Tuesday, January 8, 2008

Bob's Currency Analysis

Bob’s Currency Analysis
We’re finally back to something approaching normality after the holiday break and I hope those of you that dabbled in the market during the notoriously thin trading conditions at year end did not get stung. We witnessed something of an aggressive dollar sell-off against the euro as traders squared positions ahead of the New Year and persistently weak data continues to keep the greenback on the defensive.

The pair is largely unchanged today, trading within a narrow 1.4680 to 1.4740 band. Retail Sales data out of the eurozone for November was again disappointing, recording a 0.5% decline on the month and 1.4% decline on the year but this negative was offset by a strong set of factory orders numbers out of Germany for November, 3.4% up on the month against a 1.5% forecast decline. The only data of significance today is the US pending home sales figure for November, which tends to act as a gauge for actual homes sales figures for the proceeding month. It should not have a huge impact as a flat number is expected, but a sharply negative number could move the market against the dollar. The market is effectively awaiting the ECB on Thursday and with the MPC not expected to shift from its hawkish stance on inflation, the euro is likely to remain well supported before then. We have comments from two fed officials today, Plosser and Rosengren, both of whom are speaking about the economy and Rosengren’s speech in particular needs to be studied closely as he is the one member of the Fed that voted for a 0.5% cut back in December. With stock markets remaining under pressure and the ‘R’ word being banded about freely, markets are beginning to talk up the prospect of a 0.5% rate cut from the Fed at the end of January, particularly as there is no FOMC meeting in February. I would expect us to remain in a 1.4650 to 1.4750 price range for the rest of the day and really do not see any benefit in entering the market in the middle of this range. Any upward spike outside of this band towards 1.48 is likely to attract selling interest and should offer some value. Strategy: Sell EUR/USD on rallies that peak around or above 1.48, with target downside price of 1.4705.

Sterling rallied strongly this morning, rising to as high as 1.9828, having hit a 5 month low of 1.9652 overnight. We are edging closer to the Bank of England decision on Thursday and while the market consensus is for no change in rates, there is still a reasonable chance the MPC will move to cut rates again this week. I personally believe they will cut this week because the 9-0 vote in December has clearly demonstrated where the Committee is now leaning and following their own dire warnings about the risks to the economy in 2008, followed by a series of weak data reports, there appears little point in the MPC postponing a cut to February. For this reason and given the downside risks to sterling this week, it is foolhardy to back the UK currency. I am 100% bearish on sterling at present and only recommend selling it, at the right price of course. The euro offers no value against the UK currency but cable prices above 1.98 are worth taking, with target limits of 1.97 and even 1.9680 easily achievable. Cable could dip very low this week, possibly to 1.9350, if the Bank of England does cut on Thursday. In economic data news, the BRC retail sales report for December reveals same store sales only rose a paltry 0.3% on Christmas last year, while total retail sales were up a modest 2.3%. The Halifax house price index rather surprisingly records a 1.3% rise in house prices for December but that report runs contrary to all recent reports and should be put down as a blip and ignored. Strategy: Sell cable on prices above 1.98 with initial target of 1.97, followed by 1.9670. As we get closer to Thursday, we will reassess our limit targets.

The yen declined for the first time this year Monday and today the trend has continued as a modest bounce in stock markets has triggered a new wave of carry trades that has seen the yen used as the funding currency. The yen made a rather exaggerated move to 108.30 last week when market were mostly sleeping and if stock markets stabilise over the next few days, the dollar may appreciate back up to 111Y and the euro to back above Y163. The medium term scenario is more uncertain and heightened caution caused by fears over a US recession could spark a sudden bout of risk aversion that would propel the yen higher at any time. With the possibility of stocks rising over the coming days in anticipation of an aggressive Fed rate cut at the end of this month and the euro likely to remain strong ahead of the ECB on Thursday, the best value trade on the yen is probably to buy EUR/JPY around prices of Y161, setting a target limit of Y163. The best time to enter a yen sell trade at present is after US stock markets have closed, but only if Wall Street has closed higher - the higher the better.

The loonie has returned to reality in recent days having appreciated by over 4 cents during late December while most traders were away for the holidays. We hope if you were holding longer-term USD/CAD long positions you were not stopped out as price did go as low as 0.9756 in late December. There was no real reason for the move other than a repatriation of funds into Canadian dollars for year end accounts and the underlying fundamentals if anything have moved further against the loonie in the past 2 weeks. Weak economic data that raise the probability of a US recession is not good news for the Canadian economy, which exports 80% of its goods to the US. The loonie is currently being protected by sky-high oil prices but the significance of last Friday’s IVEY purchasing managers index which revealed a contraction in business spending in Canada in December should not be underestimated. Canada’s IVEY PMI does not carry the same weight in terms of importance as the ISM indices in the US, but given the IVEY index covers both the manufacturing and services sectors and is the only reliable monthly business performance survey out of Canada, we have to take it at face value. This week sees the release of December’s employment data on Friday but we know labour is essentially a lagging indicator and may be behind the eight ball in terms of showing where the economy is right now. Of equal importance will be November’s trade balance, also out Friday. The Bank of Canada meet in a fortnight’s time and with real fears over a sharp slowdown in the economy and the Fed already cutting aggressively, the chances must be increasing that the Bank of Canada will cut interest rates again this month. Once the US dollar convincingly breaks back above 1.0140, USD/CAD could quickly find its way to 1.05. Strategy: buy USD/CAD on dips towards 0.9970 with an initial limit price of 1.0060. A break above 1.0080 should see targets upped to 1.0130 and 1.0190. Longer-term long positions should have the stop loss set at 0.97.

Bob B

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