Bob's Currency Focus - Friday

Payrolls are good, yet the Dollar sinks

Today was one of those crazy trading days where logic went out the window. Dollar supporters were praying for a good nonfarm number to boost the chances of a short-term dollar recovery. The number was better than expected and when one takes into account the fact that August’s -4k number was revised to +89K, one would think that this was mega news to push the dollar significantly higher. After all, the Fed cut interest rates by 0.5% last month, on foot of the then reported -4K jobs contraction. Markets had anticipated 100k new jobs in September and got 110k plus a net +94k thanks to the revision for August.

EUR/USD plummeted to 1.4032 from 1.4130 before staging a Lazarus-like recovery to rally to a current 1.4150. Why? If anybody knows, answers please on a postcard to the above address. Why the earlier moves this week, if there is no follow through when there is actual hard evidence to support the dollar? It may be that major players have remained out of the market until the dust has settled and with rate cut expectations on the wane following today’s news, we could see the dollar make a genuine move next week.

And what of the loonie? CAD came off a full two cents from its overnight price to hit a staggering 0.9785 against the US dollar Friday. That is a 2% move and when one considers it had already advanced 17% since March, we are now witnessing one of the sharpest moves we have ever seen amongst a major currency pair. Although Canadian employment data was much stronger than expected, employment is a lagging indicator and the true impact of Canada’s lack of competitiveness owing to its muscled currency won’t be known for a few months. While in economic terms one would believe the currency’s rally is not sustainable, we must remember that the CAD’s rally is more speculatively driven than fundamentally driven and speculators won’t stop while there’s more profit to be had. Of course it isn’t sustainable from an economic perspective but it now looks as though we won’t see a reversal until the loonie runs off a cliff, with the Canadian economy close at hand. There is much disquiet within the euro area about the overvalued euro and the impact this is having on business, yet the euro is only up 7% this year against the US dollar, while the Canadian dollar is up 16%. And add to this the fact that less than 10% of euro area exports go to the US, whereas 80% of Canada’s exports go there. Go figure! The Canadian Foreign Minister has attributed the loonie’s rise to a weak US dollar, but that’s only part of the story. CAD is the speculators favourite currency this year and it has been driven to values far beyond its remit. And the Canadian economy will soon be picking up the tab, mark my words Mr Dodge.

Bob B

Bob's Currency Focus

Thursday Oct 4: 16:00

Euro
The euro has rebounded to 1.4140 having hit a low of 1.4066 as markets grappled with the meaning of the ECB policy statement Thursday. Traders are positioning themselves ahead of the critical US payroll report 12:30GMT Friday which is going to determine the dollar’s immediate fate and today’s price swings may only prove to be temporary. The euro also fell against sterling today, going as low as 0.6910 before bouncing back to 0.6925. The ECB look set to stay on hold for the remainder of they year and with Trichet iterating downside risks to euro economic growth in the medium term, the euro may well struggle to recapture the 1.42 level against the dollar unless we see a poor non-farm number from the US Friday. With carry trade appetite on the up, the euro could hit 1.65 against the yen today. EUR/CAD is the one cross that offers some medium term upside value, having hit a low of 1.4050 today.

GBP
Sterling firmed after the Bank of England kept rates unchanged. Halifax house index shows the first price decline this year and with expectations of a rate cut before the end of the year, the pound’s gains could prove to be short-lived. Expect caution ahead of tomorrow’s US nonfarm payroll number and GBP/USD should largely remain in the 2.03 to 2.0440 range between now and then. With no UK data for the remainder of the week, sterling’s immediate fate depends on US data and a strong payroll number could see cable fall back below 2.0250.

USD
The prospects for Friday’s payroll number took a knock when the weekly jobless claims figure rose by its highest level in 4 months Thursday. Expect whiplash moves in the currency between now and 12:30GMT Friday. A figure of over 120K Friday should see the dollar push the euro back below 1.40, while another disastrous number <40K will raise expectations of further rate cuts and the greenback should fall to a new record low against the euro and to 2.05 against sterling.

YEN
The Japanese currency is totally out of favour this week and even declines in global equities in the past 2 days has failed to spark a yen revival. There should be consolidation below 117 against the dollar ahead of Friday’s payroll report, where a negative number could lead to a sharp correction back down to 115. The ratio of longs to shorts was nearly 50:50 in the latest COTS report, so the yen does not have the same potential to move as sharply as it did back in August, if risk aversion levels were to rise later this week. However, given the weight of the carry trade this week, AUD/JPY and GBP/JPY could sell off significantly Friday, if a weak US payroll report leads to heightened concerns about the state of the US economy.

