Friday, January 11, 2008

Bob's Currency Focus 16:00 GMT

The dollar suffered a double blow yesterday 1) when ECB President Jean Claude Trichet delivered a more hawkish statement than the market had anticipated and 2) when Fed Chairman Ben Bernanke signalled the Fed is prepared to take “substantive action” to offset against the downside risks to growth, indicating the Fed would cut rates aggressively. Markets now expect a 50 basis point cut when the FOMC meets at the end of this month. Although inflation is a significant issue in both jurisdictions (headline inflation is in fact higher in the US than in the Eurozone), the two Central Banks have very differing views with the Fed is set to gamble on inflation in an attempt to cushion the effects of the credit crisis and to try and stimulate growth, while the ECB is adopting a wait and see policy. For most currency traders this appears on the face of it to be a no-brainer, i.e. rate differentials are going to very much favour the euro, so the obvious thing to do is to buy the euro against the greenback. The problem is that the market may at any point decide the ECB is wrong and once market doubts begin to mushroom about the sustainability of eurozone growth, the euro will come under increasing pressure. This penny may however take some time to drop. The euro now has the advantage in terms of sentiment and it quickly needs to push its advantage home, if it is to take the coveted 1.50 price handle. We could see a strike at that level next week. An early break above 1.4822 is required to retain the current momentum, otherwise we are likely to see an early retracement back to 1.4640 early next week. In economic data today, the US trade deficit widened to $63.12 in November, primarily owing to a major increase in petroleum prices. US import prices were flat in December, but imported inflation in 2007 as a whole reached a record level and Fed watchers will be monitoring next week’s consumer price data very closely, to ascertain just how much wriggle room the Fed actually has in terms of delivering further rate cuts. For now the euro will probably hold its position into the weekend and traders will hope for a push towards the lifetime high at 1.4966 next week. Traders need to be on the lookout Monday as there is always the possibility of a major injection of funds into the dollar if fears over a sharper global slowdown intensify. For now I do not see any value in buying the euro at the current price. There is value in selling though with a S/L placed above 1.4840, but one is doing so in the knowledge that this is a value trade only that it runs contrary to current market sentiment and assumed direction. Strategy: Sell down on prices around 1.48 once 1.4822 holds, with S/L above 1.4840. Target 1.4680, then 1.4645.

Cable may be trading Friday at the same levels at which it opened Thursday, but essentially the currency was the big loser yesterday as it failed to bounce after the Bank of England kept interest rates on hold. The market began pricing in a cut from the end of last week but traders have not rushed into removing those shorts thus far. One must suspect the Bank of England know something we do not and we need to note they would have had access to December’s consumer price data before delivering their decision, so it could be that we will see an upside surprise in the UK inflation rate, when the data is released officially next Tuesday. It will be dangerous to back against sterling between now and then particularly given the currency is grossly oversold across the board. I am very much a sterling bear but I don’t see any value in selling at current prices against the euro, dollar or swiss franc. I do expect to see some limited correction next week, after which time we may well enter the market again. The euro in particular has appreciated too much too soon against the UK currency and there must be room for a return to 0.74 at least, before the next leg up. Strategy: Wait for cable to rise to 1.9750 and sell at prices around or above this level with a S/L above 1.9850. Downside price targets are 1.9660, 1.9550 and 1.95.

The yen has benefited from a fresh bout of risk aversion as stocks dipped across the globe Friday amid fresh credit concerns and fears of a wider economic recession. Fed Chairman’s Ben Bernanke’s commitment to cut interest rates failed to trigger a rally in Japan overnight where the Nikkei plummeted to a 2-year low. The yen has appreciated against the dollar, having pushed the greenback back to below 109, but the move is unconvincing and a late rally in stocks this evening could trigger a broader retreat for the Japanese currency. The euro did reach 162.27 against the yen late Wednesday evening but fell back to below 161, before recovering to 161.35. In economic data, bank lending in Japan was up a mild 0.2% on the year in December, easing from a 0.7% gain in November, while the Economy Watcher’s Survey reported increased pessimism about both the current health of economy and the outlook for the next 12 months, amongst small business owners. The Japanese economy is stuttering along right now and the only reason the currency is gaining in value is because growth concerns elsewhere are leading to a repatriation of funds back into Japan. Any sustained rally in stocks is likely to see risk tolerance levels rise and see both the dollar and the euro appreciate against the Japanese currency. My preferred buy is the EUR/JPY pair, although traders probably need to curtail their profit ambitions, given the wider uncertainty that is currently driving markets. Carry traders have been very brave in recent days with the high yielding Australian and New Zealand dollars attracting very strong support. If these new carry positions should unravel in the coming days, they will lead to a higher appreciation of the yen. Strategy: Buy EUR/JPY on prices close to 160.50 with initial upside target of 162, followed by 163. Employ a S/L just below 160.

December’s employment report released today showed Canada lost jobs in December for the first time in 8 months. The economy shed nearly 19,000 jobs while markets were expecting a gain of 15,000. The report is meaningful because it came on the foot of a sequence of weak economic reports out of Canada over the past month and suggests the world’s eight biggest economy may be infected by the ails of its larger neighbour and that Canada, as well as the US, is facing a difficult year ahead. One bright light is the fact the unemployment rate remain unchanged at 5.9% while wages grew at their fastest pace for 10 years, highlighting just how tight the labour market in Canada had become. The decline in employment though is likely to raise alarm bells within the Bank of Canada about the economic outlook and with inflation not a deterrent at the moment, a rate cut from the Central Bank on January 22 looks a near certainty. There was better news for the loonie when the Trade surplus for November widened higher than expected and exports rose for the first time since July (up 3%). This report helped stabilise the loonie and prevented the dollar from taking out the key 1.0222 resistance level, which has held since last September. If you followed my advice of recent days, you should have exited with handsome gains. 1.0222 is now a key barrier for the loonie and if the greenback breaks significantly above this level, 1.03 should be hit very soon and parity may well fade in the mirror behind us. Strategy: Buy on any dips back towards 1.0090 with upside targets of 1.02, 1.0220 and 1.03. Those who are in on the longer-run should hold the positions and wait for 1.05. We will move our stop towards parity, once 1.0222 is firmly behind us.

Bob B

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