Friday, October 26, 2007

Bob's Currency Focus - 16:00 GMT

Yet another high for the pair Friday, coming up just shy of 1.44, but trading in bullish fashion just below this level. 1.45 now looks like a certainty to be hit next week and markets may not even wait for the Fed on Wednesday, such is the negative sentiment surrounding the dollar. We are in major overbought territory and a major dollar correction is due, once the market is satisfied a significant top has been put in place. We are highly unlikely to see any correction though until after the Fed meeting next week. Any sell-offs in EUR/USD between now and next Wednesday is only likely to be down to bouts of profit-taking, unless there is some Central Bank intervention (unlikely) and this may offer a fresh opportunity to enter the market long. The US dollar is showing increased signs of being abandoned by major players and the sharp rise in gold and oil prices over the past 3 days are very worrying for the dollar and the US economy as a whole. For now the euro will probably keep the pressure on ahead of the Fed and dips below 1.43 are likely to attract strong buying interest. One needs to keep the radar on for any comments from Fed officials and ECB officials ahead of next week’s Fed meeting.

Sterling has fallen badly against the euro Friday as the single currency tries to establish itself above the 0.70 line. There was no data out of the UK Friday but with traders positioning themselves ahead of next week’s Fed meeting, the euro is in popular demand, while continued uncertainty surrounding the UK housing sector is dampening demand for the pound. The euro however is massively overbought at present and offers no value against sterling at present levels. Sterling has the potential to push the euro back to 0.6950 later next week, although further euro buying against the dollar and the yen ahead of the Fed may mean it is wise to stay out of it for the moment. Cable rallied to 2.0572 this morning but could not hold these levels and is currently languishing near Thursday’s close at 2.0518. Sterling clearly is not the currency of choice of the anti-dollar brigade right now and cable’s ability to rise to the 3-decade highs of 2.0650 next week very much depend on how the dollar performs across the broader spectrum. If there is a major market correction next week and traders exit their positions, sterling should gain against the euro, Australian and Canadian dollars, simply because there is a much smaller % of sterling long positions out there than there are long positions on the euro and the commodity currencies.

Japan experienced the seventh consecutive month of deflation in September according to a report released last night and with Industrial Production surprisingly in decline, there are still several question marks about the outlook for the Japanese economy and interest rates. It is highly unlikely the Bank of Japan will raise rates again this year. The yen has managed to hold its own against the US dollar and sterling today, but this is owing to weakness on their part, as opposed to any renewed strength in the yen. The Japanese currency may sell-off a little later today if US stock markets close on a high and we could see the dollar rise to 114.50. The picture for next week looks bleak for the yen, as a cut in US interest rates is likely to trigger a fresh wave of carry trades, with the yen being used as the preferred funding currency. There is huge complacency out there however and this is clearly evident in the steam-rolling advance of the high-yielding Aussie dollar over the past few days. Any serious glitch in global stock markets could send the carry trade running for cover and in this event the yen could make significant inroads, even later today. Keep an eye on the Dow’s performance this evening.

The loonie did it again Friday, hitting yet another 33 year low against the US dollar, when the pair slid to below 0.96 briefly, to touch 0.9588 this morning. Manufacturers in Canada are less optimistic about manufacturing conditions with a 3rd quarter survey showing the key business sentiment index slipped to +2 from +7 in quarter 2. Weekly earnings in August softened to an annualised 3.1% from 3.7% in July, something that will please the Bank of Canada. The loonie is trading softer this afternoon and the US dollar has strengthened to 0.9630 against the currency, while the euro is up to 1.3850, having been as low as 1.3750 earlier today. The loonie offers no value against the dollar at present rates but with an expected rate cut from the Fed and record high oil prices, the US currency will find it difficult to make much progress. The euro continues to be the currency to buy against the loonie, especially on any dips back to 1.3750, or even below 1.38.

Bob B - Oct 26

Thursday, October 25, 2007

Market Watch: Canadian Dollar - October 2007

Is the high-flying loonie going to punish the Canadian Economy?

