Sunday, December 16, 2007

Bob's Currency Focus - Sun Dec 16

What a remarkable couple of days Thursday and Friday for the greenback, gaining 3 cents against the single currency, 2 cents of which came on the final day of the week. There is a combination of reasons for the move, principal among them being US inflation numbers for November which printed higher than expected and which suggests the Fed is more limited in its ability to aggressively ease rates in the coming months. Headline consumer price inflation has hit 4.3%, the highest in 2 years, with the core rate rising to 2.3%, the second monthly rise in the key annualised rate which is now inching further away from the Fed’s 1-2% comfort zone. Other US economic data last week was much stronger than expected with Retail Sales in November rising 1.2%, the highest in 6 months, and Industrial Production jumping 0.3% after falling half a percentage point in October. The consumer spending data in particular means the dire forecasts for quarter 4 GDP in the US are probably greatly exaggerated. Meanwhile the euro performed worse than most currencies over the past few days so we have also witnessed a broader correction in the single currency, further explaining the crash against the greenback. There will probably be a reassessment of sentiment for the US currency as we move closer to Christmas and a failure by the euro to quickly recapture the 1.45 price handle could mean a further slippage to 1.4350 and result in an eventual retreat all the way back to 1.3850. The underlying fundamentals for the euro have not changed however and with the Fed likely to remain under pressure to cut rates while the ECB remains on hold, the medium term outlook still looks to favour the euro. One important observation from Friday is that the dollar was the chief beneficiary from a rise in risk aversion levels as stock markets came under pressure. The yen, which is generally the chief benefactor during bouts of risk aversion, was distracted Friday following a weak domestic economic report (quarterly Bank of Japan Tankan Survey) but the Japanese currency could resume its role as main beneficiary if risk aversion levels remain elevated into this week. This might put an end to the dollar’s steep ascent. Strategy: Wait.

Cable plunged Friday and the pound lost almost 3 cents on the day. Cable closed the week below 2.0180 and the dollar is now within striking distance of the psychologically important 2 dollar line for the first time since August. There was no economic data out of the UK Friday and it was broader dollar strength that proved the pound’s undoing. Against this the UK currency did manage to appreciate against the euro, pushing the single currency back below 0.7150. November’s consumer price inflation is out Tuesday and if it prints much higher than expected, the pound might temporarily be able to push the euro back to 0.71. I still do not like the outlook for sterling and prefer to sell the currency after failed rallies, where a better entry price is available. Strategy: Wait until better price available on cable. Sell the pound against the Swiss franc on prices close to 2.33 with a target price of 2.30.

The yen declined further against the dollar Friday as the yen was punished for a poor quarterly Tankan survey report with big manufacturing and non-manufacturing firms in Japan returning a pessimistic outlook for the first quarter of 2008. This being said, the yen is never one to respond in a meaningful way to its own domestic data and with some economists downgrading the prospects for the extent of US rate cuts following the release of a robust set of inflation numbers for November, the dollar extended its gains through to the week’s close. US stock markets closed significantly down Friday and with the high yielders all retreating sharply against the greenback, it is something of a surprise the yen did not benefit more and facing into elevated risk aversion levels Monday, the dollar offers no value at prices close to Y113.50 and we could in fact witness a sharp retreat towards Y112. With the euro under broader pressure, the yen should be able to push the single currency back towards 162, if stock markets continue to struggle Monday. Strategy: sell USD/JPY at prices close to 113.50 with initial target of 112.50. Sell EUR/JPY at prices above Y163.50 with target of Y162. Monitor stock market performance closely.

The loonie had a very good day Friday, coming off a 3 month low against the greenback to close 0.3% higher, while the Canadian currency also made strong gains against all the European currencies and the Aussie dollar. The loonie jumped on the coattails of the greenback Friday as the North American currencies rallied strongly. The parity line however looks to be behind USD/CAD and we could see this pair go significantly higher this week as we move into the holiday period and more positions are closed out. There are still far more loonie longs than shorts in the market, so there remains the risk of further sharp depreciation for the loonie in the near-term. This Tuesday sees the release of November’s inflation data and if it is returned soft, the loonie will face a further sell-off because benign inflation makes it easier for the Bank of Canada to further cut rates in early 2008. Expect the loonie to give back most of Friday’s gains against the US dollar on Monday. Strategy: Buy USD/CAD on price drifts towards 1.0120, setting an initial limit target of 1.0220 with 1.0270 next. Positional traders should remain long on USD/CAD, keeping the target price of 1.05. We will look to move up our S/L from 0.9760 once price has been established above 1.02.

Bob B - Dec 16

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