak dollar. Markets will also be looking at the Pending Home Sales index for September which will give an indication of what to expect from October’s house sales data, released later this month. Major negative data out of the US could trigger a decline in stock markets and a rise in risk aversion levels, which could artificially protect the dollar. Today’s market should be data driven and we could see price action bump around a bit, but a high PCE figure and a strong ISM number should give the dollar a boost. Expect to see price move largely between 1.4350 and 1.4480, unless the data is extreme on one side or the other. The tendency is to still buy on dips, because sentiment towards the dollar remains very negative, but await today’s data releases before deciding to enter the market. Many market players won’t show their hand until Friday’s nonfarm payroll data is released.

Sterling has gained massive support this week from somewhere, soon after all the TV and market analysts were forecasting its downfall. Who would have thought a month ago that cable would be trading at 2.0840 within a few weeks? Well, not me neither. Just this morning, UK data printed quite poorly, with October’s CIPS manufacturing PMI slowing to 52.9 from the reported 54.7 a month earlier, but markets shook this off as if the data were not released. My feeling is that sterling is gaining primarily from a new wave of interest in the carry trade, thanks to a rate cut from the Fed, and also because sterling is seen as having more upside potential than the euro right now, particularly as it has broken above key technical levels. The Bank of England’s Barker, on two occasions in the past week, appeared to intimate the MPC were in no rush to cut rates anytime soon, so this too is helping to support sterling, at least in the short-term. Markets may believe cable now has the potential and the momentum to take it to 110. After all it is only 160 pips away. I would be very reluctant to buy cable at the current price, as there is scope for a very sharp decline, particularly of if the dollar triggers any sort of broader correction. Such a correction though could see sterling gain against the euro, as there are infinitely more euro longs in the market than sterling ones. We’ll look for a possible return to 0.69 for EUR/GBP over the course of the next few days and then buy the pair. Sterling is hugely vulnerable on the yen and Swiss crosses, if risk aversion levels rise. There is no value in buying sterling at current levels and it is worth selling down cable at levels over 2.0820.

The yen, as we predicted, became the principal victim of the Fed rate cut, with carry traders jumping in to sell the currency immediately after the announcement, to fund positions on high yielding currencies like sterling and the Australian dollar. This urgency may prove to be premature because 1) the cut was already fully priced in (more than once), 2) there is no clear commitment for further rate cuts from the Fed and 3) rampant oil prices are putting a dampener on the global economic growth story and may lead to a softening in growth prospects across the globe and see stock markets react adversely, which in tuen will put pressure on the carry trade. For now though, the yen has given up the 115.50 price mark against the dollar and needs to recapture it quickly if it is not to cede trend direction to the greenback. If the dollar takes out 116, then 117 could be hit within a couple of days and we could see an eventual rise back up to 118. I have an inkling the higher energy prices and the begative impact this will have on economic growth prospects will begin to weigh on markets over the next few days and unless there is a sharp pullback in oil prices, risk aversion could return with a vengeance and the yen will be the main beneficiary. A move back below 115 today could see a quick decline to 114 and return to the downward trend. We could see EUR/JPY quickly correct back to 165, having jumped 500 points in the past 4 days. If risk aversion levels remain high, expect the yen to gain massively against sterling, which has once again gone above the 240 price mark. It also has scope to gain significantly on the Canadian and Australian crosses.

Loonie supporters must have been doing cartwheels across the floor Wednesday as the currency hit its highest level against the US dollar in 50 years. Yes, that is FIFTY years. The pair crashed below 0.95 and 0.9450, before tipping 0.9416 – a new record. As to whether this is an anchor that may last for more than a few hours, we do not know, but the frantic rate at which the loonie is advancing must be very worrying for the Canadian Government (Yes, Mr Flaherty, some of us hear you, but do please talk louder). We have now witnessed a 24.5 cent rally in the loonie since last March and that is unprecedented. Either we enter a period of consolidation, or, in my view, we are going to see market intervention and a cut in interest rates from the Bank of Canada. Canada’s economy is being made uncompetitive virtually overnight and it has nothing to do with the country’s low productivity levels, which are indeed low, but it is as a direct result of a massive speculative gamble by currency traders. Speculators are using oil prices as a gauge for how far they can push the loonie, but as is pointed out by an article in our archive from last week, the contribution of oil revenues to the growth of the broader Canadian economy is hugely exaggerated. Canada’s economy is in danger of hitting a wall, and very quickly, if the soaring loonie is not brought down to earth. Bank of Canada officials need to come out in force to talk down the currency and start sending a large proportion of the speculative players to the exits. For today, there has to be the potential for a rise back up to at least 0.95. There is absolutely no value in buying the loonie against any currency at current price levels, but if you wish to jump on the loonie bandwagon, at least wait for some correction. The euro, to my surprise, fell to 1.36 against the loonie this morning, but this to me remains the value trade, i.e. buy EUR/CAD. Stock markets are down thus far today and an appreciation in the yen could see the CAD/JPY cross fall dramatically.

Bob B - Nov 1

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1 comment:

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