Six months ago I wrote an article warning the loonie (called this because of the bird on Canada’s one-dollar coin) was undervalued, oversold and due for a reversal in fortune. At the time the US dollar was worth 1.1850 against the Canadian dollar, with the euro valued at 1.56 Canadian. The Canadian economy was beginning to pick up following 6 months of lacklustre growth to the end of last year. Oil prices were rallying to over $60 having come off a low of $50 a barrel earlier in the year. Consumption was on the up, exports were growing steadily, employment was rising faster than forecast, business confidence was improving and there were some early signs that inflation was beginning to tick upwards. Against this backdrop of evidence it was a mystery why the currency was rejected, but that soon changed when economic report after report demanded the world take notice. Before we had time to blink the loonie had appreciated to 1.0850 against the US dollar by the end of May, at the time the Bank of Canada sat down to deliver their latest monetary policy assessment. When the Bank then signalled to markets that interest rates ‘may’ need to rise to keep inflation in check (interest rates were on hold for a year prior to this meeting), it helped catapult the loonie to new highs. Although the loonie was now up to a 1.04 to 1.07 price range against the US dollar, few experts believed it would ever reach parity with its US counterpart, with even fewer believing it could happen this year. At the beginning of 2007 most currency analysts and seasoned gurus predicted a price range for the pair of between 1.12 and 1.20 for the year. As of 12:00 EST on October 19, 2007, the US dollar was worth CAD0.9636. Hence the loonie has appreciated 18.84% since its low in February and in terms of the calendar year it has risen 17.34% against the US currency. This is a staggering level of currency appreciation in such a short time frame and while it may be celebrated by Canadians travelling abroad, it carries with it a very real set of economic challenges and dangers that could seriously derail Canada’s economy.

Firstly, let us look at the reasons why the Canadian dollar has appreciated in 2007:

1) Interest Rates: T
The principal driver for major currency movements is a shift in interest rate differentials. The Bank of Canada had largely been expected to keep interest rates unchanged at 4.25% this year, but in July the bank upped its lending rate by 25 basis points to 4.5%. The Bank has since moved to a neutral policy stance and rates are not expected to rise again for the foreseeable future. In the US the Fed, who were also expected to keep rates on hold throughout the year, actually cut rates by 50 basis points in September, to bring the key rate down to 4.75%. So currently, while interest rates are still higher in the US, the differential in rates between the two countries has narrowed by 0.75%. Markets have also priced in a further 25 basis point rate cut for the Fed before the end of the year, so in currency pricing terms the USD/CAD currency pair is trading on the assumption that by the end of this year both will have the same core interest rate of 4.5%. While this is the most important contributor to the loonie’s appreciation against the US dollar, it does not explain the level of appreciation we have had. Looking to the wider market, the interest rate differential between the euro area and the US this year has narrowed by 1.25% and during this time the euro has appreciated by 6.11% against the US dollar, compared to the 17.34% achieved by the loonie. Measuring currency appreciation purely on the movement in interest rate differentials, we might have expected the loonie to have appreciated by 4.9% against the US dollar (using the euro as the base denominator). But this is 12.44% less than the actual appreciation seen. We must also note that in terms of interest rate outlook, the European Central Bank is leaning to the upside on future rates, while the Bank of Canada is ‘tilting’ to the downside. Thus, if currencies are moving on interest rate differentials alone, the euro should be performing much better than the Canadian dollar. Yet the Canadian dollar is today worth 10.7% more than euro than it was back on January 1st. So is the real value of the loonie USD1.1087 and should the euro be worth CAD1.54 rather than the CAD1.38 we have today?

