Disorderly Financial Markets

We have entered a very strange world of whiplash-like shifts in currency prices which has made trading a highly dangerous and totally unpredictable game. Over the past week we have seen record drops in many currencies against the dollar and the yen while in the past 2 days we have seen lazarus-like recoveries for the euro, sterling and all of the commodity currencies. The bounce in stock markets over the past 24 hours does not feel real and given the economic fundamentals are deteriorating further, it is also not sustainable. There have been some farcical episodes on the world’s stock markets with the German DAX gaining 11.28% on Tuesday, thanks primarily to some bizarre trading on a sole component, i.e. Volkswagon. Sterling has gained 20 yen since its lows of last Friday, while the UK currency has earned 10 cents against the dollar since yesterday morning. Add to this the Aussie dollar being up 15% against the yen in a day and the Canadian dollar up 8 cents against the dollar in the past 20 hours and you begin to see just how disorderly and ridiculous the world’s financial markets have become. It is almost laughable, except there are some big monetary exposures behind these huge swings which are proving to be very expensive for those holding them. It is simply not worth trying to trade in these conditions, unless traders are using the swings to unwind previously exposed positions. One should not be fooled into thinking that trends are reversing, they are not. The high yielding currencies in particular could get a hammering later in the week, especially against the US currency.

There is much talk about the Japanese authorities intervening in the currency markets, following a G7 meeting of finance ministers at the weekend, when the subject was discussed. We will not know until after the event if intervention has taken place, but such has been the depreciation in the yen since Tuesday morning that it may well be possible that the Bank of Japan came in and used the global stock rally as an opportunity to sell the yen. One fact is unavoidable though and that is that the yen’s recent appreciation owes nothing to speculators forcefully moving the currency, but rather it is the result of a repatriation of funds back to Japan, as investors liquidate assets which were originally taken out using the low-yielding yen as the funding currency. For this reason, intervention could prove to be useless exercise over the long run as essentially what is happening is that the yen is returning to its base value, having been grossly under-valued for years. The Bank of Japan may even move to cut rates on Thursday in an attempt to curb the currency’s appreciation but again the net result might only be some short term respite. The yen will only truly depreciate again when risk aversion levels abate and investors feel confident to once again fund risky assets in emerging markets through the low-interest yen.

Do not trade in these market conditions! If you must, use 1:1 leverage.

Bob B - Oct 29

Currency Markets a Dangerous Sea to Swim

Currency Markets have entered a state of panic these past few weeks and there is very little in the way of profitable trading to be made, with wild swings the norm on any currency pair that includes the US dollar and the Japanese yen. The US dollar in particular has reached valuation levels against some currencies that were unimaginable just 3 months ago. While I had been calling the dollar undervalued since the beginning of the year, the steep nature of the dollar’s rise is greatly out of proportion with the shift in economic fundamentals for the leading currency pairs and the dollar’s rally is now overdone. A glance at the commitment of traders report for any of the past number of weeks, a report that details the number of open currency positions on the Mercantile Exchange, makes for interesting reading as it clearly indicates that the dollar’s current appreciation has little or nothing to do with traders bets on various currencies. The dollar has appreciated as sharply as it has done because of the credit squeeze and the shortage of dollars on the open market and also thanks to the repatriation of funds back into dollar assets, primarily from the emerging markets, as investors unwind their riskier assets.

The end result is a total distortion of currency markets with some of the smaller currencies at or near capitulation status. The yen’s sharp appreciation is one of the major problems and as long as the Japanese currency remains as strong as it currently is, we will not get normality back to the markets. The yen has appreciated over 30% against Australian Dollar since July and is up 20% against most other major currencies in that period, excluding the US dollar against which it has gained 7%. In the past month, the US currency itself has gained almost 20% against the Canadian dollar, its largest trading partner.

What does all this mean for currency traders? It means the market is unpredictable and dangerous to trade. It is largely a fruitless exercise trading intra-day because fear is the King and fear rises or subsides depending upon how stock markets perform and these are currently swinging madly from one side to the other without warning. Technical indicators mean little or nothing in this market with currency prices sailing through support and resistance points as if they didn’t exist. Economic data is also largely ignored as stories about credit problems, bank rescues and fiscal bailouts take precedence.

What should one do? Nothing! Sit on the sidelines until liquidity levels reach something akin to normal. One should also remember that when liquidity levels do normalise, the US dollar and the Yen will come under intense selling pressure. Positional trading is also dangerous right now because while the value trade would appear to be to sell the dollar or the yen, the result tends to be the opposite as both currencies continue to benefit unfairly from the broader market uncertainty and traders can be left holding positions with huge deficits. EUR/GBP is the only currency pair I like at the moment and with neither side having a hold on direction it can be lucrative to trade in either direction. The range looks to be from 0.77 to 0.7850 at the moment and I have also noticed that in recent weeks, the pound usually does better during the morning session while the euro then retaliates during the US session.

Trade safely, if at all in this market, and avoid the dollar and the yen.

Bob B - Oct 21

Market Mayhem

The dollar is on course for one of its best weeks in history, despite a tirade of weak economic data out of the US and a worsening of the credit crisis, with no official approval yet on the US government’s rescue package for the banking system. How can the dollar make such hay in this environment?

The answer is simple. FEAR! Logic abandoned financial markets several weeks ago and now traders and investors alike are living on their wits. The credit crisis has spread across the globe and with liquidity having dried up, markets are much thinner than normal and it does not take much to move them in one direction or the other. It has been all one way traffic this week however with the dollar and the yen taking all other major currencies to the cleaners. The euro at one stage today was down 9 cents from where it was trading against the dollar last Friday. Sterling was down 11 cents against the dollar in the same time. The euro fared even worse against the yen which has been the week’s strongest currency. Risk aversion is at an extreme level and funds are flowing into the low-yielding yen and dollar at a breath-taking pace. The commodity currencies have also been hit hard with the Aussie dollar coming off the worst. The carry trade has been completely liquidated with the yen now trading at multi-year highs against all of the high yielding currencies. We should be close to the bottom in terms of many of these currencies, but logic does not apply in the present market and economic indicators and technical charts have virtually zero influence. The greenback has today hit a 12 month high against the euro, the Aussie dollar and the Canadian dollar.

The euro has been plagued by bailout stories of European banks and this has badly damaged the once teflon currency. The short-term outlook may be unkind to the single currency but when the dust settles, the euro’s healthy current account balance should prevail over the worsening debt situation in the US. The ECB is resisting calls to cut interest rates but with some European Governments taking it upon themselves to resolve the banking crisis, the ECB’s credibility and indeed the euro itself is being undermined.

This is not a market for small traders and intra-day trading and most traders are advised to avoid it until we see some semblance of order once again. If you must trade, employ very low leverage to minimise your exposure and trade pairs that do not include the dollar or the yen. A backlash against the dollar will happen, but only once market players have calmed down and there is some evidence of light at the end of that dark tunnel.

The regular column will return next week.

Bob B - Oct 2

Bob's Currency Focus - Sep 22

What does the US bailout fund mean for currency markets?

Since Friday’s US announcement of an extraordinary fund to allow financial institutions to cash in bad debts in exchange for taxpayer’s money, the dollar has got it on the chin. The creation of a help-out fund totalling $700 billion comes on top of a government bailout of AIG, which cost a further $85 billion earlier last week. As the US already has a vast current account and budget deficit, the required capital can only be provided through the issuance of government debt and the flooding of the market with dollars. This is not good for the dollar in the long run, because ultimately the more dollars on the market, the less they are worth individually. Even short term sentiment is against the dollar, despite the fact there is a global economic slowdown and investors across the world have been running for cover. Some analysts believe the final bill for the ‘bailout’ will more likely be closer to $2 trillion, an even worse prospect for the dollar. What the dollar does have going for it is the fact that there appears to be little to justify much faith in many of the other major currencies at the moment and because of this, ongoing volatility looks likely while investors weigh up the pros and cons of holding dollars versus other major currencies. The dollar’s strong Rally through July was fuelled by the repatriation of funds back to the US, rather than currency traders laying long positions on the dollar, so if these funds now dry up, given the dollar’s poor yield and rate outlook the currency will struggle and should be sold on any significant rallies. The euro should be able to make it back to 1.50 and only a firm indication of lower interest rates from the ECB is likely to terminally damage the single currency. There is the very real danger that a new commodity price bubble could form over the next couple of months, if the dollar declines too sharply. Speculators willingness to pour back into commodities en masse was evident again late last week, when oil and gold staged massive bull rallies. While Central Banks worldwide have thrown billions at the financial markets in an attempt to calm them, the massive and sudden injection of liquidity could come back to haunt Central Banks in the form of rising inflation and a return to a stagflation environment, which will temporarily put a stop to any consideration of easing in monetary policy. The commodity currencies should outperform in the coming weeks.

EUR/USD
The market is less concerned about economic data at present while traders look more towards safe havens while risk aversion and general market uncertainty persists. The dollar has been abandoned as a safe haven as investors don’t like the thought of an additional $700 billion + being printed and circulated to protect the US banking system. The euro is trading almost 5 cents above the lows from last Friday as currency traders see the euro area financial system as much more secure than that in the US while the relatively flat current account balance in the euro area immediately looks a far more attractive bet than the ballooning one in the US. EUR/USD sold off by 21.5 cents from early July to the middle of September and there is every reason to believe that a 50% retracement of that move could now be underway. That would see the euro rise to 1.4950 and indeed a return to above 1.50 is possible, especially if the deterioration in euro area economic data does not accelerate. Currency markets are a law unto themselves at the moment and one thing we can be certain of is that uncertainty itself will continue to prevail, so big swings will make short-stop trading strategies virtually redundant. Wednesday’s German Ifo survey report is the next economic event that could potentially unhinge the euro. The sharp deterioration in that survey’s index last month caused a major euro sell-off.