CAD
Still the most resilient currency on the market and the CAD has now closed better than parity against the US dollar for 4 consecutive days. The economic fundamentals for Canada remain sound and the first big test for the parity-beating currency will come in the shape of August’s employment data on Friday (11:00 GMT), which is released 1.5 hours ahead of the US payroll data. A strong Canada payroll number could send the USD/CAD to below US0.99, while a minus number will see the CAD fall sharply against its US counterpart, regardless of the outcome of the US employment report. The CAD is overbought on most of the crosses at the moment, with little value on offer, although CAD/JPY could scale 118 if both the Canadian and US data is good on Friday.

Central Bank Outlook: ECB & BoE

ECB: October 4
Members of the ECB’s monetary policy committee find themselves in an unenviable position with political pressure on the back of a rapidly rising euro, uncertainty about the euro zone economic outlook, credit market problems and rising euro zone inflation all in the mix, when the MPC sits down to deliberate on its monthly policy statement on October 4th. The only thing that seems certain is that the ECB will leave interest rates unchanged at 4% but markets will be listening closely to what the Bank’s President – Jean Claude Trichet has to say when he gives his press conference after the rate announcement. After the last meeting in September smart money was on one more rate hike before the end of the year, probably to come in December next. The ECB may still decide to signal such a likelihood this Thursday, in its pursuit of price stability (September is the first time inflation has risen above the ECB’s 2% comfort zone since August 2006 - a 2.1% preliminary inflation rate for the month was reported last week). Despite political pressure, particularly from France, the ECB is not in a position to shape their policy around curtailing the value of the euro. The only respite that can be expected here is for Trichet to reiterate previous remarks about a strong US dollar being in the best interests of the US. It is neither his place nor that of the ECB to try to influence the value of the euro against the dollar and the forum for any action on that matter will probably rest inside the G7 group of meetings, and not with the ECB. However the other major issue that the ECB must take into consideration this week is the deterioration in euro area economic data, particularly over the past month. Unlike last month when reduced economic sentiment could have been attributed to the credit woes in financial markets, there is now growing evidence of an industrial slowdown in the euro area economy, with both manufacturing and non-manufacturing sectors in decline across all the major economic blocks of the euro zone. While expectations of an interest rate reduction at this stage are premature, economic interests in the euro area as a whole will be looking for a deliberate shift in ECB monetary policy this week. Expect the ECB to acknowledge downside risks to growth, but to make direct reference to upside risks to inflation. Also expect Trichet to avoid using the ‘vigilance’ word and the core message that markets will probably extract from this week’s policy meeting is that euro area interest rates are now likely to remain unchanged through to the end of this year. Such an outcome will likely see the euro come under pressure, though the euro will probably lose most of the ground in the days leading up to the meeting.

BoE: October 4
Many analysts see the possibility of rate cute from the Bank of England this week, with the probability currently around 40%. The Bank’s Governor has a major credibility issue hanging over him going into this week’s MPC, following the fiasco of the public run on the Northern Bank early last month and the BoE’s u-turn on providing supportive financing during the credit crisis. The BoE also got their inflation forecasts completely wrong this summer and with inflation easing to an annualised 1.8% in August and the housing sector starting to cool, the Bank may feel obliged to start cutting rates sooner rather than later. As the MPC’s chief hawk and policy spinner, Governor King must shoulder most of the blame for having completely miscued on the economy’s inflation risk and unless the BoE ease rates quickly the wider economy may start to slow sharply, following 5 interest rates rises since August 2006. With ample evidence of a global slowdown and downside risks to UK economic growth, there appears no logical reason for the BoE to hold off on a rate cut until later in the year. In addition, the Bank does not know the real impact of the credit crisis on the UK banking sector and it is best to err on the side of caution. They should act this week. Some of the more rational and dovish voices on the Committee are sure to push for a cut at Thursday’s vote and should they succeed, it could spell more trouble for Governor King in his position at the helm of the Bank of England. I see the chances of an easing this week at 50%. A rate cut would see a rapid demise of the pound, while even if the Committee stand pat, sterling may still come under pressure as markets are likely to price in a cut for later in the year.

Ted Bearstruck
2nd October 2007