Friday, December 7, 2007

Bob's Currency Focus: Dec 7 - 16:30GMT

Coming towards the end of another week and rather surprisingly the euro is little changed against the dollar from last week’s close. Friday’s non-farm payroll number for November was marginally higher than forecast but as it didn’t really surprise on either side, the market has been unable to take any direction from it. The unemployment rate was reported at 4.7% with economists having predicted a tick up to 4.8%, while hourly earnings in November rose a sizeable 0.5%, much higher than the 0.2% seen in October. The data is strong enough to prevent the Fed contemplating a 50 basis points rate cut next Tuesday and with a 0.25% cut already priced in, the euro was unable to sustain any meaningful rally Friday. Sentiment should work against the dollar however in the run-up to Tuesday’s announcement and I will be surprised if we are not trading closer to this week’s high of 1.4770 before then. The market has had a rather muted response to ECB President Jean Claude Trichet’s hawkish statement yesterday and it will be something of a surprise if that statement does not play out in a much stronger euro next week, against the backdrop of further US rate cuts. Trading levels are beginning to thin and will thin out even more the further into December we go, so the market will become somewhat erratic. The stage though is being set for a further euro attack with 1.50 being a very realistic target before the year end (there are plenty of option contracts out there that want this price to be hit before the options expire at year-end). Expect a run-up in the euro between now and next Tuesday’s with the advance likely to become more pronounced in the period immediately leading up to the meeting. A break above 1.4770 could see price closer to 1.4850 in and around the time the decision comes out. Strategy: Start to buy on dips towards 1.46 with target prices of 1.47, 1.4760. If price holds above 1.47 buy with target of 1.48 and once holding above 1.4770, target 1.4850 and 1.49. We will see where prices are at Monday.

Sterling has done remarkably well over the past 24 hours when once considers interest rates were cut Thursday for the first time in over 2 years. The pound is virtually unchanged against most currencies Friday and has made gains against the lower-yielding Swiss franc and Japanese yen. Renewed dollar weakness and a strong rally in equity markets helped protect sterling in the aftermath of yesterday’s decision but the medium-term outlook for the currency is not very bright. Most traders saw little value in selling cable following a 3 cent decline Wednesday, but selling pressure will re-emerge on any significant pound rallies we see. Cable could run up to over 2.04 in the lead-up to the Fed rate announcement on Tuesday next, but thereafter cable may continue its downward trend, with the possibility of sharp moves as trading condition get thin. The ECB yesterday did not do sterling prospects any good (by dashing hopes for wider Central Bank easing) and we could witness a strong upside rally in EUR/GBP next week, with 0.7250 being the initial target and 0.73 being realistic before the end of the year. Sterling best chances against the euro are if the euro experiences a sharp sell-off itself, which seems unlikely in the short run given the ECB’s stubborn policy position. In the only data release out of the UK Friday, business think-tank body NIESR estimated UK economic growth slowed to 0.6% in the three months to the end of November. Strategy: Wait until after the Fed on Tuesday before considering a sell down of cable, but any rallies above 2.04 deserve the attention of cable bears. 2.0084 is the target next week.

The yen had to take it on the chin again Friday as stock markets continued to rally and risk tolerance levels rose, thus leading to renewed interest in carry trades funded by the Japanese currency. Indeed, the yen will probably remain under pressure until after next Wednesday, i.e. after stock markets have exhausted their upside rally, following an expected Fed rate cut on Tuesday. Data out of Japan overnight showed annualized quarter 3 GDP was revised downwards from 2.6% to 1.5%, which was a major surprise and highlights that the US economy is not alone in terms of facing an uncertain future as we come towards the end of the year. The yen has depreciated 0.35% against the dollar Friday and the pair now stands just shy of the 112 price line which is a significant barrier level. A break above 112 could mean the dollar will advance back towards 114 against the yen by the middle of next week as the euphoria over the Fed coming to the aid of the markets sends the yen packing for a few days. The euro has risen to 163.80 against the yen Friday and Y165 looks a certainty come Tuesday night. The Japan’s currency will likely come under further pressure on the carry crosses through to next Wednesday. Strategy: Buy EUR/JPY on any dips below Y163 with target prices of Y164 and Y165.

The loonie has showed some impressive resilience over the past few days and is now trading at the same price it was at against the greenback, prior to Tuesday’s Bank of Canada rate cut. As we have seen recently in the past number of months, the loonie strengthened just ahead of a key employment report and then made rapid gains immediately after the actual release. I have become suspicious of how the market trades Canada’s monthly employment report, because some segments of the market appear to be two steps ahead of the rest of us, but that’s an issue for another day. November’s 43K gain was impressive and the report points to continued solid growth in Canada’s labour sector against a background of competitive pressures from a strong currency and a slowing US economy. Jobs tend to be a lagging indicator though and it could me several months before we see the true impact of the recent strains which have been put on the Canadian economy. The US dollar failed to sustain a break above 1.02 over the past 3 days and today the loonie took control pushing the greenback back sharply, the pair touching 1.0007 before settling closer to 1.0050. It is highly unlikely we are witnessing a return to the downward trend, but a temporary correction was due and we could see another attempt by the loonie to break parity before the uptrend gathers pace again. Strategy: hold current longer-run upside positions and switch S/L to 0.97.60 to protect against Fed decision increased volatility during thin market conditions. Short run positions should buy on levels above the parity line using 0.9945 as a S/L and target 1.0140 and 1.0185. The loonie should also continue to make gains against the Japanese yen through to next Wednesday.

Bob B - Dec 7

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