GBP
Sterling has gained 5 cents against the dollar since last Friday morning, something of a remarkable feat when one takes into consideration the litany of bad economic data that continues to stream out of the UK. Last week’s surprise increase in retail sales offered some level of comfort but the accuracy and veracity of the retail sales figures have come in for much criticism over recent months and this number may simply be another blip in the series. The UK, along with the US, has a worrying current account deficit and with the British economy seemingly in freefall, there is little reason to buy the pound on fundamental grounds. The pound’s only real chance of appreciation is if risk tolerance levels rise further, thus attracting additional funds into the high-yielding currencies like sterling. Cable should struggle to make it past 1.85, but if the dollar comes under increased selling pressure because of market concerns over the US financing plans, cable could return to 1.90, before the market is forced to take stock of its value once again. If the dollar manages to stage a broader rally across all markets, then cable could quickly fall back to 1.7850 over the next week.

JPY
The yen got hammered last Friday as a surge in global stocks triggered a return to risk tolerance and a resumption of the carry trade. The Japanese currency has lost 10% against both the Aussie and New Zealand dollars in the past week, while it has also ceded major ground to the euro and the pound. The US dollar is the only currency against which it is trading higher against than at the start of last week. The yen will be undermined by the ban on short selling of financial stocks which will limit the downside for global stocks and hence prevent the sort of extreme bouts of risk aversion that were so evident all last week. However, the speed with which traders have returned to carry trades looks to be over-ambitious and with stock markets trading lower thus far on Monday, we could see a forced scaling back of these positions overnight which should help the yen claw back some ground. How markets respond to the US bailout plan for banks will be pivotal for determining direction over the next week, so the reaction of US stock markets needs to be watched very closely in the coming days. Economic data will not have any major significance this week.

CAD
The loonie has broken below key resistance of 103.71 on Monday, meaning the currency has now appreciated by 4 cents against the greenback in the past 3 sessions. Nothing has fundamentally changed in the Canadian economy, but a surge in oil prices over the last few sessions aligned with renewed appetite for risk has sparked a recovery in the Canadian currency. The loonie has been carried along on the wave that has seen a very sharp sell-off of the US dollar on Monday. Canada’s healthy current account balance is also attracting investors as markets look to a huge worsening of the US debt situation with the proposal of a $700 bailout package for US banks. Volatility is likely to remain and while the loonie does now have a chance to send the greenback back as far as 1.02, any sharp up-tick in risk aversion will work against it and could see USD/CAD jump back to 1.07 by the end of the week.

Bob B - Sep 22

Bob's Currency Focus

Is it the end of the world as we know it?

The Fed’s bailout of insurance giant AIG is the latest spectacular episode in what has been one of the most frightening weeks in the history of global financial markets. On Monday Lehman Brothers became the largest (by a street) bankruptcy failure in the history of Corporate America. Also on Monday, Merrill Lynch, Lehman’s closest cousin on Wall Street, was taken over by Bank of America in a rushed deal, executed just before markets opened on Monday, when Merrill was certain to be the next guillotine victim of those shorting financial stocks. Today, we learn that Lloyds TSB and HBOS (the UK’s largest mortgage lender) are on the verge of a merger, forced upon HBOS, as their share price has plummeted so much in recent days that their market capitalisation value has plunged to farcical levels. And today the Russian stock market had to be closed after its index fell 17.5% in an hour. This follows a similar closure on Tuesday, after the index lost 20%. These are scary times and the impact is resonated across currency markets as well as equity markets, with the risk aversion Japanese yen slaying all before it. It is not a market for rational trading based upon the latest economic indicator releases and technical analysis charts, but rather it is a market to best avoid, unless the trader has massive risk tolerance levels. The volatility is resulting in huge swings across most major currencies and in particular any currency pair involving the US dollar, or the Japanese yen. Logic is out the window and wide shifts in sentiment towards what is happening in wider financial markets is forcing currencies in one direction or another. A look at the latest Commitment of Traders Report essentially shows a mediocre volume of open currency trading positions against the norm, which tells us 1) liquidity levels remain dangerously low and 2) currency movements are not being influenced to any great degree by speculative currency trading, but by the repatriation of funds across exchange rate borders, primarily to Japan and the US, resulting in the yen and the dollar appreciating significantly against the other majors. The yen has now appreciated to 2-year highs against the euro and the Aussie dollar and to multi-year highs against the high-yielding pound and Kiwi dollars. The carry trade has essentially been completely liquidated in the past 2 weeks although extreme negative market sentiment could see the yen gain further, particularly against the euro.

The current market is too risky and volatile and short stops are not working. Traders are best advised to avoid the dollar and yen and to stay away from the market until it settles, or else stick to pairs like EUR/GBP, AUD/NZD and EUR/CHF. Those stuck in open positions may need to sit them out or if brave enough, to enter the market at current range extremes, and collapse the two positions at the halfway point.

Bob B

Bob's Currency Focus

EUR/USD
The dollar’s relentless rally continues unabated, sending the euro to a 2008 low on Thursday of 1.4327. This happened after the ECB’s ‘no bias’ monetary policy statement when the Governing Council voted to hold rates steady. The market did go after the euro after that event believing the ECB will be forced to cut rates sooner rather than later but the dollar gained ground against all currencies, excluding the yen, after the IS reported that the US Services Sector expanded in August, with the business PMI coming in at 50.6, moderately above the 49.0 expected. Global stocks have tanked today, but the dollar continues to benefit from an inflow of safe haven flows and today it registered its highest exchange rate of the year against many currencies. The dollar and the yen seem to be the only game in town right now with investors reluctant to load bets on European or commodity currencies. Friday will offer another litmus test for the US economy when the nonfarm payrolls report is released. The omens don’t look good however, after Thursday’s initial jobless claims numbers came in at the worst level in 5 years, while both the ISM services and manufacturing reports record contractions in employment during August. It may well be a case of damage limitation and if the figure is something better than -50,000, then the dollar should not be penalised. The euro is oversold, but with support at 1.4365 taken out on Thursday, there seems little to stop the pair quickly descending to test the 1.40 level. Momentum could take the dollar there over the next week. Caution is needed however as the dollar has now registered a 10% gain against the euro in little more than 6 weeks, while the chance of a US interest rate hike seems more distant now than it did back in July. This dollar rally is not supported by any major shift in the rate outlook, which would tend to suggest it is unjustified and over-extended. Another point worth noting is that the positive economic data seen recently out of the US is nearly exclusively down to a sizeable upturn in exports, but in the past month alone the dollar has wiped out all of its losses for the year and subsequently its competitive advantage in the export market. Be warned! This dollar run is not sustainable, even if the greenback continues to make gains in the short run.

GBP/USD
The nightmare continues for sterling and at one stage today the pound was down 23 cents on the price it was trading at on August 1st. The sell-off is extreme and it is not just a dollar phenomenon because sterling is also trading at a record low against the euro and a multi-year low against the yen. The Bank of England reneged on its duty today by pressing the mute button after they voted to keep interest rates unchanged. It beggars belief that the MPC did not see fit to offer some sort of statement to address the turbulence that has been unleashed in UK financial markets at a time when the Chancellor of the Exchequer states the economy is in the worst economic downturn for 60 years. We will have to wait 2 weeks to get an insight into the MPC’s thinking but given the Bank of England’s lack of foresight and indifference to the sort of creative monetary policy adopted by the Fed, much of the blame for sterling’s sudden collapse can be laid squarely at the door of the MPC. Sterling has had only one meaningful upside day since August 1st last and a depreciation of this magnitude is almost unprecedented, for the currency of a major developing economy. The technical indicators are nearly off the chart, so extreme is the sell off in the pound. One bright spark came today when the pound did at least manage to push the euro back to the 81 pence handle, but that is scant consolation for pound supporters that see GBP/USD record new lows on an almost daily basis. Cable has to rise above 1.80 before it is safe to buy. Another weak close today could se it hit 1.75 before the next shot at a recovery.

Bob B - Sep 4

Bob's Currency Focus

EUR/USD
The key question we would all like an answer to now is has the dollar rally gone too far? From 1.6035 in the middle of July to below 1.46 before the end of August is as aggressive a move as they come, but it has happened during a period when liquidity is markedly low and currency moves tend to become exaggerated. We must look for the change in interest rate differentials over this time period to determine whether or not the dollar’s rally is justified in the wider scheme of events. There is no doubting weaker euro zone data has had futures markets reassessing rate expectations for the euro area and the yield on the March forward contract has fallen to 4.11% today, from 4.61% on July 21, thus a narrowing of 0.5% in the rate differential. The yield on US treasuries has hardly moved over the past month, so therefore we can say since the euro hit its peak, rate expectations between the dollar and the euro have narrowed by 0.5%. Since the ECB started its current monetary tightening cycle way back in Dec 2005, a 1% shift in rate differentials between the US dollar and the euro has translated into an approximate 8% movement in the exchange rate. Therefore the 0.5% shift seen over the past 6 weeks should translate into roughly a 4% gain for the dollar. A 4% gain would mean EUR/USD should now be trading at around 1.5395 and not 1.4595. That suggests the current rally may be overdone by as much as 8 cents. Of course rate differentials are likely to narrow further in favour of the dollar through to the end of the year, when falling commodity costs should give the ECB greater wriggle room to consider cutting interest rates, while any pickup in economic activity in the US will bring closer the day when the Fed will be in a position to increases US rates. For now though, the market seems to have lost the run of itself and it is sheer momentum rather than economic fundamentals that is driving EUR/USD lower. It is therefore dangerous to sell the euro at the current price and while most traders would prefer to follow the trend down, one is best advised to only sell down at an attractive price (closer to 1.50), which is not currently on offer. We could witness a very sharp correction higher in the euro next week, when liquidity returns to normal after the August holiday period comes to an end. Today’s Ifo business survey for August shows sentiment amongst German business executives fell much more than expected, hitting new record lows and pointing a probable recession in the euro area’s largest economy. I previously remarked that the ECB’s rate hike in July could prove to have been a fatal error of judgement and all of the economic data we have seen since holds up that argument. Jean Claude Trichet and his colleagues have not been in touch with reality and their failure to accept the basic economic principle that slowing economic growth will always temper inflation reveals a level of naivety that is worrying. Having been largely responsible for guiding the euro’s meteoric rise over the past 2 years, the ECB may now be looking for ways of trying to cushion its fall.