2) Oil Prices
It is a well established fact that the Canadian dollar often follows the movement of oil prices. The correlation is difficult to understand in the sense that while crude oil is an important export component, it only constituted 8% of total exports from Canada to the end of August 2007. An even more surprising stat is that in constant dollars, crude export revenues only rose 1.3% thus far in 2007, lagging the increase in total exports, which are running 1.8% higher than the same period in 2006. Oil prices have risen from a low of $50 in January to a high of $90 (Oct 19). The fluctuation in oil prices is volatile and what we can clearly ascertain is that Canadian oil companies have been unable to reap the full rewards because oil proceeds (denominated in US dollars) are converting into a smaller number of Canadian dollars than they used to. By the way this goes for all other US dollar-denominated commodities also, most of which have not experienced anything near the level of price inflation seen in oil. In terms of the increase in overall Canadian exports in 2007, crude is only responsible for 3.7% of the total increase. In the case of Canada, oil is only an 8% component of all exports and has contributed a mere 3.7% to the year over year gain in all exports in 2007. Therefore oil is something of a misnomer as far as the loonie is concerned and oil on its own should never be used for determining what the loonie exchange rate should look like. Will someone please notify those misinformed speculators?

3) GDP
Canadian GDP has been very robust in 2007, the economy coming off a rather lethargic performance in the second half of 2006, when it grew at annualised rates of 1.3% and 1.5% respectively in the final two quarters. Canada grew by an impressive annual rate of 3.9% in quarter one 2007 and a moderately slower 3.4% in quarter 2. This compares very favourably with annualised growth rates of 0.6% and 3.8% in the US for quarters one and two in 2007. While Canada’s GDP rates seem high this year they fall well short of the levels of growth regularly seen in Asia and many of those countries have their currencies pegged to the US dollar, so they have grown spectacularly with little or no currency appreciation - China has grown at annualised rates of over 11% in the first 3 quarters of this year and its currency has moved only marginally. A fairer comparison for Canada might be to look at the GDP rates for the euro area and the UK. The 13-nation euro area has grown at annualised rates of 3.2% and 2.5% in quarters 1 and 2 while the UK has grown at rates of 3.0% and 3.1%. While growth was more robust in Canada than in Europe, the Bank of Canada raised interest rates by just 25 basis points this year, as against 50 basis points by the ECB and 75 basis points by the Bank of England. We can however make the assumption that the strengthening loonie was instrumental in keeping inflation at levels that meant the Bank of Canada only had to raise rates once this year. We can deduct that Canada’s growth in 2007 is on average 29% greater than that in the euro area in the first half of this year. If we use growth as a means of determining currency value and use the euro as our base measure we see the euro has strengthened 6.11% against the US dollar so far in 2007 and if we factor in the growth differential for the Canadian economy, it means that using this calculation the loonie should have appreciated 7.88% against the US dollar (6.11% * 1.29). The loonie has in fact gained 17.34% in this time, so one could argue that 9.46% of the loonie’s appreciation in 2007 cannot be explained by underlying economic fundamentals, when we take growth as the factor behind currency appreciation. Therefore the loonie should be trading at USD1.0739 and not at the USD0.9650 price it is currently at.

The Predicament

All bull runs must come to an end some time, surely. The start of the current loonie bull trend can be traced back to January 2002, when the US dollar was worth CAD1.60. There is also a precedent for the sharpness in the loonie’s appreciation – back in 2003 the loonie rallied by 21% over the year before a 5% correction in the first 5 months of 2004. The economic circumstances were different back then as the Canadian dollar was still cheap in US dollar terms, meaning Canada was still competitive internationally and the US and global economies were expanding at an increasing rate. Today we have a slowing US economy and a global economy that has started to stutter, so it is now a seismic challenge for Canadian companies to be competitive internationally at an uncertain time when the US dollar is cheaper than the Canadian dollar. At the very least, Canadian companies will need time to adjust and for this to happen the currency has to stabilise soon, or Canada’s economy is destined for a hard landing.

How might the loonie bull be brought down?

