Bob's Currency Focus - 13:00 GMT

EUR/USD
Trading is tentative Tuesday ahead of the FOMC rate announcement with traders unsure of direction. The euro rose to 1.4742 early this morning only to decline to 1.4656, on the back of another disappointing ZEW business survey out of the euro zone. The German think tank’s expectations index for December dropped to minus 37.2 from minus 32.5 a month previous. The current conditions index also fell, to 63.5 from 70.0 in November, meaning German businesses are more pessimistic both about current activity and about the growth outlook for 2008. The euro has grown adept at shaking off poor economic data of late and with ECB council members issuing more hawkish rhetoric Monday, the euro is likely to be well bid on any further dips. We could witness significant volatility immediately after the Fed statement is released this evening and with a 0.25% cut already fully priced in, direction will likely be determined by the content of the Fed’s statement. A 0.25% cut accompanied by cautious language underlying upside risks to inflation would support the dollar, while a 0.25% cut with a shift in bias towards policy easing would tend to damage the dollar, as this would worsen the dollar’s rate differential outlook against other major currencies for the coming quarter. If the Fed decides to be aggressive and cuts the Fed funds rate by 0.5% like it did back in October, the dollar will probably sink. It could take 30 to 60 minutes for the true impact to be established and any traders entering the market and trading the news immediately after the release are playing with fire. I expect to see the euro recover today’s losses and appreciate ahead of the announcement, but what happens thereafter is anyone’s guess. Strategy: Buy euro on any dips towards 1.4650 prior to the announcement and exit the market before the FOMC release. We will analyse the statement tomorrow and see what it means for the dollar going forward.

GBP
Cable has rallied for a fourth consecutive day Tuesday and the pound is currently trading around the 2.05 price level. Sterling is essentially trading well above its station and the currency is getting a false lift on the back of a resurgent carry trade, back in vogue thanks to expectations for a Fed interest rate cut today. The pound has risen against every major currency today, rising 0.5% against the euro, 0.26% against the dollar, 0.36% against the yen and 0.86% against the Swiss franc. The party may well end this evening, particularly if the Fed’s statement fails to rally stock markets, at which time the aggressive run-up in carry trades over the past number of days will begin to unwind. The UK trade deficit in October narrowed to £7.1B from a record £8.0B in September, but this is hardly a reason for celebration through rapid sterling appreciation and once today’s much heralded Fed event is out of the way, markets will again examine sterling with close scrutiny and with a sharp slowdown forecast for the UK economy in 2008, it is difficult to see sterling not coming under pressure in the coming days. It is conceivable cable could run up to over 2.06 later today if the Fed delivers more than what the market has priced in, but even if this is the case, cable should begin to retrace its gains later this week. Positional players may well see any price over 2.05 as an incentive to enter the market and go short, even if they have to sit it out and wait for the pair to top out before tumbling again. Strategy: short-run traders should maybe focus on EUR/GBP, buying dips to around 0.7150 with a target price of 0.72. Cable is worth selling on prices above 2.05 with downside price targets of 2.0370 and 2.0310, but this has the added risk of the Fed statement later Tuesday.

JPY
The yen continues its retreat Tuesday as carry traders targeted the currency to bump up positions on high yielding currencies like cable and the Aussie and New Zealand dollars, ahead of an expected rate cut from the Fed later today. The dollar rose to over 112 against the yen for the first time in a month but has struggled to stay there while the euro has changed little against the Japanese currency as it too retreated early Tuesday. Japanese consumer sentiment dipped further in November, but the currency’s decline has more to do with a rise in risk tolerance than any adverse impact of domestic economic data. If the Fed is aggressive and cuts rates by 0.5% today or shifts its policy bias towards monetary easing, we could witness a stock market rally for the next few days and the yen will decline further. The currency will be able to regain ground once the current bout of market euphoria comes to an end and that could even happen as early as this evening, if the Fed statement falls short of market expectations. It is too difficult to make a call on yen direction, with uncertainty large ahead of the Fed statement, so the best course of action could be to avoid the yen until we have had time to analyse this evening’s statement and gauge the reaction of equity markets. A sharp retreat in equities will see the yen appreciate just as sharply. Strategy: Await Fed announcement and avoid the yen for the moment.

CAD
The loonie has remained trapped within a 1.00 to 1.0140 price range against the dollar ever since last Friday’s Canadian employment report. The loonie has been unable to make a real impression and the US dollar is being bought against it on any dips towards the parity line. We could see the loonie strengthen a bit immediately ahead of the Fed announcement as nerves creep in and any subsequent negative statement for the US dollar could see parity broken for the first time since the Bank of Canada announced its rate cut last Tuesday. However, if the Fed cuts by 0.25% and remains cautious on inflation, US dollar bulls may well return to the market en masse and the greenback could once again advance to the 1.02 line. I’m inclined to not enter the market today, given the potential risks to the greenback (I’m a bull on USD/CAD) and any traders with an intra-day bid on USD/CAD are advised to get out at the best possible price before this evening, and not to risk their profits. Longer run I continue to be long on USD/CAD and maintain a price target of 1.05 with a S/L of 0.9760. Strategy: Intra-day, do not enter the market until after having had a chance to assess the immediate significance of the Fed Statement.

Bob B – Dec 11