GBP/USD
15 cents this month is what the dollar has gained against the pound. Gains of this magnitude in such a narrow time span are unprecedented and it must added, they are also generally unsustainable. The big problem with cable at the moment is trying to pick a bottom. It had looked last week that 1.85 might prove to be a point from which the pound would rebound, but earlier this morning the pair went as low as 1.8329 and we cannot be confident of having yet hit a bottom. A serious lack of liquidity this month has cost the pound dearly as negative sentiment against the UK currency has encouraged traders to use the rather thin trading conditions to send the currency tumbling. Cable certainly offers value to buyers at current prices, but the problem is that volatile trading could see the market move significantly lower without warning and leave positions exposed. Next week, when market liquidity will improve, we could see a greater volume of value trades come into the market and lead to a corrective bounce in the pound, possibly a sharp bounce. There is no data of any real not this week, with the exception of Nationwide house prices on Thursday, which will show a further retreat in UK house prices. With UK consumer price inflation running at 4.4%, the Bank of England, which meets next week, is not in a position to ease UK interest rates for now, thus cable’s collapse to 1.83 looks to be way overdone. A safer trade involving the pound would be to sell EUR/GBP, because with so much bad news already priced into sterling and the euro economy slowing at an equally fast pace, there is scope for a substantial pullback in EUR/GBP over the coming months.

JPY
While the dollar has steamrolled over every other major currency this month, it is only marginally higher against the yen. We have seen a major unwind in carry trades in recent weeks and this together with a rise in risk aversion on equity markets has broadly protected the Japanese currency. The euro has fallen back to the Y160 price mark and we could potentially see this pair fall to 1.45 by year end, particularly if European equity bourses remain subdued. As long as the dollar remains in vogue against other currencies, the yen will struggle to make gains against the US currency and if economic data out of the US gains more positive momentum, USD/JPY will become one of the long plays for the rest of this year, with the potential for a push towards at least 1.15 before the year end. There is the danger of a reversal in US dollar support over the next 2 weeks when liquidity levels rise and in this environment the yen could also find itself on the back foot, particularly against the euro, pound and Swiss franc, given the extent of the currency’s gains in August. Economic data out of Japan will continue to play a minor role and yen traders instead need to focus on the performance of global equity markets as well as following US economic data over the coming weeks.

CAD
The loonie has proven itself to be remarkably resilient over the past week, gaining broadly across the board against every single major currency and significantly so against the euro, pound and Australian dollar. The rollercoaster ride of commodities in the past week has failed to puncture support in the loonie, which seems to have gained a new lease of life, possibly owing to a growing appetite for North American currencies, thanks to the revival in the US dollar. Canadian economic data has printed mostly in line with expectations over the past week but the all important litmus test comes later this week, when Quarter 2 GDP is published. Following a contraction in quarter one we should see a marginal gain in growth in quarter 2 as exports grew thanks to a dramatic increase in commodity prices. If we get another contraction, Canada will officially be in a technical recession and this will hurt the loonie very badly, particularly if commodity prices continue to tumble this week. The loonie may come under pressure against the greenback and USD/CAD offers good value on any dips back towards 104.30. The key support on the downside for the greenback is 103.70 and as long as this holds the pair will remain in an uptrend. For those going long, a stop should be placed below this price level. Against the other majors, the loonie could continue to make inroads on the euro, although any break below 1.52 might be unrealistic ahead of a euro correction higher.

Bob B - Aug 26

Bob's Currency Focus

EUR/USD Review
We have witnessed one of the most remarkable dollar rallies in recent times over the past couple of weeks, as the greenback has made record gains against most of the other major currencies. There has been virtual meltdown in GBP/USD and AUD/USD in the past 10 days, while the euro itself is now trading over 11 cents below the high it hit against the dollar in early July. The euro shed 4 cents alone in a 24 hour period into last Friday. The sharpness of the move has taken many in that market by surprise, but what is even more surprising is the fact that it does not appear to be justified by any major shift in economic fundamentals. There are a number of reasons for the strong rally at this time:

1) Liquidity seems to have been drained from the currency market at the moment (August holiday factor) and it does not take big volumes to shift currencies. With the trend already having shifted to the greenback a fortnight ago, the drop in liquidity is allowing exaggerated market moves, which is disproportionably benefiting the dollar. The dollar is so significantly overbought that a corrective reversal could easily manifest in a 5 cent rally in the other direction.

2) The sustained drop in commodity prices is resulting in a direct flip of trades that had worked for major funds in the first half of the year, with oil, gold, commodity currencies and EUR/USD being the big losers. Those who believed oil prices were a simple consequence of supply/demand issues are now nowhere to be seen as the speculative bubble that oil prices had become bursts spectacularly, with a barrel of crude plunging by $34 in the last 4 weeks. Depending on how far the decline in commodity prices has to go, this may determine how far the dollar’s rally might go.

3) Jean Claude Trichet’s monetary policy statement on August 7. The ECB President did make several references to an increase in the downside risks to growth in the euro area when delivering his policy statement on August 7 last. In reality, the ECB, rightly or wrongly, has not changed its policy stance as its primary concern remains the upside risks to price stability and Trichet again stated the ECB had ‘no bias’ with respect to monetary policy. However the markets responded to Trichet’s statement as if it were surprisingly dovish and sent the euro decidedly lower.

4) Eurozone economic data has pointed to a troubled euro economy for a few months but markets chose to ignore that data, preferring instead to focus on a struggling US economy and a detached from reality ECB that kept telling markets that the euro area economic fundamentals were sound. The ECB’s rate hike in July could go down as a gigantic faux-pas by a Governing Council that is clearly lacking economic foresight. Markets are now reassessing the outlook for the euro area economy and interest rate differentials going forward, which is weighing on the euro. The Fed’s policy of trying to stimulate economic growth in the US is now being rewarded by currency markets that don’t like what they see elsewhere. Of course the aggressive nature of the Fed’s rate cutting is largely responsible for the sudden run-up in commodity prices that in turn made inflation shoot up across the globe, but it now looks that this inflation spike was also a bubble and Central Banks like the ECB and Bank of England have been found wanting because they continue to fail to recognise this fact.

5) Carry Trade unwind. With some Central Banks, notably the RBA and RBNZ moving towards easing interest rates, the narrowing in rate differentials has resulted in a significant liquidation of carry trade positions in the past week. EUR/JPY is the most loaded carry trade currency pair in the basket and it has come off by over 5 yen in the past week, hurting the euro against the dollar, which has advanced against the Japanese currency. EUR/JPY is still very much over-valued in a historical context and if the carry trade comes under increased pressure, this would mean a greater sell off in EUR/JPY would pit the euro even lower against the US dollar.

6) Technical considerations. When EUR/USD broke below 1.5283 on Friday morning last, the pair went below a key technical support that had held since last March and this essentially opened the floor underneath the pair, with the next key line of support not seen until 1.4615. The pair also went below the 200 day moving average and the dip below this level has many traders now believing the longer run trend has reversed in favour of the dollar. The technical breakout has led to a loss of confidence in the euro and in some part explains the extended decline we have seen.

7) Russia and Georgia. On Friday the euro had its worst day ever against the dollar, since becoming a hard currency and while there were other factors at play, the 5 cent decline between Thursday and Friday coincided with the outbreak of hostilities between Russia and Georgia. This will not have helped the single currency, given the proximity of the EU to both countries. This probably accelerated the flow of safe haven funds into the dollar.


So where now for EUR/USD? The pair is very much oversold but in an illiquid market situation, anything could happen in the short run. There is no known support for the euro right down to about 1.4620 and given the whiplash fashion in which the market has moved of late, it is not beyond the bounds of possibility that we could see the pair slide to that level before we enter a genuine period of consolidation. Two releases this week will have a bearing on short-term direction: Wednesday’s Retail Sales out of the US and Thursday’s GDP data out of the euro area. It is conceivable the GDP data could reveal a horror story for the euro area and if the number is markedly lower than forecast, it could send the euro tumbling. The euro may have a battle to reach 1.50 before then and could find itself being sold off on any rallies towards this key mark, ahead of the US Retail Sales figures. However, given the brutality of the move to the downside, a sizeable correction upwards cannot be ruled out, especially if the euro can earn some momentum and if it pushes above 1.50 and holds there. It is a dangerous market to trade given the pair has not settled into a new trading range and the fact liquidity levels appear to be running so low.


GBP
Sterling has had an absolute nightmare against the dollar over the past 10 days, losing an average of almost a cent a day. All technical supports to the downside have given way and cable is now trading at a 2-year low. There is no arguing the current dollar rally is overdone, yet when one looks at the economic fundamentals out of the UK, it does not inspire sterling buying, even at bargain basement prices. A visit to 1.85 is now on the cards, possibly by the end of September, although this may come after a corrective retracement to at least 1.93. Even a 0.6% jump in the annual inflation rate to 4.4% in July was not enough to engineer a sterling rally. Indeed the pair sold off after the release of this data on Tuesday, which tells us in the current uncertain economic climate the market is currently more interested in currencies that are backed by growth stimulating policies like the dollar than in currencies with restrictive monetary policies like the euro and the pound. The woeful economic data out of the UK over the past few months has finally caught up with the pound and the UK currency is now vulnerable to being targeted by speculators that may see it as a soft target. I would like to see some period of consolidation before re-entering the market on sterling, but those who retain shorts on cable should move stops down to around the 1.9350 price level, which is just above the 2008 high which gave way last Friday. A corrective rally is overdue and it is dangerous to sell at current prices below 1.90, unless employing stops close to 1.9150.