1) Deterioration in Economic Data
It is only a matter of time before the sharp appreciation in the currency begins to weigh heavily on the domestic economy. The first signs of strain will be seen in Canada’s trade data, as cheaper imports and more expensive exports should take their toll on the country’s heretofore impressive trade surplus, in particular with the US. The decline in manufacturing shipments will intensify as US consumers shy away from buying ‘more expensive’ Canadian products and Canadian consumers themselves travel south of the border for cheaper American cars and other large durable goods. Employment will soften as Canadian companies lay off people because the company is unable to compete or because of reduced order intakes owing to a US slowdown. Corporate profits will tumble as companies that export their products and services see their revenues plummet because of the poor exchange rate. GDP numbers will decline as an export-dependent economy struggles with productivity and competition. Once disappointing data begins to regularly hit the newswires, speculators and investors alike will ditch the currency and the loonie will gradually depreciate. However, because of the significant time lag between the here and now and when economic reports become available, the drip feed may be too slow to prevent a sharp economic slowdown.

2) Bank of Canada intervention
If the Bank of Canada is seriously concerned today about the outlook of a 96 US cent economy over the next year, then they could cut interest rates which would lead to sell-off and result in a significant depreciation in the loonie. The Bank of Canada do not have sufficient foreign exchange funds to influence the loonie’s value through direct market intervention and in any event such an exercise would prove futile, as demonstrated by the failed intervention we witnessed this summer from the Reserve Bank of New Zealand. The Bank of Canada should at the very least up their concerned rhetoric in public, to signal a determination to face down currency speculators, who we can argue are responsible for more than half of the currency’s appreciation in 2007.

3) Financial Market Stresses
If we get a prolonged period of deterioration in global financial markets, traders and investors alike will be forced to reassess risk and outlook for the wider global economy. Speculators poured into the loonie this year upon the belief that the Canadian economy could withstand a US slowdown – the theory being Canada is a commodity rich country and a booming world economy demands more commodities and a commodity currency could only go up. When markets finally come to their senses and accept a downgrading of the global economic outlook, then commodity prices should drop, as should appetite for commodity currencies like the loonie. In this situation existing speculators will liquidate their Canadian dollar currency positions and the loonie will depreciate to a more realistic value level. How quickly it happens will depend on the trigger for the liquidation event, but it may not be orderly and the loonie could fall very sharply.

4) US Recession
If the US economy should find itself officially in recession (GDP contracts), then it is highly unlikely that Canada will get off scot-free because the ‘guilt by association’ syndrome is bound to stick. The loonie will come under persistent pressure, not just because our speculator friends run for the exits, but also because a recession scenario will create a new wave of Canadian dollar selling by funds and investors, who see the loonie in a completely different light.

It could be 6 months before I delve into such detail on this subject again and if I am to make a forecast now I guess my view is that the US dollar will very soon bottom out against the loonie and by April 2008 the greenback will have risen to be trading in a range of 1.07 to 1.11 once again. I also believe economic performance will suffer in Canada over the next half year with productivity failing to keep pace with the rising competitive challenge of a grossly inflated currency and the Bank of Canada will be forced to move, to cut interest rates by at least 50 basis points within the next 6 months.

Ted B'Struck - October 25, 2007

Bob's Currency Focus 12:00 GMT

US Existing Home Sales in September came in 8% lower than in August, twice as bad as what economists were forecasting. We witnessed a very strange turnaround on the Dow Industrial Average when it came from being 200 points down (understandable given the clatter of bad news circulating – including Merrill Lynch’s report of a near $3 billion dollar loss in Quarter 3, owing to the subprime fiasco) to close in positive territory. The reason appears to be that traders now appear certain that Ben Bernanke will don his white knight suit again next Wednesday and deliver a further rate cut. It is somewhat disturbing when financial markets rally in the wake of bad news on the assumption Central Banks are going to bail them out, but ultimately the US Fed are to blame for creating this market mindset. No other Central Bank has followed suit with respect to the credit crisis fiasco. Germany’s Ifo business index, one of the most important indicators for the euro, held up fairly well in October, coming in at 103.9 in October, from 104.2 in September. This indicates that the euro’s strength is not yet seen as a major threat to the euro economy’s largest player. The dollar is going to have few friends for the next week, ahead of the Fed meeting, and 1.45 is now a realisable target for EUR/USD if the Fed cut interest rates on Wednesday. We should continue to buy the euro on dips and we could see an attempt to hit 1.4350 today. With almost everyone long on EUR/USD, there is the danger that some event like another sudden stock market blip or dovish comments from the ECB could trigger a wave of profit-taking and send EUR/USD plummeting lower, similar to what happened on Monday. But if caution is exercised and you don’t get too greedy, the direction to be on at the moment is up. 1.4240 appears to have formed as an interim support point and behind this there is further support at 1.42 and 1.4180. 1.4320 needs to give way for a crack at 1.4350 later today. If price stalls on the upside, expect a retreat to 1.4250. Keep an eye on US stock markets, because if they do fall sharply, the dollar may be offered some temporary respite.

