Bob's Currency Focus - 15:00 GMT

As we close out a tumultuous week on financial markets, the dollar is lacking direction with traders as uncertain about the health of the wider global economy just as much as they are uncertain about what a US recession means for the country’s currency. The dramatic fall we have seen on Wall Street’s leading averages over the past 3 days is not a corrective downturn but more a true reflection of just where Corporate America currently sits not just in terms of economic performance / outlook but also how its value is seen in the eyes of investors. A disappointing economic report here and there is nothing when compared to the negative sentiment quarterly earnings reports published by Citigroup and Merrill Lynch have generated. Both banks made staggering losses of the order of $10 billion each - each the equivalent GDP of a small country. Citigroup alone had a write-down of over $18 Billion and with some analysts predicting the total write-down from the entire subprime debacle could top $300 Billion, it is clear there is plenty more bad news to come from the Financial Sector. Of course the subprime risk exposure spreads to banking institutions well beyond the shores of the US, so there are sure to be unpleasant surprises to come from other quarters of the globe. The wider global picture is now a very crucial issue for the fate of the dollar because if contagion from the US sours economic growth elsewhere and in particular if global stock markets remain under pressure (i.e. have entered a bear market), we could witness a major repatriation of funds back into dollar denominated assets and bonds and the dollar would appreciate significantly in the coming months against the European and commodity currencies, irrespective of what happens to interest rates.

EUR/USD
Today EUR/USD has been trading within the same range as Thursday, but again the euro has held the advantage for most of the day. US stock markets were expected to rally strongly Friday as a stimulus package from the Government is due to be unveiled by President Bush later today. A strong rally in stocks would tend to undermine the dollar as the rise in risk tolerance would trigger an outflow of funds that have streamed into the currency in recent days. The Friday session will probably be very volatile again and when looking at it in simple practical terms, it is difficult to understand why investors would want to buy into stocks today, a mere day after the shadow of a looming recession grew ever larger. There are no economic releases today to alter the recessionary outlook so the economic fundamental view of the world today should in essence be the same as it was yesterday. We could however see a strong surge in stocks initially, but there is a real danger of a late sell-off after the euphoria fades and grim reality returns. For that reason we could see the dollar struggle in the early part of the US session, but then rebound. Positioning for the weekend will important in the current climate, so after 17:00 GMT we should see higher than normal Friday activity in the currency markets. We may see the euro use the positive impetus generated from the US rescue package to try to take out 1.47 this afternoon but if Wall Street does not respond positively to the Bush stimulus plan, currency prices could return to where they were at this morning – EUR/USD 1.4620, while another sharp sell-off in stocks and rise in risk aversion could potentially trigger a dollar rally towards 1.4550. Strategy: Sell down on failed rallies from around the 1.4690 to 1.4720 price region. Limit target prices are 1.4635, 1.4610, 1.4590 and 1.4556.

GBP
Sterling came off 1.5 cents against the dollar as December’s retail sales out of the UK disappointed markets. The consensus was for a 0.2% gain during the holiday month following a 0.4% gain in November, but instead consumers kept their money in their pockets and sales declined by 0.4%. As well as raising greater concerns about the health of the UK economy, today’s report raises the prospects of an imminent interest rate cut from the Bank of England in February. Although inflation numbers this week printed higher than expected the change was marginal and UK consumer price inflation at 2.1% is relatively benign compared to the current inflation rates in the euro area and the US. The pound could come under stronger pressure later Friday if risk aversion levels rise and we could potentially see cable decline to the 1.9483 low seen earlier this month. A break below that level will shatter confidence and could ultimately lead to a decline all the way back to last year’s low just below 1.92 over the next week, particularly if global stocks continues to come under pressure, which will deter interest in high-yielding currencies like sterling. We maintain our bearish bias and prefer to sell cable on prices in the 1.97 to 1.98 price level. Today’s poor economic data has set sterling back against the euro with the pair revisiting 0.75. The UK currency has scope for further retracement against the single currency but will probably need a broader sell-off of the euro or renewed interest in higher-yielding currencies to help it. Strategy: Sell cable on prices above 1.97 with target prices of 1.9570 and 1.9540.

Yen
The yen has had a strong afternoon having been sold off aggressively this morning with investors betting a stimulus package announced by the US Administration Friday would lead to a strong rally on Wall Street, thereby reintroducing risk tolerance and putting the low-yielding currencies under pressure. The gamble proved to be misdirected however because as at 17:00 GMT the Dow leading stock average is down 0.51% having been up 1.5% 3 hours earlier. The dollar has declined to 106.88 against the yen from an earlier high of 107.59. The euro has fared worse, coming off a high of Y157.80 to currently trade at 156.35. Positional adjustment leading into the weekend will be important for the yen, particularly as Monday is a holiday in the US. As long as stock markets struggle, the yen will remain supported but a late rally on Wall Street will lead to the yen being ditched in favour of high yielding currencies. Trading around the yen is so erratic at present that it is dangerous to get involved, although any dollar prices around Y106 to Y106.50 look attractive bids, given the extent of recent yen gains, but entering the current market against the yen has significant risks. Strategy: remain on sidelines and await market stabilization, at which point buy EUR/JPY with target objective tba.

CAD
The loonie has settled Friday and managed to hold its own, but is coming under increasing pressure close to the 1.03 price mark. A close above that level Friday would put the loonie in a vulnerable position facing into next Tuesday’s Bank of Canada meeting. November’s retail sales numbers are released just 30 minutes before the Bank’s interest rate announcement Tuesday but are so close to the main event, they will prove largely meaningless. I expect the Bank of Canada to cut rates by 25 basis points, bringing the key interest rate for Canada to 4.0% and also to signal a possible further rate cut when the Monetary Policy Committee meets again in March. This will not be good news for the loonie and if commodity prices also decline next week, it will remove an important area of support and we could witness a spike to 1.05 in USD/CAD by the end of next week. Today’s report on manufacturing shipments which recorded a 1.1% rise in November looked impressive on the headline number but was rather less impressive when one delves into the detail of the report – the rise was thanks to the massive lift in petroleum and commodity prices during November. On the actual volume of shipments, there was no change between November and October. We will probably see a move to 103.50 ahead of Tuesday’s meeting, unless there is a broader sell-off of the greenback on Monday, when US markets are closed. USD/CAD remains the most lucrative of the major pairs to buy on dips and I remain a staunch bull on the pair. Strategy: Buy USD/CAD on dips towards 1.0220 with upside price targets of 1.03 and 1.0350. Positional longs following the trend should wait for initial price target of 1.05, with stop loss just below the parity line. We will review the positional outlook after the Bank of Canada rate announcement.

Have a good weekend!

Bob B - Jan 18