JPY
The yen has more than held its own since losing the Y110 handle to the dollar late last week. While the dollar has gone on to trounce the other majors on Friday and Monday, it has hit a wall against the Japanese currency, failing to break above Y110.40. The yen is befitting from a wind-down in carry trades triggered by the decline in commodity prices, which is helping it retain its strength across the board. The shift to monetary policy easing by some Central Banks is narrowing the rate differential outlook on many of the yen crosses, which is lessening the appeal of carry trades. However, Japanese domestic economic data has been poor of late and Qtr 2 GDP released later tonight should tell us the Japanese economy contracted in the last quarter and signal it might be in technical recession right now. The yen will not be damaged to any great extent unless the data is so bad that it initiates an argument for a Bank of Japan rate cut, which seems unlikely given rates in Japan are already a lowly 0.5%. The medium term to longer term value trade on the yen crosses is still with EUR/JPY which remains close to historic highs. The pair should be sold down on any advances to the 168 / 169 price region and given the softness shown lately by the euro there is the prospect of a retreat in EUR/JPY to at least 160 before the end of the September.

CAD
The loonie is now trading at levels against the greenback last seen this time last year, around the 1.07 price handle. Last Friday’s employment report which revealed the commodity-rich Canadian economy shed over 50K jobs in July was an eye opener and suggests the economy is struggling even more than originally thought. The decline in commodity prices has hurt and given the bullish tone of USD/CAD, there is every prospect of the pair reaching 1.10 in the near-term (next month), with the possibility of a return to 1.15 by year end, if commodity prices continue to fall. I said last week that the loonie did have scope to appreciate against the euro to 1.60. Well, it has gone to as low as 1.5870 today and there is room for a return to 1.56 over the next week as greater confidence in the US economy could help the loonie appreciate against the major European currencies, as well as against the yen.

Bob B - Aug 12

Bob's Currency Focus

EUR/USD
The dollar has pushed the euro to below the 1.55 price handle on Tuesday and a convincing break below here could trigger a steeper decline in the days ahead, possibly setting up a near-term test of 1.5283. Central Banks take centre stage this week, the Fed kicking off proceedings with a rate announcement later today, while the ECB issue their latest monetary policy statement on Thursday. There is certain to be no change from the Fed and with instability in the financial sector still a primary concern, it is most unlikely Bernanke & Co. will shift from their neutral policy stance, despite reservations from a number of the Fed’s hawks in recent weeks. It is possible that at least 2 members might decide to vote for a rate hike today, but they are likely to be outgunned by the majority, although the hawks’ inflation concerns may have to be accommodated by way of a stronger worded statement. There are only 10 voting members in today’s FOMC vote. Prior to the Fed’s statement release at 19:15 GMT, we had the ISM services index which came in at 49.5, ahead of a forecast for 48.6. The reading is still below 50.0, so it indicates contraction in the non-manufacturing sector, so it offers little in the way of positives for the dollar. The past week has seen a waft of softer economic data out of the euro area and with a significant contraction in the manufacturing and services sectors, declining exports and a further depressed consumer, the euro zone looks to be pushing towards a recession. Oil prices have fallen below $119 this morning and with commodity prices in general falling sharply over the past month against a slowing global economy, the ECB decision to hike rates in July is starting to look like a possible mistake. However don’t expect a climb-down from the ECB just yet and indeed if just to maintain the Governing Council’s credibility, ECB President Jean Claude Trichet is unlikely to turn dovish on inflation, although he is likely to back away from any suggestions of possible future rate hikes. The markets may place the ECB in a more neutral position this week, regardless of what Trichet says and this could see the euro retreat even further, particularly if oil prices continue to fall as this would ease inflationary pressures in the euro area and give the ECB room to ease rates later in the year. A break below 1.5460 should see us drift to 1.5350 and ultimately see the April low of 1.5283 taken out. It is conceivable it could happen this week.

GBP
Sterling has come under sustained selling pressure in the past week as wave after wave of soft economic data has finally weighed on a pound which had taken on a Teflon ‘nothing-sticks’ trait over the past 2 months. The break below 1.9650 on cable yesterday could be significant and we may now see the dollar push the pound back towards the year’s low at 1.9337. The pair dropped to 1.9528 this morning before recovering towards 1.9570 and the next important line of support on the downside is at 1.9460. June’s Industrial Production (-0.2%) and Manufacturing output data (-0.5%) for the UK was much lower than expected, while a July services PMI reading of 47.4 (slightly higher than the 47.1 print last month) is hardly a cause for celebration as it signals further contraction in the dominant services sector. With the Manufacturing and Construction PMIs deeper into contraction last month, the UK economy looks to be accelerating towards recession. The current slide in commodity prices, if it is sustained, could hurt the pound badly as it is commodity price inflation which is preventing the Bank of England from cutting interest rates. The Bank meet this Thursday and while the Committee should cut rates immediately to help stimulate the UK economy, the MPC is certain to stand pat, as the Committee is dominated by short-sighted Central Banks hawks, incapable of looking beyond a current month’s consumer price inflation report. There is absolutely no reason to buy sterling at present other than against the euro if one believes the euro economy is in as equally a bad predicament as that of the UK, but even that is a risk, because the UK’s over-dependency on the housing and financial sectors means the UK economy is likely to decelerate at a much faster pace than that of the euro area. The pound should be sold on any failed upside rallies against the dollar and there is every chance of a sub 1.90 price on cable by the end of September.

JPY
The yen has more held its own in recent days as a drop in commodity prices has led to a paring of carry trades. The US dollar has thus far failed to breach an important technical indicator at 108.50 and while this price level holds, the yen could potentially make more significant progress against the euro and the high yielding Australian and New Zealand dollars. While lower commodity prices can help raise risk tolerance levels and fuel a rally in stocks which is generally negative for the yen, a retreat in commodity prices brings closer the prospect of interest rate cuts, particularly in the euro area, UK and Australia and a narrowing of the rate differential outlook is a positive for the yen against most currencies, with the exception of the US dollar, where rates are likely to remain on hold. Tonight’s Fed rate announcement is a major risk event for the yen because if the Fed prove to be more hawkish and threaten a possible rate hike in the coming months, then this could be sufficient to see the dollar rise to 109. The reaction of stock markets will be important as an adverse reaction in equities would see risk aversion rise and this will offer some short-term protection to the Japanese currency. The value trade of all the yen crosses is on EUR/JPY, which still trades close to lifetime highs, despite a sharp deceleration in the performance of the euro area economy. This pair should be sold down on any advances to 169 and there is every chance the pair will slide back to Y165 in the very near term. If the Fed’s statement this evening is not dollar supportive, the greenback will find it difficult to break out to the upside of the recent trading range and USD/JPY could spend the next week trading largely within a narrow 106.80 to 108.50 price range.

CAD
The loonie’s resilience has finally been broken by the greenback and on Tuesday USD/CAD broke out above 103.70 for the first time this year. This signals the pair is now most definitely in an uptrend and we could witness a very quick move to 105, with 108 being possible by the end of the month. Today’s Fed rate announcement will be crucial however as the greenback needs a hawkish bias to gain greater momentum. If the Fed stands pat and keep a neutral policy stance, the fate of USD/CAD over the next month will most likely rest with commodity prices, primarily oil. This Friday’s employment report out of Canada will also be important for gauging possible direction of Canadian interest rates and another negative employment number would hurt the loonie. Look for consolidation in the 103.70 to 105 price region over the next 2 days and only a break below 103.70 would mean a possible trend reversal in favour of the loonie. A rebound in oil prices would offer the Canadian currency some much-needed protection. The loonie is oversold on many of the crosses, particularly against the euro and there is some scope here for a pullback to 1.60.

Bob B - Aug 5

Bob's Currency Focus

EUR/USD
After a waft of weak data the euro eventually succumbed to selling pressure this week, although it staged an impressive recovery from late Wednesday, coming off a low of 1.5522, to trade at a full cent above this level on Thursday morning. The single currency was buoyed to some degree by today’s inflation print for July, which at 4.1% is the highest rate on record, since the ECB came into existence. With the ECB’s target inflation rate at 2%, some market analysts still believe there is scope for further rate hikes from Trichet & co. There is greater evidence however that the euro economy is decelerating at an alarming pace and divergence issues between the euro’s major economic blocks is likely to become an increasing concern over the coming months. US data has mostly surprised to the upside over the course of the past week but the real test will come with Friday’s non-farm payroll number. Thursday’s GDP figure is unlikely to have any sustained impact, given its historical context and the fact the number will be distorted by the Government’s stimulus package which helped prop up consumer spending in May and June. The Initial claims number for last week will be monitored closely as an indicator of what Friday’s payroll number might look like. Oil prices rocketed by almost 5 dollars on Wednesday and if this triggers a new bout of oil buying, the dollar is going to struggle. There are so many factors at play in the market at present and plenty of uncertainty about the direction of the major economies and interest rates, while a worsening credit crisis still looms large in the background. In this environment it will be difficult for either the dollar or the euro to make huge progress without facing some headwinds. Upside surprises in GDP and the non-farm payrolls, together with falling oil prices, is what the dollar needs if it is going to end the week on a high. The biggest risk to the euro in a broader sense could come from any negative comments from ECB council members (admission that the growth slowdown is worse than ECB had anticipated) or destabilising comments from French or Italian government officials about the ECB or euro. The range should remain 1.55 to 1.5660 for now, with Friday’s non-farm number being the key scheduled event which could push the pair beyond the boundaries. There is definite value in selling down on any rallies close to 1.57.