Cable has been hovering in no-man’s land for the past few days and looks as though it is waiting for something to happen to give it some direction. This morning’s BBA data from the UK shows a dip in mortgage approvals from 61K in August to 52.7K in September. Ongoing concerns about the fate of the UK’s housing sector will probably prevent aggressive buying of sterling, but the sheer negativity of sentiment surrounding the US dollar might still allow cable push higher, particularly in bouts of broad dollar sell-offs. There is the potential for a rise to 2.0550 or maybe higher today and cable could potentially take out the 28 year high of 2.0651 in the next week, as few are going to want to buy the dollar with the prospect of a Fed rate cut looming. For today, cable should trade within a 2.0420 to 2.0550 price range, with the bias to the upside. The euro has risen to 0.6775 against the pound Thursday and the pair is likely to remain largely within the 0.6940 to 0.7010 price range. Sterling offers good value on levels close to 0.70.

The yen has weakened Thursday and increased interest in carry trades in the expectation of a US Fed rate cut will put the Japanese currency on the defensive. We could see the dollar return to Y115 later today if stocks rally, while the euro should be able to hit Y164. The underlying credit risks remain however and any rise in risk aversion levels will propel the yen sharply higher. In the build-up to next week’s Fed meeting the yen could come under further pressure as higher yielding currencies will tend to benefit more. We have consumer price inflation data released in Japan this evening and a further negative reading for the national index in September will weaken the yen and probably kill off any notion of a rate hike from the Bank of Japan this year. The country has been in deflationary mode for each of the past 6 months.

The loonie weakened somewhat Wednesday, retreating when stock markets went into decline, but the currency rebounded before the market close. In early Thursday trading, the loonie has appreciated to within a whisker of the 33 year high it hit against the US dollar on Tuesday. The USD/CAD pair is trading at 0.9634, just above the 0.9625 low. The Canadian currency has been buoyed by higher oil prices and the prospects of a further narrowing in US-Canada interest rate differentials as early as next week. It is difficult to see the loonie being able to appreciate much more against a background of a slowing US economy and significant competitive problems, but traders that support the loonie don’t seem to be phased by the concerns and if they can drive the US/CAD pair to below 0.9625, then there is no reason why we cant see a retreat to below 0.96, setting up a new record target of 0.95 for the coming week, when US dollar sentiment is likely to remain negative. If risk aversion levels rise and stock markets go into decline again, then the loonie will suffer and the US dollar could push back up towards 0.9750. The euro again offers good buy value on levels close to 1.3750 against the loonie.

