Monday, December 10, 2007

Bob's Currency Focus - Dec 10 - 14:00 GMT

The euro has made a significant rally Monday, taking almost 0.8 cents off the dollar, now trading at 1.4720. Although markets may be discounting a 50 basis points cut by the Fed Tuesday, the longer-run rate outlook for the dollar sees it at a big disadvantage against the euro, so the greenback is coming under further pressure ahead of tomorrow’s key FOMC meeting. Euro area economic data Monday was mostly positive with the German trade balance printing at €18.1B for October, over €1.1B higher than forecast. French Industrial production also soared in October, rising a massive 2.1% on the month against a forecast increase of just 0.4%. The impact of a stronger euro has certainly not deterred the industrial powerhouses of France and Germany and today’s results have helped push the euro higher. Friday’s payroll data from the US, while marginally better than anticipated, nonetheless signals a slowdown in the labour sector and simply gives the Fed breathing space to continue to cut rates. I personally would not rule out a 50 basis point cut by the Fed Tuesday, because this particular FOMC has become more unpredictable, inflation has more or less been abandoned as a principal Fed concern and there is most definitely a Bernanke put to appease US financial markets. While we might not agree entirely with the ECB’s ultra hawkish stance, we can at least say the ECB is consistent and monetary policy is most definitely not dictated by financial markets, as is currently the case in the US. Expect the dollar to remain under pressure against the euro in the build-up to Tuesday’s meeting and any break above 1.4770 will be significant, because it could trigger a temporary move closer to 1.49. We also need to be cautious, because we saw last week that both sterling and the Canadian dollar actually appreciated in value in the days after the respective Central Banks announced rate cuts and expectations of a rate cut in either of those jurisdictions was put at less than 50%. Markets have priced in a 100% chance of a Fed cut tomorrow, but this being a 0.25% cut. I prefer to buy the euro on dips back towards 1.4650, with upside targets of 1.4730, 1.4770 and 1.4840.

Cable has lost the run of itself Monday, rising sharply to a high of 2.0467, up over 1.5 cents on the day. Considering cable languished below 2.02 immediately following last Thursday’s Bank of England rate cut, it is quite a remarkable feat. The currency moved before today’s producer prices report, a report which although signalling higher than expected inflation at the factory gates, is hardly going to alter Bank of England monetary policy, which shifted to the easing side last week. House prices for October, in a separate report released by the department of local government today, grew to an annualised 11.3% in October from 10.8% in September and this also helped to support the pound. Cable offers no bid value on prices above 2.05 and even 2.0450, even if the market is nervous ahead of Tuesday’s FOMC meeting. The euro also slipped to 0.7180 against the pound Monday but has since recovered towards 0.72. Sharp sterling gains are likely to be continued to be met by sharp sterling sell-offs because the outlook for the UK economy is uncertain at best and with the Bank of England having joined the Fed in policy easing, positional traders will be looking beyond the UK currency. On Tuesday we have October’s trade balance and if we see another record deficit, sterling will sell down. Trading will continue to be thin ahead of the Fed and some currency moves will be exaggerated, including sterling’s. Strategy: Wait until after Fed meeting on Tuesday. Do not buy sterling at present levels.

The yen remains under pressure Monday as the prospect of a US rate cut on Tuesday has seen risk tolerance levels rise and a resurgence in the carry trade, with the yen being used as the preferred funding currency. The yen is only down fractionally against the US dollar, but is down 0.5% against the euro and 0.75 against sterling. It is down almost 1% against the Aussie dollar. With stock markets up today and likely to continue their rally if the Fed cuts rates tomorrow, the yen may be sold off further and we could potentially see the dollar rise to Y113 and the euro to over Y166 by tomorrow evening. In economic news, data released overnight showed Japan’s machinery orders surged by more than 12% in October, but against this the closely monitored economy watchers survey revealed that ordinary Japanese workers were not very enthusiastic about either current economic conditions or about the country’s economic outlook during November. Strategy: Don’t trade the yen until after the Fed decision, when markets have settled again.

The loonie weakened moderately Monday against the greenback but the pair has remained firmly inside the 1.00 to 1.01 trading band ever since Friday’s employment report. The loonie strengthened down close to the parity line again Monday but was unable to break through and the dollar has since advanced to 1.0080. Housing Starts in Canada rose to a 227.9K rate in November, up 0.1% from October but this was largely in line with forecasts and had no market impact. While base metal prices have fallen, oil is up over $1 a barrel and this should offer some short-term protection to the Canadian currency. Overall I expect the uptrend to continue, but we may continue in a period of consolidation until after the Fed rate decision Tuesday. The loonie has come off quite sharply against the euro Monday, losing over 1 cent, with the euro up to CAD1.4750. Strategy: Buy USD/CAD on dips towards 1.00 with limit targets of 1.0090 and 1.0135. Longer run bid positions should be retained with S/L at 0.9750 and target of 1.05. The loonie may appreciate against the dollar in the lead up to tomorrow’s Fed announcement, so anyone who is has entered long today on USD/CAD need to time their exit.

Bob B – Dec 10

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