GBP/USD
Sterling has shown remarkable resilience against the adversity of shocking economic data over the past month, data soft enough to have pared several percentage points off any other currency. GBP/USD is still trading at the higher end of its trading range over the past few months and the pound has essentially grown immune to weak domestic data. However, it is primarily negatives which are keeping the currency afloat, primarily a market belief the Bank of England will not step in to save the economy and it is believed if the Bank were to do anything it will raise interest rates rather than cut them, adding to the attraction of sterling’s high yield. Nationwide reported house prices fell 1.7% in July, for an 8.1% annual decline, the steepest drop ever in the series. The UK economy looks destined for a certain recession, if it is not in one already, and with the Bank of England uttering hawkish rhetoric, they are clearly signalling they have a very different view to the US Federal Reserve on inflation prospects, so things are going to get a hell of a lot worse in the UK economy over the coming months. Friday’s Manufacturing PMI will be important to gauge if last month’s appalling run of PMIs in the manufacturing, services and construction sectors was an unlucky once-off or the start of an accelerating deterioration in the wider economy. It is highly dangerous to buy sterling against the dollar with the economic predicament facing the UK, even if sterling does even manage to make some short-term gains. In the medium to longer term sterling looks destined for a return to at least the mid 1.80s and a sudden spike downwards in the currency cannot be ruled out, given the downside risks and the pound’s elevated value at present. The downside against the euro should be more limited in the short run as the euro area economy also slows quite sharply. The pound’s direction through to the end of the week will be determined by US economic data, but we should be looking at a return to 1.9650 over the next week. It could happen this week if US data prints stronger than expected and oil prices are subdued.

USD/JPY
The yen has come under modest selling pressure Thursday as risk tolerance levels rise thanks to two very positive days for global stocks. The Japanese currency has been protected to some degree thanks to sell-off in commodity currencies in recent days, which has seen a paring of carry trade positions, especially against the Australian and New Zealand dollars. There is still sizeable complacency in the market though and both the US dollar and the euro look to be overvalued against the yen, when taking into consideration the deterioration in economic conditions, particularly in the euro area. Friday’s non-farm payroll data out of the US will be a major test of risk tolerance and if the number prints much worse than expectations, the yen should be the biggest gainer on currency markets. There is significant selling of the US dollar above Y108.30, but if the US currency does manage to reach 109 by the end of the week it will mark a further step up in the pair’s trading range and we should see Y110 next week. However it is dangerous to sell the yen at current prices, given all the underlying risks, and there is definite medium term value in selling down the euro on any advances by the single currency towards Y170.

USD/CAD
The loonie has failed to penetrate 1.02 against the greenback since the pair sailed over this important price level several days ago. The US currency though has not managed to capitalise on its momentum and has failed miserably to reach 103. The key economic releases out of the US over the next few days will be critical and could be decisive for the future direction of the pair. The only release out of Canada is today’s monthly GDP number for May, but its significance is likely to be dwarfed by the quarterly GDP figure out of the US. Stronger than expected numbers out of the US today and tomorrow (non-farm payrolls) coupled with a further slide in commodity prices could potentially see the greenback rise to 103.77 (the year’s high) and place the pair firmly in a longer run uptrend, which could see the loonie cede 1.05 very quickly. There is some value in buying at present, with a stop tightly below 1.02. If data prints badly for the greenback, then expect 1.02 to give way very easily and the pair should quickly return to 1.0130.

Bob B - Jul 31

Bob's Currency Focus

EUR/USD
Euro zone data keeps disappointing and this morning’s German Ifo business survey reported the sharpest fall in business sentiment since 2001. Also, preliminary readings for the manufacturing and services sectors of the euro area see another month of contraction in July, with the slowdown accelerating. The Ifo business climate reading fell to 97.5 in July, down from 101.3 in June. The composite PMI for the euro area (measuring both manufacturing and services economic activity) is seen as falling to 47.8 in July, from 49.3 in June. French and Italian business sentiment also fell more than expected in July and all told, economic woes for the single currency zone are mounting. It is difficult to fathom that the ECB has just hiked rates against this background and only time will tell if that policy decision was a big mistake, especially if oil prices continue to ease. The dollar has made significant gains overt the past 2 days but it is essentially only back to the levels it was trading at prior to the breakout of the Fanny Mae/Freddy Mac crisis 2 weeks ago. The real test for the dollar will be if it can break below 1.5610 against the euro and hold below this level. If we can achieve that, it may be time to look for a possible retreat all the way back to 1.5283. The euro picked itself up impressively from a low of 1.5637 to reach 1.5697 in the hour following the Ifo Business survey release and after a brief stint above 1.57 after US existing home sales numbers disappointed the pair is back around 1.5670. Oil prices will continue to play an important role in the greenback’s fortunes. There is a sense that sentiment is beginning to shift against the euro and although weak US economic data will curtail dollar gains, traders need to be on their guard for any comments from ECB and Fed officials. Any softening in tone from ECB Council members will hurt the euro. If the dollar holds below 1.5720, it is worth selling down from close to 1.57, as the pair may have another run at that key 1.5610 price level either today or tomorrow. Any break below that should see us return to 1.55, possibly by Monday. Today is a very important day for direction, because the dollar has not managed a 3 day rally against the euro for 2 months.

GBP
Sterling has had a weird couple of days. On Wednesday it rose sharply against every other major currency, although its gains against the dollar were more modest, while today it has plunged after European currencies came under pressure early this morning and after it was announced monthly UK retail sales plunged by their heaviest amount since the series began. The Bank of England minutes on Wednesday reveal Tim Besley voted for a rate hike at the MPC meeting earlier this month. It is the first time a member has voted for a rate increase since July of last year. The hawkish bias to the minutes sent sterling rising rapidly as investors began to price in the possibility of a future rate hike from the Bank of England. In fact the minutes even stated that August would be a more appropriate time to increase rates, if a rate hike was warranted. One has to wonder if the MPC is seeing the same data as the rest of us. The dollar has finally managed to break below the 1.99 support point that held firm for 10 days and if it can push sterling below 1.98, then we should have a trend reversal and the pair could go considerably lower over the next week. 1.99 is a key price barrier and if the dollar does not hold it, the pound could make another run towards the 2 dollar mark and 2.01. Tomorrow’s GDP release in the UK is crucial and if it shows a contraction, which is unlikely, then sterling will sell off very sharply. If selling down, traders should place a stop around 1.9910. The pair is still being bought on dips and remains dangerous for bears, until 1.98 is broken. Sterling could find itself pegged back towards 79.50 against the euro by early next week.

JPY
The yen has been hammered this week by the dollar, the euro and the pound. The euro registered a new lifetime high on Monday at 169.95, while the dollar hit a 7 week high against the yen yesterday just below 108. The Japanese currency has stabilised somewhat today as falling stocks and a rate cut in New Zealand has temporarily stalled the carry trade. If the current stock rally comes to an abrupt end, then the yen could gain significantly against the US dollar, given the pair currently trades 4% above the worst levels from last week. However any resumption of the stock rally will continue to see the yen out of favour and the dollar could potentially try to rally all the way to 110 over the next week. There is no value on selling the yen against any currency at current prices, given the risk, while any euro moves towards Y170 offer very good medium term value for a sell down on what is the most over-stretched of the yen crosses.

CAD
There was no economic data out of Canada on Thursday and the currency continues to trade within a tight range against the greenback, moving between 1.00 and 1.0115. While headline inflation rose to over 3% in June, the core rate was contained at 1.5% and this affirms the view the Bank of Canada will keep rates on hold for the foreseeable future. Commodity prices have come off considerable in the past week, with oil prices shedding $20, yet the loonie has managed to hold its own across the board, indeed making gains against the euro and the yen, while holding tight against the US dollar. A sustained slump in commodity prices will eventually hurt the loonie against the US currency and it is difficult to see the pair not returning to 1.02 over the next week, unless there is some renewed scare in financial markets. The loonie has also been helped by a rise in risk appetite, but that too is under threat with the recent stock rally looking shaky by Thursday. The euro has fallen to 1.58 this morning, as I projected a few days ago and there is the potential for a decline to 1.56 for EUR/CAD over the next week, if the euro continues its decline against the US dollar.

Bob B - July 24

Bob's Currency Focus

EUR/USD
Holding in a tight range since last Tuesday’s surge to a new lifetime high. The pair peaked at 1.5906 today before declining to the 1.5850 price range, the equilibrium price for the pair over the past 4 trading days. With no data to direct price, the pair is practically in limbo today, although there remains a decidedly bullish tone as every dip in price is met with a rapid recovery. It is disheartening for dollar supporters to see that 3 days of a rally in stocks and a sharp sell-off in oil has failed to muster any rally whatsoever in the greenback and it seems the market is only interested in news that can justify sinking the US currency further. We are at a very important junction for the pair and the next move up or down could prove critical for how this pair trades through the rest of the summer. The dollar has to send the pair below 1.5750 and push towards 1.5610, otherwise another rally towards the lifetime high of 1.6025 looks certain over the next week. There are a few important indicators out in the euro zone this week, including the German Ifo business survey and preliminary readings for the manufacturing and services PMIs. These could surprise to the downside and pose some risk for the euro. It has been remarkable how silent the ECB has been over the past week in response to the recent run-up in the euro and softening economic data and this may be taken as a signal the ECB is not at all uncomfortable with the current high value of the single currency. There was ample opportunity over the past week for ECB officials to take the steam out of the euro’s rally, but it failed to do so. However, the recent rally in the pair has been wholly because of problems in the US banking sector and if risk aversion abates over the course of this week, the euro could give back most of those gains. While confidence in the US economy remains low, the euro will remain well bid and the dollar will struggle to make much progress, regardless of how the data prints. The dollar must break below 1.780 and hold below this level before we can talk about a possible reversal of sorts. On value grounds, it is worth selling at prices close to 1.59, although traders need to be aware the market may be seeking to push the pair back above 1.60 in the short term.