Bob B - Oct 25

Wednesday, October 24, 2007

Bob's Currency Focus - 12:00 GMT

The euro has drifted to the downside Wednesday and as I write, it is at 1.4230 against the dollar, down from 1.4260 overnight (but it did go as low as 1.4190). This afternoon is going to be quite an unpredictable market with traders awaiting the latest instalment of the US housing sector horror show, when the existing homes sales data for September is released at 14:00GMT. Nobody is forecasting an optimistic outcome and the average consensus amongst economists is for the annual sales rate to have fallen to 5.3 million homes from the 5.5 million reported for August. US stock markets are expected to open lower today and the housing news, coming just 30 minutes after the open, if really bad, could spook investors and send stocks tumbling. Ironically, a subsequent rise in risk aversion and a rush to the exits could send the dollar higher and there is a chance for a fall in EUR/USD right back to Monday’s levels of 1.4125. Any decline might prove to be short-lived however as a deterioration in the housing slump is likely to increase the chances of a Fed rate cut next week and that is not good news for the dollar, facing into next Wednesday’s key meeting. All is not so rosy in the euro garden either though, as this morning’s preliminary PMI data point to a significant slowdown in the euro area’s manufacturing sector, with growth slowing to its lowest level since August 2005. The chances of any imminent ECB rate hikes are fading fast and this will curb aggressive buying of the single currency on levels close to 1.43. Overall the risks today are to the downside and a possible spike lower similar to what we saw on Monday. Looking to the events over the next week though and the underlying sentiment, it is difficult to see the dollar holding any gains it may make for long, so the wisest move right now may be to buy the euro on dips. If you are short in the market, you might stay in, but keep moving your stop down, because we may witness another serious bounce later.

With no data of major significance this week, sterling is profiting from the wider uncertainty surrounding the economies in the US and the euro area and this morning the pound broke below the 0.6950 price level against the euro, a barrier that had held firm for the past 2 weeks. With the euro coming off the back of some weak data and growing concerns about the heightened value of the currency, the pound could potentially hold the euro around the 0.6950 in the days ahead. The major barrier to any further sterling move is if a rise in risk aversion leads to a major sell-off of the higher-yielding currencies today and tomorrow, which would see the pound fall off more than the euro. Cable looks very lofty above 2.05 and offers good sell-down value on prices above this level, with the possibility of another dip to 2.0350 or lower, if volatility levels pick up later today. The current market volatility is making cable an ideal pair to trade in both directions, although the range band has widened in the past week to 2.0250 to 2.0550. Sterling is vulnerable on the yen and Swiss franc crosses at current prices if stock markets sell off.

Carry traders currently want to sell the yen (given the sharp ups and downs we are witnessing), but the ongoing uncertainty in global financial markets means the yen keeps rebounding and we could see the Japanese currency retaliate further today if stock markets retreat sharply. The US dollar hit the Y115 price mark Tuesday but couldn’t hold it overnight, as traders bought the yen when Asian stock markets closed weakly. The pair has now gone as low at 114.10 today and could test Monday’s low of 113.25, if US equity markets tumble later today, while the euro could return to Y160.50. On the other hand, if equity markets rally, the yen will again be sold off and the dollar should be able to rally right back to 115, while the euro could climb to 164 this evening from the current 162.50 price level. September’s trade balance in Japan came in higher than expected and signals the appreciation in the Japanese currency after the credit crunch crisis in August failed to dampen demand for the country’s exports. The Australian and Canadian crosses could move significantly lower today, if the carry trade does experience a major wobble.

The loonie hit yet another high against the US dollar Tuesday, this time a 33 year low, as the US currency sank to a mere US96.25 cents against its Northern cousin. Monday’s decline was quickly shaken off by the Canadian currency as yesterday it resumed its mantle as the world’s strongest currency this year. While the loonie is vulnerable to a major correction at some point, its speculative backers are still not prepared to abandon the currency, just yet. The aggressive nature of the loonies march Tuesday will have put the frighteners up many would-be Canadian shorts and with no further major economic data out this week, only another spike in risk aversion is likely to lead to any significant sell-off. At prices below US0.97, the loonie offers no real value and with risks of further market volatility this week, there is the potential for the US dollar to again rally to 0.98, even if the greenback is unable to sustain any gains for long. The euro continues to offer good value against the loonie at current prices, especially around the 1.3750 price level.

