Thursday, November 8, 2007

Bob's Currency Focus - 18:45 GMT

Messrs Bernanke and Trichet took centre stage Thursday - Bernanke giving his semi-annual testimony on the economy to the government Finance Committee, while Trichet was issuing a statement on ECB monetary policy soon after the MPC announced the key interest rate for the euro area was to remain at 4.0%. Bernanke testified he expects growth in the US to soften into the middle of next year, with a pick up in the latter part of 2008. He did not give any indications either way as to the future direction of interest rates. Trichet on the other hand again emphasised the upside risks to price stability over the medium term in the euro area, saying the MPC were ready to act in a firm and timely manner to keep prices under control. Although Trichet did state that on balance risks to growth were to the downside, the ECB nonetheless expects the euro area economy to grow in and around its potential rate in 2008, thus meaning the ECB retains a tightening bias. The euro jumped back up to 1.47 on the strength of a hawkish sounding Trichet but has failed to break above this level, primarily because stock markets remain in turmoil and the movement of funds into US bonds is somewhat protecting the dollar. However as neither Bernanke or Trichet failed to make any direct reference to the strong euro/weak dollar in their prepared statements this is an indication neither Central Bank is particularly worried about the current exchange rate. 1.50 now looks on the cards sooner rather than later, as many would-be dollar market entrants would have been put off by the ECB’s stance today while most of those extreme euro long positions may hold out for a better price. The market continues to show little appetite for a proper correction and any dip towards 1.46 is likely to attract fresh buying. On Friday, we have September’s Trade deficit number out of the US, but this is unlikely to have much market impact, unless it produces a major surprise. A more sustained period of stock market pressure could see the dollar make some gains, but unless it is extreme, it is unlikely to lead to any major sell-off of EUR/USD, given the outlook for interest rate differentials.

The Bank of England kept interest rates on hold Thursday and said nothing in the statement release, so we have been left guessing as to whether there was any notable shift in the stance of Committee members, until the minutes are released in a fortnight’s time. Sterling got a bounce after the announcement as the stay on rates offers the currency some short-term relief. Cable ran up to 211.16 today and is currently trading just below this level, up 1.1 cents on the day. While clearly overvalued giving the softening outlook for UK growth and UK interest rates, the extreme level of negative dollar sentiment continues to protect the pound. Sterling even managed to push the euro back to 0.6950 today but will find it difficult to make gains beyond this level. The Conference Board reported Thursday that the leading indicator for the UK economy fell 0.1% in September, the third consecutive decline in the index. While the leading indicator is not a market-moving index, the result does nonetheless validate other recent reports on economic activity which signal the UK economy is cooling. Sterling has got a temporary stay of execution from the Bank of England and there is the potential for cable to rise further if sentiment against the dollar intensifies further. There is no value though at the current price as there is a very real danger of a sharp correction downwards. Expect EUR/GBP to creep back up towards 0.70 Friday.

The yen has continued to perform strongly Wednesday as stock markets again came under pressure. The dollar is trading at two month lows of 112.28 and is not far off the year’s lows which are in the sub 112 price region. If the yen should appreciate and pushes the dollar below the pivotal Y110 price level in the coming days, it could have a major knock-on impact for the entire currency market, with the carry trade and EUR/JPY likely to come under enormous pressure. Japan’s Economy Watchers index, a survey of barbers, shopkeepers and others who deal directly with consumers, declined for a seventh month to 41.5 from 42.9 in September, the Cabinet Office said today in Tokyo, indicating merchants are the most pessimistic they've been in four years, signaling slumping wages and a weakening job market may have convinced consumers to scale back spending.. A number less than 50 means pessimists outnumber optimists. Despite this gloomy assessment, the immediate outlook for the yen depends on the performance of equity markets, although any gains the currency does make will probably be given back very quickly when markets stabilize, as long as the USD does not fall below the boom or burst 110 price mark. AUD/JPY and NZD/JPY should retreat overnight if Wall Street closes down sharply.

Are we beginning to see the first glimpses of a chink in the armory of the loonie. We have now seen two rapid declines in the currency in successive days and sharpness of the moves suggest there is a sudden willingness to take on the loonie bulls, the first such move we have seen against the loonie since the global credit crisis issue first broke back in August. Canada’s Prime Minister Stephen Harper was the latest senior figure to suggest the loonie’s rapid rise was out of step with the underlying fundamentals and suggested a period of ‘reflection’ was required and that the issue was one for the Bank of Canada and not the Government. The loonie plummeted Wednesday evening, with the greenback rising to 0.94. The pair is currently trading just below this level following another highly volatile day of trading. If we are witnessing a turn in the loonie, or at least an attempt at a temporary correction, we could see the greenback rise swiftly to 0.95. The smart longer-play money should go on EUR/CAD. Today’s housing starts numbers out of Canada were broadly in line with expectations. Friday’s Trade Balance for September is key for the loonie, because the first creeks in the Canadian economy will probably be seen in its export volumes. A dramatic decline in exports or a major narrowing of the trade surplus could send another wave of Canadian dollar long positions to the exits.

Bob B - Nov 8

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