GBP/USD
Sterling continues to hold its own and cable is trading on Monday in exactly the same range as on Friday last, while the pattern is identical, an early dip in the morning to 1.99 before a recovery to 1.9970 in the afternoon session. Sterling is benefiting from a temporary flow of funds into the currency and this should not be mistaken for a reversal in trend. The economic fundamentals out of the UK keep getting worse and this morning Rightmove reported house prices fell by 1.8% in June. There are a number of key releases this week in the UK, starting with Wednesday’s BoE minutes, followed by retail sales on Thursday and an advance print of quarter 2 GDP on Friday. Markets have essentially priced in a very hawkish MPC but if Wednesday’s minutes show Committee members to be more concerned about declining growth than rising inflation, then sterling could sell off very sharply. Sterling offers no value on prices near 2 dollars, even if the pair temporarily shoots above this level. When markets regain some confidence in the US currency, sterling will be an immediate target of market traders. If UK data prints on the poor side this week, the euro might also rise to above 80 pence and possibly gain some momentum to see it close in on the record price near 81 pence. I would wait until after Wednesday’s minutes before entering the market on sterling, as it in itself could trigger some very volatile trading and we will be in a much better position to judge sterling’s prospects after we have had an insight into the thinking of MPC members.

USD/JPY
The yen fell to a record low against the euro Monday as risk tolerance levels rose thanks to 4 consecutive rallies in global stocks. The pair hit a high of 169.90, which is an extraordinary price when one considers the market panic that followed the Fannie Mae and Freddy MAC mortgage crisis in the US early last week. The euro’s price is totally exaggerated and one could do worse than sell the EUR/JPY down at the current price around 169.50. If the current rally in stocks proves to be a false dawn and risk aversion levels rise again, the yen will gain very quickly. In addition, the euro has a number of economic risk events this week, which could send the single currency lower. Economic data out of Japan will not have a market impact this week and with the calendar in the US, also on the light side, the yen’s fate against the greenback will very much depend on the performance of US stocks. There is definite value in selling down, if prices rise close to 108, as the pair actually hit a low of 103.78 last week, and the pace of the dollar’s rapid recovery might prove to have been premature.

USD/CAD
The Loonie has taken on a firmer tone on Monday and has made modest gains across the board, against all major currencies. There was no economic data on Monday to influence the currency, although a rebound in commodity prices has offered some support. The market has been reluctant to see the loonie break parity against the greenback over the past week, but an upside surprise in Tuesday’s domestic retail sales could be the trigger the Canadian currency needs. Also this week we have got the latest consumer price inflation report on Wednesday and here again, another higher than forecast print, especially in the core rate, should send the loonie higher. The loonie should also be able to appreciate to at least 1.58 against the euro, while the currency would also benefit from any sustained rally in the US dollar, against the other majors.

Bob B - Jul 21

The Dollar Malaise

Negative sentiment towards the dollar has reached fever pitch proportions over the past week and for once it is not weak economic data that is the driving force. No, rather it is the US Government’s plans to shore up ailing mortgage lenders Fannie Mae and Freddy MAC that has put the frighteners on investors. If the US government needs to follow its plan with actual cash, the cash will come from the taxpayer, via issuance of more government debt. And let us face it, we are not talking about small numbers here, but mind-boggling figures that run into the trillions, potentially pushing the country to even more extreme debt proportions and undermining the value of the US dollar. Markets have been spooked by this prospect and a report in the Financial Times today about some sovereign wealth funds diversifying out of US dollar assets is hardly a surprise. A major loss of confidence in the future direction of the dollar on the part of major debt holders is a very serious concern for the US Treasury and it is the one thing that could potentially trigger some market intervention, if the fears of these debt holders do not abate soon. Despite clear evidence of a marked slowdown in European economies, the currencies of these countries have no difficulty hammering the dollar, on an almost daily basis at present, as the US currency appears incapable of holding onto gains for anything more than a few hours at a time. Investors have thus far been happier to forgive Europeans economies for their underperformance, rather than be caught holding low-yielding US dollars. It is clearly a mistake to believe these European economies are going to ride the storm and come out smelling of roses, but for now the focus is less on economic data and more on market fear about the future of the US financial system. Although US inflation (5% in June) is running higher than that in the euro area (4% in June) and the UK (3.8% in June), the chances of a US interest rate hike are dwindling with the Fed stating its overriding focus is a resolution of the credit crisis. The Fed expects inflation to moderate as growth eats into demand. Markets still expect to see the ECB hike at least once more, while the Bank of England is also seen leaning on the hawkish side, which is justifying the recent rush of cash into European currencies. This is merely a short run play, because eventually the European Central Banks will creak under the weight of an accelerating downturn and will need to soften their tone. When they do, it will mark the beginning of a dollar revival. If they wait too long, or believe rate hikes are the way forward even against slowing growth, then we are certainly in for an even more extended period of discontent for the US dollar.

Ted B - Jul 17

Bob's Currency Focus

Currency markets are very volatile at present with the fallout from stock markets and commodity markets essentially dictating the short-term direction of all the major currencies. Economic data is hardly getting a look in as panic of financial market collapse in the US becomes the over-riding factor. One striking observation from the past few weeks is that the euro has replaced the yen as the market’s preferred ‘risk aversion’ currency, when stresses are undermining global financial markets. The primary reasons for this is the single currency’s more attractive higher yield and a hawkish ECB. All of the high yielding currencies, in particular sterling and the Aussie dollar, have done particularly well in the past month, despite the crash in global stock markets. The yen is the worst performing currency during this period, which is something of a major surprise, given the yen steamrolled everything before it during the last 3 bouts of major risk aversion in March, January and last August. Sentiment surrounding the US dollar is at an all-time low because of the Fannie Mae and Freddy Mac mortgage lending crisis in the US and because oil prices refuse to let up. Traders are using every ounce of bad news to push up the price of crude and thus put downward pressure on the dollar, which in turn gives added impetus to the spike in prices for the wider commodity class, creating a vicious cycle. It may take direct market intervention to break this cycle because commodity investors are not being deterred by the global economic slowdown theory, while confidence in the wider financial market system is at an all-time low.

EUR/USD
The euro is knocking on the door of the lifetime high of 1.6016 and while we have seen a slight retreat on Monday, the dollar came unstuck at support at 1.5840 and the pair has since advanced back towards the 1.59 line. Markets shrugged off the announcements by US Treasury and US Fed in terms of declaring financial support for the ailing mortgage lenders Fannie Mae and Freddy Mac and it is going to take something more special to regain confidence in the US financial system. Another poor economic print from the euro area Monday saw Industrial Production in May plunge by 1.9%, although this was slightly better than the forecast decline of 2.3%. Economic data is taking a back seat at present as dollar sentiment is effectively driving this pair and that sentiment has never been more negative. Tuesday sees the release of the latest ZEW investment sentiment survey from Germany and producer prices in the US, but neither is likely to have any real impact and of more importance will be the testimony before Congress by Fed Chairman Ben Bernanke in the afternoon GMT and any planted comments that may come from governing members of the European Central Bank. The euro looks dangerously overvalued but while it remains so close to the 1.60 price line, traders will want to try and challenge the record highs set back in April. On the other hand any vocal interventions by Central Bankers could send the pair spiralling back 200 points. It is best to stay on the sidelines until the pair settles down somewhat, although medium to longer term traders might see value in selling down on any prices close to 1.59.

GBP/USD
Producer prices came in slightly below expectations in June but it still has not prevented output prices from climbing the most in annual terms in 10 years. While economic activity may be depressed, prices certainly are not and markets are using price inflation to keep the pound well bid, in hope of a rather unlikely rate hike from the Bank of England in the coming months. Tuesday’s consumer price inflation numbers for June will be critical for the pound and the market has already priced in an annualised CPI rate of 3.6%, and anything significantly lower than this will hurt the pound. Like the euro, the pound offers no value on current prices against the dollar, but it is likely to continue to trade in the higher trading range of 1.9650 to 2.0050 until there is some shift in the goalposts. Investors are weighing in behind the pound on yield grounds and also because the euro looks over-priced, but it is dangerous to buy cable on prices above 1.9850, even if the pair does go higher in the short term. Cable is likely to come under increased selling pressure the closer it gets to the 2 dollar mark, particularly if economic data continues to disappoint and points to a more marked downturn for the UK economy. The euro does not offer any value above 80 pence and EUR/GBP could easily decline towards 0.79 if there is a broader US dollar recovery that sees the euro sell off more than its UK rival.

USD/JPY
The yen has resisted a sell-off on Monday despite a strong recovery in European stocks, ahead of the US bell. Some profit-taking on the euro has seen EUR/JPY return to the 1.59 line, having hit a lifetime high earlier in the session of 169.65. The US dollar is back to where it started the day at 106.26, giving up all of the day’s earlier gains. Markets have gone cold on the Fannie Mae and Freddy Mac rescue package already, which does not augur well for risk aversion as we go deep into the US trading session. The yen needs to appreciate back towards the 105 mark against the dollar, if it is to have any chance of joining the euro in severely punishing the US currency. The Bank of Japan has a rate announcement on Tuesday morning and it is certain to signal no change in rates and it is also unlikely the Bank’s Governor will signal future rate hikes when he attends his Press Conference, given the precarious economic situation in the world’s second largest economy. The yen will continue to trade on dollar sentiment and it may continue, for the time being at least, to pay second fiddle to the euro when risk aversion levels are on the up. Any dips towards 105 would offer some decent dollar buying opportunities, given the speed at which the market has been willing to sell off the yen in recent weeks. The yen is undervalued on all the crosses and the only one with some semblance of value is NZD/JPY, which has hardly moved in the past month.