Bob B

Tuesday, October 23, 2007

Bob's Currency Focus - 15:00 GMT

The dollar may have gained the most in one day for almost two and a half years against the euro Monday but true to it form it gave back most of those gains today and the euro is now trading at the same levels it was at last Friday. The only thing that is going to enable the dollar make progress at present is if we have a sustained period of instability in equity markets, whereby a heightened demand for US bonds and a repatriation of overseas funds back to the US would see the dollar appreciate against all currencies, except the yen. Stock markets have rebounded Tuesday (albeit prematurely, as the fundamental concerns that triggered last Friday’s move have not changed) and panic-stricken traders that ran for the exits Monday are back in droves to sell-off the greenback. While this presumptuous approach may work for today, there is quite a deal of complacency out there and I for one will be surprised if we do not see Monday’s uncertainty resurrect itself again later in the week. A further capitulation in stock markets is likely at any time and traders need to be on their guard. The euro has returned to 1.4250 Tuesday lunchtime and this in itself is a sizeable bounce from yesterday, so it may be expecting a bit much to hope for a higher close than that this evening. There remains a possibility that the pair could even retreat right back to 1.4180, if US stocks start to plummet. If stock markets do remain stable over the next few days, then I expect to see the euro to sail over 1.43 again Wednesday, when the US existing homes sales data is released (barring a major upside surprise in this data). Poor home sales figures this week may well copper-fasten a Fed rate cut for next week and with this prospect looming large the dollar will find few friends this week. The dollar’s only hope is for risk aversion levels to remain high, something that will temporarily protect it.

Sterling has had a great day Tuesday, hitting the 2.05 bar against the dollar, while sending the euro scurrying back to 0.6950. It has recently come off those levels but remains well bid. We have witnessed with sterling over the past few weeks that every major rally usually leads to major sell-off. I maintain my position that cable is a good sell at levels close to 2.05, while the sterling offers good value against the euro at any price close to 0.70. With no major economic data out this week (except October’s CBI data Tuesday, which while softer than expected, is not a major market-mover) sterling is likely to run with the flow. This makes it a great currency to trade, particularly cable, while it remains in the 2.0250 to 2.0550 price range. If there is a breakout in cable this week, it could come on the upside, if US housing data is weak enough to assume a Fed rate cut on October 31st. Risk aversion levels remain high and with the pound also being sold for M&A reasons, sell-offs on rallies in the currency should continue.

The yen returned to the familiar role of funding currency Tuesday and suffered major losses to the euro, sterling and Canadian dollar, while the dollar rose to Y115 this afternoon. The dollar in particular will find it difficult to make gains beyond 115.50 in the short-term, while the yen is certain to rally strongly, if market volatility rises. The euro has almost recouped all of its losses from Monday again the yen and could rise to 165 against the Japanese currency over the next few days. If equity markets fall sharply, the yen could carve out major gains against sterling and the Canadian dollar, as these crosses look heavily weighted with short-term bets.

The loonie is experiencing one of its best days ever Tuesday and has put the disappointment of a sharp reversal on Monday clearly behind it. Even before Tuesday’s Retail Sales data was released, the loonie had chalked up 1.5% on the US dollar, while having also hit new high for the year against the euro of 1.3714. One might be forgiven for believing it all appears a bit suspect in how the Canadian dollar appreciates significantly in the run-up to key major data releases – that subsequently prove to be greater than market expectations (Retail Sales were 0.7% Vs 0.6% expected), but this observation aside, the loonie remains the currency to buy on dips as it invariably rebounds strongly. USD/CAD hit 0.9625 this afternoon, its highest level since 1974 and on current prices the CAD offers no value against the US dollar. The euro does offer very good value against the loonie - currently on offer at 1.3750, considering the pair opened the day at 1.3868 and the euro is well bid today. Eventually the realisation that a US slowdown will hurt Canada’s exports will weigh on the loonie, but as of yet, the currency is showing no sign of weakness.

