Thursday, January 10, 2008

Bob's Currency Analysis - 16:00 GMT

The euro rallied strongly following the ECB’s Press Conference, after ECB President Jean Claude Trichet clearly indicated the Central Bank was still in a tightening policy mode, although rates were again left on hold at 4.0% Thursday. The ECB highlight heightened inflation risks and price stability and warned it would act (by hiking interest rates) to quickly bring prices under control, if and when required. Headline inflation is running at 3.1% in the euro area as against 4.3% in the US, but the two respective Central Banks have very differing monetary policies right now. While the ECB are threatening to hike interest rates, the Fed are currently in the middle of an easing cycle and with the Fed it’s not so much a question of can they cut, rather than by how much? The euro has attracted strong support following the ECB statement and has risen to a new lifetime high of 0.7530 against the pound while rising to 1.4750 against the dollar. The ECB has little concern about a strong euro as the currency issue was not even mentioned in Mr Trichet’s statement. The ECB is essentially leaving it to the Fed to appease financial markets and markets will be studying Ben Bernanke’s speech at 18:00GMT this evening for clues as to how the Fed might act when its monetary policy committee meets later this month. Today’s developments have quashed hopes that the ECB might soften its tone and create the prospect of a future rate cute. Rate cuts in the euro area are a long way off, if we are to believe Mr Trichet and his colleagues. While the euro looks very much inflated in value, few will want to back the dollar against it with a further Fed rate cut imminent at the end of January, a cut which could stretch to 50 basis points. It now seems that if the euro is to breach the 1.50 price barrier, it will do so in the near-term, most probably by the first week in February, if at all. The next upside target for the euro is the 1.4820 price level reached briefly last Friday. Any sustained break above 1.48 is going to require a rethink by many pundits whom believed the euro had already peaked (1.4966 in Nov last). Ben Bernanke could pose further problems for the dollar tonight if he chooses to signal how the Fed may act on rates when the FOMC meets later this month. The Fed has proven itself to be the weakest link of the major Central Banks in terms of capitulating to market demands and with Bernanke at the end of November having already broken from a strict policy of keeping the FOMC’s meeting intentions to itself, don’t be surprised if the Fed Chairman lets something out of the hat this evening. Strategy: no value in buying euro at current prices until there is a significant dip and given the downside dollar risk from Bernanke’s speech this evening, it is best to stay out of EUR/USD for the remainder of today.

The Bank of England surprised many, including me, by deciding to ignore market demands and to keep interest rates on hold at 5.0%. We won’t find out how close the decision was or what reasons were given to wait, until the minutes of the meeting are released in two weeks time. Sterling has done disastrously following the announcement, with most sterling short positions staying in the market and being added to by new short positions from traders whom now seem absolutely confident that a rate cut is coming in February. If any of the MPC members believed waiting would take some pressure off the currency, which in turn would help temper inflation, they got it badly wrong. Sterling would have done better had the Bank cut rates today as many would then believe rates would remain on hold until March at least. What is obvious, and by consequence deeply worrying for the Bank’s calamity-prone Governor Mervyn King, is that markets believe the Bank of England got it glaringly wrong. The UK’s headline inflation rate at 2.1%, is less than half of that in the US (4.3%), where rates have been cut by 100 basis points since September and are expected to be cut by perhaps a further 50 basis points at the end of this month. I suspect the Governor of the Bank of England himself did not wish to cut this month as he has always been one of the more hawkish members of the Committee. Sterling has fallen to an all-time low against the euro Thursday, the euro rising to as high as 0.7537 and with the rate differential outlook over the coming months very firmly in favour of the euro, one must fear for the UK currency. The euro reaching 80 pence is now a very real prospect. In saying that, sterling is massively oversold at present and some form of limited correction is due. A correction may potentially be triggered tomorrow if UK Industrial Production numbers for November prove to be very positive. I remain a committed sterling bear though, so I will wait to sell sterling at a more attractive price, i.e. upon failed pound rallies. There is little value in selling the currency at current prices. A significant bounce in equity markets could give sterling a temporary and much-needed bounce against the yen and the Swiss franc, currencies against which it has plummeted in the past couple of weeks. Strategy: Wait for rebound in cable and sell at prices between 1.9750 and 1.9850. We need to see a substantial correction in EUR/GBP before contemplating buying this pair.

Despite a strong late rally on Wall Street Wednesday, Asian stocks plummeted overnight thanks partly to a report from Goldman Sachs that raised the prospects of a recession in Japan. The euro did still gain over 130 pips from the time of our report Wednesday, peaking at 161.82, before retreating to 161.20 at the time of print, with stocks again under pressure Thursday. The yen has gained half a percent on the dollar today and where it ends this evening is very much dependent on the performance of US stocks into the close. If Ben Bernanke says something in his speech this evening that sends stocks higher, the yen will be sold off into the close and the dollar might return to Y110, while the euro should be able to head into the Asian session around the Y162 price level. Japan’s leading indicator for November came in at a lowly 10 points, a long way short of the 50 point boom or bust level. The reading means the Japanese economy may struggle to perform in the 6 months from Nov 2007. The fate of the country’s currency remains dependent on broader market sentiment and risk tolerance levels and any sustained rally in global stocks will see the yen retreat across the board. Key to the direction of the yen into Friday will be Bernanke’s speech this evening and its impact on Wall Street and Asian markets tonight. If Bernanke says nothing to appease market concerns and stocks continue their downward spiral, the yen could potentially push the euro back towards the pivotal Y160 price level and push the dollar back to Y108.50. I’m still inclined to hold EUR/JPY, as stocks are due a further rally and we might wait for Y163. Strategy: Buy EUR/JPY on dips towards Y160.50 with limit prices of Y162 and Y163.

The loonie came under pressure earlier this afternoon when November’s Building Permits report followed yesterday’s Housing Starts report and disappointed on the downside. In fact USD/CAD has been trading erratically all day ranging from 1.0040 to 1.0150 with the momentum residing with bulls, following yesterday’s key break above 1.0080. Our next upside target is 1.0190, once 1.0150 gives way and then 1.0225. Once convincingly above 1.0225, the greenback should be well on its way to 1.05. The loonie has plummeted against the euro Thursday as the single currency rallied sharply across the board. EUR/CAD is now just shy of 1.50, a mark it hit briefly just after the Bank of Canada cut interest rates back in early December. Tomorrow is a critical day for the loonie with December’s employment report and November's Trade Balance both due for release. Recent data out of Canada has been soft and a negative employment number tomorrow could see the currency hammered, while a strong report will offer some respite, which should prove to be only temporary. There is potential for the employment figure to surprise to the downside as the IVEY PMI last Friday reported a sharp drop in the employment component for December. A key data element to also look at tomorrow is November’s exports % change over October and if this number reports a sharp fall, this too will spell trouble for the loonie’s outlook. Strategy: People who are long on USD/CAD for the longer haul should not fret and simply ride out tomorrow’s data (maintain S/L at 0.97) and wait for price to reach 1.05, while those looking to enter now are best advised to buy on any dips back towards 1.0030 ahead of Friday’s data, with upside price targets of 1.0140, 1.0190 and 1.0220. Otherwise wait until after the employment report, due out at 12:00GMT Friday. A strong employment report (+30K jobs and unemployment unchanged) could potentially see a pullback in USD/CAD to 0.9950, but this in turn will attract new bids at a better price.

Bob B

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