USD/CAD
The loonie has powered its way to 1.0050 against the US dollar on Monday and made smaller gains against the other leading majors, as commodity currencies meet renewed demand. Oil prices rising to record highs have not hurt the loonie, while increased concerns about the US financial system are making Canadian assets look a safer bet. Friday’s marginally negative labour report has not harmed the loonie as the labour force has proven itself to be resilient amid troubling times. Volatility will remain high with the loonie and it will struggle to break parity against the greenback, while North American currencies remain largely on the defensive. The Bank of Canada has a rate announcement on Tuesday and the Central Bank is likely to leave rates unchanged for the second consecutive meeting although the accompanying statement will need to be monitored carefully because if there is emphasis on rising inflation it could signal a rate hike in the months ahead and help fuel a strong loonie rally. The likelihood is the Bank of Canada will remain neutral and the impact should be minimal on currency markets. The euro returned to over 1.61 against the loonie early on Monday, before retreating back below 1.60. There is still potential for a return to 1.58 in the days ahead, if we witness a broader euro sell-off.

Bob B

Bob's Currency Focus

EUR/USD
The euro has performed remarkably well since last Thursday, when it shed 2 cents against the dollar after a less hawkish than expected monetary policy statement from the ECB. The pair has moved within a 1.5610 to 1.5750 trading range since Friday and if anything, the euro has looked the more bullish, with the market seemingly ready to jump on any reason to offload the dollar. An Iranian missile test Wednesday morning saw oil prices stall their recent decline and this has given a bearish tone to the greenback. Poor trade and industrial data out of Germany and France was ignored by markets. German exports fell a sharp 3.2% in May, from April, the 3rd month in 5 that exports have contracted, while the French trade deficit for May was wider than forecast and industrial production came off by a whopping 2.5% in May. The euro’s ability to shake off poor economic data is becoming too much of a habit of late and it is a classic case of nervous currency markets favouring directional trends over economic facts. The US dollar has been unable to sustain any rally it has undergone all year for very long and dollar bulls are proving themselves to be fear-driven creatures, jumping off the train at the slightest hint of weakness or price stalling. The G8 concluded in Japan with leaders failing to make any mention of the weak dollar, something else which has in essence given license to traders to sell the US currency without fear of market intervention. ECB President Jean Claude Trichet, in his address to the European Parliament on Wednesday, sounded much more hawkish than he did last Thursday after the rate setting meeting, and this encouraged further euro buying. The euro currently stands at 1.5710 and while there is little value in buying the single currency at these prices, any rally above that sees price go above 1.5760 might generate greater momentum and send the pair back up to 1.5820. The pair is due a retreat back to 1.55 at least, but the dollar needs something to spark the move. Bernanke addresses Congress on Thursday and any hint of a future rate hike in his testimony will fuel a strong dollar rally. There is very good medium term value in selling down EUR/USD on prices near 1.5750, because of the significant downside risks for the euro economy in the months ahead and the fact the ECB’s growth forecasts may prove to be over-optimistic.

GBP/USD
Sterling has bounced off a low of 1.9672 Wednesday to rally to 1.9836 against the dollar early Thursday, before retracing back to 1.9750. UK economic data disappointed again this week and sterling’s rise has more to do with a broadly weaker dollar than a stronger pound. The Nationwide consumer confidence survey for June reported another dip in consumer sentiment, the index falling to 61 from 65 the previous month, while HBOS reported house prices fell 2.0% alone in June. In addition the UK trade deficit was reported to have widened to £7.5B in May, marginally above expectations. Data out of the UK over the past 3 weeks has been depressing and points to an economy that is teetering on recession. However, sterling has hardly budged during this time and if anything it is now trading higher as traders bet the BoE will not cut rates while inflation is a threat and markets have priced in an actual hike in the coming months. In a normal economic cycle, the pound would now be pummelled, but the currency is currently evading collapse because the Bank of England’s hands are tied and traders are opting to persist with sterling because of its attractive yield of 5.0%. The MPC on Thursday, as expected, left rates unchanged and the Committee refrained from issuing an accompanying statement. Markets are currently rewarding higher yielding currencies, regardless of economic data and outlook and in this scenario sterling is likely to hold within current ranges, although there remains the risk of speculators going after the currency in the near future, because of the dismal economic picture in the UK. The dollar must break below 1.9650 to have any chance of pushing the pair back to the lower end of the range and the year’s lows under 1.94, otherwise the pair may well move between 1.97 and 2.00. The value trades are selling down on prices above 1.98. Sterling should be able to hold the euro below 80 pence, unless there is some hint of monetary policy easing from the Bank of England.

JPY
The yen is lower against every major currency on Thursday even though equity markets plunged in New York on Wednesday evening and the European bourses are trading between 1% and 2 % lower on Thursday. This apparent disconnect is the strongest evidence available that investors are now more concerned about yield than they are about growth and currency risk. The euro is trading close to its lifetime high against the yen even though European equities have collapsed over the past 6 weeks and economic data out of the euro area has been significantly sifter than that out of Japan. The carry trade seems determined to march on and the only event that might undermine it at the moment is if there is a sustained and convincing retreat in commodity prices, or evidence of a another major bank failure. It is fruitless buying the yen in this environment and the value trade is to buy the dollar against the Japanese currency on dips towards 105 and below 106. If Ben Bernanke’s testimony in front of Congress on Thursday gets the thumbs up from US stock markets, expect the yen to face another sell-off later today.

CAD
The loonie had one of its best days in weeks against the greenback on Wednesday, gaining almost a cent, although it failed to penetrate below the 1.01 line. Broad dollar weakness and a bounce in commodity prices helped the loonie gain some impetus. Housing Starts in Canada came off slightly in June, but were I line with forecasts and the data underscores that Canada’s housing sector is essentially free of the financial crisis currently ravaging the US housing sector. The loonie is likely to remain contained within a 1.0070 to 1.02 price range until Friday’s employment report. Another positive employment report could help push the loonie higher against all other currencies, especially if oil prices continue to trade at elevated levels, while a negative employment number could spark a significant sell-off and see USD/CAD return to 102.50 at least. If data is in Canada’s favour, look for the euro to drop to 1.58 by week’s end.

Bob B - Jul 10

The BoE is in the horns of a dilemma

The Bank of England is meeting this week to deliberate on monetary policy, at a time when the UK economy looks to be slipping into a steeper downturn, while inflation is rising to new highs thanks to rocketing oil and commodity costs. It is only a few months since markets had been pricing in up to 3 further rate cuts this year, but that position was reversed when inflation bubbled back above 3% in April, then hitting 3.3% in May. The inflation rate is likely to register higher again for June when the numbers come out later in the month. Markets suddenly began pricing in rate hikes over the past month with many analysts predicting it would come as soon as this week. But in the past fortnight economic data has revealed an acceleration in the downturn of the UK economy, with the manufacturing, services and construction sectors all contracting in June, while confidence amongst consumers and businesses alike are at rock bottom. It is difficult to see how the Bank of England can raise interest rates against this backdrop, unless they wish to push the economy into an even sharper downturn and into recession.

The Governor Mervyn King has recently admitted that rising inflation is owing to spiralling costs of imported oil and commodities and short-term adjustments in interest rates is not going to alleviate this problem. What the Bank will need to determine is if an interest rate hike would be successful in anchoring inflation expectations and might ward off potential second round effects, where unions are demanding higher wages from employers. But with economic growth grinding to a halt, it is likely the labour market will soften over the next 2 quarters and wage inflation should not be an issue. Also, while inflation may rise higher in the coming months until such time as there is a stabilisation or a decline in commodity costs, inflation should moderate accordingly from the middle of next year. Indeed there is every prospect that commodity prices could collapse, given the stagnant state of the global economy and in this situation inflation could begin to decline sharply from the middle of next year. It would be totally irresponsible of the MPC of the Bank of England to raise interest rates to combat an inflation threat they largely have no control over. Indeed the MPC would be better served to coordinate actions with other major Central banks who find themselves in exactly the same dilemma. The diversification in polices of the ECB and the Fed serves to remind us no coordination currently exists.

The ECB went it alone and decided to raise interest rates last week, but economic data from the euro zone in the coming months could indicate that the ECB’s decision to tighten now was a huge mistake. In any event recent economic data out of the euro area has not been as soft as that out of the UK, while the euro economy significantly outperformed the UK economy in the first quarter of 2008, the last period for which comparative GDP data is available. Therefore, the Bank of England is not under undue pressure to follow the precedent set by the ECB.

The Bank of England is clearly not in a position to raise interest rates in the current climate and in fact there should be considerable more airing for an argument to cut them this week, than there was a month ago, even allowing for the subsequent rise in consumer price inflation. It seems certain rates will be kept on hold, given all of the risk and uncertainty currently surrounding growth and inflation. A brave decision would be to take a leaf out of the Fed’s book and to cut rates, to help stimulate growth at a crucial time for the economy, on the assumption that longer run inflation will be forced to moderate anyhow as the economy slows. Either way, markets should be on the lookout for comments from Bank of England committee members in the days after the meeting, because business and consumers alike will be looking to the Central Bank for some words of wisdom or reassurance, at a time when economic growth is deteriorating at an alarming pace. It is not beyond the bounds of possibility the MPC will break with normal tradition and issue a more detailed statement this week, even if rates are kept on hold, in an attempt to more promptly address growing fears about the state of the economy.