Bob B - Oct 23

Monday, October 22, 2007

Bob's Currency Focus - 15:30 GMT

What a turnaround this morning. We saw the euro hit 1.4349 last night on the Asian session and then go as low as 1.4134 this morning, as the pair crashed when the European session got properly underway. The market is incredibly volatile at present and we have seen a significant rise in risk aversion levels, as demonstrated by major losses on stock markets Monday that in turn follows an average 2.6% loss on the major US stock indices last Friday. Major doubts persist about the outlook for the US economy and futures markets have now priced in 90% probability of a further rate cut from the Fed when they meet next week. While fundamentally this is not good news for the dollar, a flight to safety Monday triggered a major unwind of carry trades and a major scramble for US treasurys which saw the dollar catapulted higher across the board. As to whether or not this trend will continues very much depends on the performance of financial markets over the next day or two. Any rebound in equities is certain to spark a fresh wave of dollar selling which will see the euro bounce strongly. The G7 meeting at the weekend failed to generate any official response from officials of the world’s most developed nations on current US dollar weakness. It remains to be seen as to whether there were any behind-the-scenes discussions of possible market intervention to protect the dollar, but this morning’s euro reversal can probably be put down to profit-taking and a temporary movement into dollar-denominated bonds. There is no economic data today or tomorrow that is going to influence the market much, one way or the other. It is a highly dangerous market to trade at present, particularly when currencies are following the fortunes of stock markets. The euro offers good value on levels close to 1.4150 and if stock markets stabilise, then there is every chance of a return to 1.43 over the next few days. If stock markets fall sharply again Monday, then there is every chance that the dollar could send the euro tumbling towards 1.40 by tomorrow.

Cable went through the floor Monday, helped in a large way by a major liquidation of GBP/JPY carry positions. Having come off an impressive high of over 2.0550 Sunday night, the pound fell to as low as 2.0265 Monday. Cable has fallen victim to the same rise in risk aversion that has afflicted EUR/USD. Sterling has consistently been susceptible to sell-offs on any significant rallies it has mustered in the past two weeks and that trend is likely to continue. There is no economic data of note out of the UK currency this week, but the pound should in part be protected by last week’s strong GDP and employment data which has reduced the prospects for an imminent rate cut from the Bank of England. Cable could test recent lows in the 2.0240 and 2.0190 price regions before we see a meaningful bounce. Sterling again offers good value against the euro on prices close to 0.70, although there appears little scope for progress much below 0.6950 for EUR/GBP in the current market environment.

The yen powered its way forward Monday against all currencies as the G7’s official calls for an appreciation on the Chinese Yuan was seen as supportive of the Japanese economy. Friday’s collapse on Wall Street saw many traders lower their risk tolerance levels and a reduction in carry trades also helped propel the yen higher. The dollar fell as low as 113.23 overnight before recovering to 114 by the time the US session opened. The euro, which hit a high of over Y167 last week, plummeted to below Y161 this morning, before bouncing back to 161.50. If stock markets continue their sharp decline, we could see the USD/JPY challenge the lows hit back in August (below Y112), while the euro could potentially decline back as far Y155 over the course of this week. It is a high risk trading approach though because if stock markets recover Monday, the dollar could quickly advance to Y115, while the euro could return to 1.64 by tomorrow evening. The yen made big inroads on the other crosses Monday, against the pound, the Canadian dollar and the Swiss Franc.

The loonie fell off its pedestal Monday, losing more than 1 and a half cents from Friday’s high (USD/CAD low) against its US counterpart. It is possible that Friday’s low of 0.9633 is now a significant anchor and what we are seeing today could be the commencement of a more meaningful correction upwards for the USD/CAD pair. Bank of Canada Governor David Dodge stated Sunday that the rapid appreciation of the loonie in the past few weeks was not fundamentally based and with Finance Minister Jim Flaherty commenting at the weekend that Canada is carrying the burden of 33% of the US dollar’s weakness (the same as the entire euro area), it could be that Canada’s establishment figures are finally realising that the runaway currency has the potential to bring the entire Canadian economy to its feet, if the loonie is not brought down to earth some time soon. The US dollar has risen to 0.98 Monday and there is know resistance in the 0.9830 price region which could halt the greenback’s assault. We have seen too many failed rallies by the dollar over the course of the past 6 months to know that it would be premature as of now to even consider this a possible trend reversal. Rallies on the back of increased market volatility (when temporary funds find their way into US dollars) are not in themselves convincing. The US dollar needs to hold above 0.9750, if any further genuine progress is to be made. The euro remains the value trade against the loonie on the crosses, on any price close to 1.38.