Friday, November 30, 2007

Bob's Currency Focus - 18:00 GMT

Wall Street has opened sharply higher Friday as investors are buoyed from comments made by Fed Chairman Ben Bernanke overnight, signalling further monetary policy easing was on the way. Anyone who watched the broadcast may have been struck by the uncomfortable posture and lack of conviction emanating from the Fed Chief. Bernanke reiterated verbatim some of the phrases and observations made by Vice President Koln two days earlier, to give the impression the FOMC were at one on where monetary policy needs to go - at least Messrs Bernanke and Koln are at one. Based on some of the other speeches we heard from members of the FOMC this week, it is now apparent there is very clear division within the FOMC on whether rates need to be cut again so soon. Bernanke might be undermining the role of the Fed by allowing monetary policy be dictated by financial markets, meaning the Fed is merely playing a supporting role. With headline inflation currently running at 3.6%, the Fed is playing a very dangerous game indeed, particularly as up to now the US Fed is the only major Central Bank to have altered monetary policy to alleviate stresses in financial markets. The funny thing is the dollar has held up remarkably well Friday considering the events that have just passed in recent days. Add to this the fact Euro-zone inflation rose to a 6 year high in November (3.0%), virtually ruling out any hope of easing on the part of the ECB in the foreseeable future. Today is the end of the month and a closure of dollar short positions is seeing the dollar appreciate across the board, which may come as a surprise to many. The euro has got a bounce late on Friday over recent weeks, but it is seriously on the back foot right now as the dollar breaks below 1.47, though there may be a rebound later in the day. There does appear to be some correction of the dollar, but as to whether that will be carried through to next week remains to be seen. We could potentially see a decline to 1.4660 today and to as low as 1.45 next week, although a new month dawns on Monday and the greenback may once again find itself on the defensive. Strategy: Stay out until Monday, until we see where the current attempted correction closes.

Another bad day for cable which has drifted to around 2.0550, though crucially the first line of support at 2.0520 remains intact. UK Consumer Confidence hit a 4 year low in November according to the latest survey released today by the Gfk group and next week’s Bank of England meeting makes for an interesting time. The odds against a rate cut next week are still of the order of around 60%, but with the Fed forced into action and no sign of a let-up in the liquidity tightening, the MPC may be pressed into action sooner than some of Committee members would like. Sterling is facing into an uncertain week and the likelihood is the currency will face tentative trading ahead of Thursday’s key rate decision, and sterling may struggle to attract much buying support. The dollar has shown some muscle this week and cable offers the best value for a sell-off of the pound, with any rallies close to 2.07 likely to attract strong selling interest early next week. The pound could find itself pushed right back to 2.0246 over the course of next week. A broader sell-off of the euro could see sterling push the single currency back to around 0.71, but in view of the risks ahead, I would not like to make any sterling bids, at least not ahead of next Thursday. The pound also risks sharp retreats against both the Swiss franc and the yen, if risk aversion re-emerges in global stock markets. Strategy: Sell down cable on prices close to or above 2.07, with target prices of 2.0550 and 2.0460.

The Japanese yen has been the principal victim of the Fed’s comments on monetary policy this week. The Japanese currency at one stage today was down almost 4 cents from its high earlier in the week against the dollar. The prospect of further monetary easing in the US has led to an increase in risk appetite and a lack of demand for the low yielding yen. There is much complacency in the current move though as in essence what we are seeing is markets rallying on the back of what is economic uncertainty and bad news. The underlying fundamentals are exactly as they were this time last week, or if anything they are worse as economic data published this week point to an accelerating slowdown in the global economy. The Fed is prepared to let stocks dictate near-term policy however and stocks this week are rallying exclusively because of the Fed’s verbal intervention and acquiescence. Memories are notoriously short in equity markets and by next week markets will run out of reason to extend the current rally and we could see another sharp reversal lower. This will benefit the yen. The US currency offers no value above the 111-112 price range and it will take but a single day’s sell-off on Wall Street to see the yen appreciate back to around 109. It is best to wait until there is a rise in risk aversion evident before coming in to buy the yen. Look out for any potential late sell-off on Wall Street tonight. The yen is also down 0.6% against the euro Friday with the pair currently hovering around the 163 price level. There may also be value on selling down this pair at levels close to Y164 next week, when uncertainty returns to the market.

The loonie has finally ceded the parity line with the dollar Friday, two and a half months after breaching it for the first time in 30 years. Loonies followers tried bravely to defend the psychologically important levels for the past 3 days, but today the weight of a broader dollar move saw resistance at the 1:1 level give way. The dollar failed to manifest a clean follow-through and the pair has sparred around the parity line for most of the afternoon. It will be a surprise however if the greenback does not pull away above the line ahead of Tuesday’s Bank of Canada rate decision. While today’s quarter 3 GDP number at an annualised 2.9% rate came in much higher than anticipated, this is essentially of historical consequence particularly as the most recent economic data has pointed to an accelerating slowdown. After Ben Bernanke signalled the Fed would likely move to cut US rates again in December, this might be the cue for the Bank of Canada to act next week. Canada faces a similar economic dimemna to the US, but it has the added complication of a recent lack of competitiveness because of the strength of the loonie and a cooling global demand for the countries commodities, which constitute over 50% of the country’s exports. Inflation is also more benign in Canada than in the US and it could prove to be a grave mistake if the Bank of Canada flounder and don’t act to allow the economy more breathing space in the immediate term. A 0.25% cut on Tuesday seems likely and with markets still unsure as to whether the Bank will act or not, the loonie will struggle to gain bid support in the run-up to the announcement at 14:00 GMT Tuesday. USD/CAD could be destined to rise to between 1.02 and 1.03 by Wednesday, if the Bank of Canada delivers the necessary. Any retreat back to levels close to 0.99 between now and Monday will offer a good buying opportunity. It is too risky to buy the loonie against any currency before the Bank of Canada rate decision. Strategy: Buy USD/CAD on any dips in price between 0.9920 and 0.9950. Target price is 1.0020, followed by 1.01, 1.02 and 1.0250. Long run position is to go short on the loonie and wait for price to hit 1.05.

Bob B

Have a good weekend!

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