Sterling should continue to hold its own against the euro and the dollar, trading within recent ranges, while markets continue to rule out the possibility of rate cuts. But any sustained move against commodities will tend to undermine the pound because a relaxation in energy and food costs would make the Bank of England a certain candidate to then ease its monetary policy in the months ahead. This week’s MPC meeting could prove to be a non-event for the currency, if, as expected, rates are left on hold and the Bank does not issue any detailed statement. There is serious downside risk for the currency over the medium to longer term.

Ted B - Jul 8

Bob's Currency Focus

EUR/USD
The euro fell to 1.5610 early Monday as the knock-on impact of the ECB’s more dovish than expected statement last Thursday rolled into Monday, leading to a further liquidation of euro long positions. Monday’s economic releases did not help the euro with Germany’s Industrial Production declining by 2.4% in May, the steepest decline in 9 years, against a consensus rise of 0.5%. Recent economic data out of the euro area has been very poor and the only reason the euro has held up is because of the hawkish stance of the ECB. If euro zone economic data continues to reflect a sharpening slowdown in economic activity, the ECB’s rate hike last Thursday could begin to look like a serious error of judgement and could lead to a longer run sell-off in the single currency. In fact with commodity prices at risk of a sharp decline owing to the global economic slowdown and US interest rates almost certainly at their nadir, the medium to long-term outlook for the euro over the next 6-9 months does not look particularly bright. The euro may have peaked at 1.6016 and current prices around 1.5650 would appear to offer very good medium term value, even if the euro has come off sharply in the past few days. There looks to be no reason why EUR/USD will not now retreat to test key support levels around 1.53. This is a data light week on both sides of the Atlantic and direction will be influenced more by scheduled statements from the G8 and Fed Chief Ben Bernanke than by economic data. Oil prices will continue to play a dominant role and any further rise in oil prices will be seen as a reason to sell the US currency. The G8 has been pretty much ineffective in the past in dealing with the oil/dollar crisis and it may be wishful thinking to expect anything from the Japan summit of the leaders of the 8 largest economies. Indeed a return to the usual mantra of the requirement for oil producing nations to support increased oil production will likely be laughed off by financial markets and rather than leading to support for the dollar, it may well undermine it. There is value in selling down the pair on prices close to 1.57, with the potential for a return to 1.55 or even 1.54 over the next week. Watch out for Bernanke’s speeches on Tuesday and Thursday as these are likely to be the most important events of the week. Unless the Fed Chief signals an intention to raise interest rates to offset rising inflation, the dollar will not be aided.

GBP/USD
Sterling is coming off the worst 2 weeks of economic data we have seen in years, with one report after another signalling a sharp downturn in the performance of the UK economy. Soft data has not been restricted to the housing sector, with economic activity in the manufacturing and services sectors entering contraction in June while the retail sector also comes under pressure. Sterling rose to 2 dollars against the dollar last week as traders speculated the Bank of England might raise interest rates to stave off the rising threat of inflation. This inflation however is commodity-driven and is outside the influence of the Bank of England and there is zero chance the MPC will move to raise rates when they meet later this week. This realisation has finally sunk in with markets and this morning the pound slid to below 1.97 against the greenback while the euro rose to above 79.5 pence. The Bank of England would normally be rushing to cut interest rates in an environment where growth is flat or negative but feel constrained by inflation concerns. In this environment the UK slowdown is only likely to become more pronounced and the medium term outlook for sterling is bleak. The Bank of England may feel forced into cutting rates, even while inflation is rising, as the Fed has done in the US, gambling that commodity prices are likely to retreat in the medium term. Mervyn King has not sown the inclination to be so creative in his policy thinking, so expect a wait and see approach this week and the Bank of England to stand pat on rates. Cable should be heading back to test the lower end of the trading range at 1.94, so it is still worth selling down on prices close to 1.97. There could be a lot of volatility this week, while any retreat in commodity prices will prove to be negative for sterling as it will relieve inflation pressures and make it easier for the Bank of England to cut UK interest rates. The euro will struggle to climb much above 80 pence against the pound, in the absence of any signal from the Bank of England to ease rates.

USD/JPY
The yen is the worst performing of all the major currencies Monday as markets use the pick-up in stocks and rumours of a G8 reference to the need for a strong dollar as a reason to offload the low-yielding Japanese currency. The yen may struggle in the short-term in a situation where G8 leaders might issue some coordinated statement on the dollar and commodity prices, as the impact could lead to a rise in stocks and risk tolerance that would undermine the yen. However, expectations from the G8 summit are probably exaggerated, particularly with respect to any direct reference being made to the dollar, and any resultant disappointment in markets could see risk aversion rise again and lead to the yen recovering somewhat against the dollar and the euro. Domestic data will not have any significant impact on the direction of the yen during this week. The euro is clearly massively over-valued against the yen at prices over Y168 but it is difficult to see the trend being reversed in the immediate term unless there is some sustained downward move against the single European currency. The only currency offering value against the yen at the present time is the US dollar and that is only on dips back towards the Y105 price level. Stock market performance will need to be monitored closely over the coming days as will the scheduled speeches from Fed Chairman Ben Bernanke.

USD/CAD
The loonie has continued its see-saw battle against the greenback over the past week and the pair remains pinned in a 1.0050 to 1.0250 price range, offering the most lucrative range-trading pair of all the majors. Soft economic data and concerns over the country’s sagging growth are preventing the loonie from getting away while equally soft economic data from the US and rising commodity prices continue to prevent the greenback from making a decisive move. The medium term outlook would tend to favour the US currency given the risk of a sharp correction in commodity prices, while any signal from Ben Bernanke that US interest rates are destined to rise could see the upside gain in the short run. Next Friday’s employment data out of Canada will be important although only a sharp decline in the employment total is likely to lead to any meaningful rally on either side, to the upside in this case for USD/CAD. In the unlikely event the G8 meeting results in some coordinated effort that sees in a retreat in commodity prices, then the loonie would also come under selling pressure. For now, expect the loonie to range between 1.01 and 1.03, with the value trades being bids on prices nearer to 1.01. The loonie could extend its rally this week against the euro, given the ECB has signalled a pause in interest rates and the euro could retreat to 1.58 at least against the Canadian currency.

Bob B - 7th July 2008

Oil crisis and forex market

Oil prices have hit $143 a barrel and there appears to be little let-up as traders push the energy commodity to record highs, almost on a daily basis. At the same time the US dollar is hovering near record lows against a line of major currencies with markets continuously seeking to send the US currency lower. Commodity traders jump on any reason, no matter how minute, to send crude prices higher. The subsequent rise in oil prices is then taken as a vote of no confidence in the dollar and the greenback duly obliges, going lower in value. This would not be so bad were the related moves in some way proportionate, but the reality is that since last summer every 1% fall in the US dollar index has corresponded to a massively disproportionate 10% rise in the price of crude. Of course there are other factors driving crude prices, but it is no coincidence that oil prices began scaling the current spike around the same time the US Federal Reserve embarked upon an aggressive rate cutting campaign, a policy move that caused the US dollar to nosedive. Oil prices have reached such an alarming level that they are now having a damaging effect on global stock markets (inflated energy costs are eating into disposable income and drying up consumption demand for other products and services). US and European bourses are today officially in bear markets (the major indices having lost 20% from the peaks achieved within the past 9 months). As investors scramble for returns outside of equities, we are seeing some major fundamental disconnects in currency markets, something which has been amplified in recent weeks.

What are these disconnects?

1) A rise in risk aversion no longer translates into liquidation of carry trades. If one glances at the major carry pairs – EUR/JPY, AUD/JPY and NZD/JPY, one will notice that even in a situation where equity markets have plummeted over the past month, these carry pairs have in fact gone higher. The reason for this is twofold: a) while stocks have retreated, commodity prices have gone up and commodity currencies like the Aussie and Kiwi dollars have been well bid and b) Volatility levels as measured by the VIX indicator have remained low, even while stocks were selling off at a record pace in June. This is encouraging risk takers to keep selling the yen against higher yielding currencies.

2) Weak economic data is not weakening a currency in the current market. A case in point here is sterling, which has appreciated against every other major currency over the past 2 weeks, despite some dire economic releases from the UK which point to an ailing economy on the brink of recession. The euro has also been appreciating against a backdrop of softening economic data. Why? The Central Banks in the euro area and the UK have highlighted that they are more concerned about rising inflation trends than slowing growth conditions. The ECB is expected to raise interest rates this week at a time when the euro zone economy is slowing rather sharply, while the Bank of England has hinted the next move by the MPC is more likely to be a rate hike rather than a rate cut (markets had been expecting further cuts given the economic downturn). For the immediate term investors are more interested in higher yield, not growth prospects, and the comfort of higher interest rates is attracting their money. This of course is having a damaging effect on the dollar, with the Fed less concerned about rising inflation than the ECB and Bank of England, even though headline inflation is running higher in the US than in the euro area or in the UK.

This disconnect of course cannot last. Eventually markets will reach breaking point, which will happen when there is clear evidence of demand destruction for crude oil, or when spiralling energy inflation sparks some form of direct market intervention, or when the Fed is forced to hike US interest rates before they would like to do so. It may be premature to start expecting conciliatory tones from an ultra-hawkish ECB.

This disconnect situation does throw up some interesting medium term value trades in currency markets. The one that currently jumps out is GBP/USD, which is on offer to sell today just below the 2.00 mark. The UK economic situation is fast developing into a crisis and it is difficult to see how sterling can hold its elevated market position, regardless of what reality disconnect appears to be gripping the Bank of England. The euro also looks to have been on an extended honeymoon, although the ECB still holds considerable street cred with traders and Trichet & Co. cannot be dismissed as lightly as a Bank of England which is less than consistent in its policy approach.

Ted B - Jul 1