Tuesday, January 29, 2008

Bob's Currency Focus - 17:00 GMT

The euro has come off a fraction today as the market seems reluctant to push it through the 1.48 price barrier, ahead of Wednesday’s GDP data and Fed rate announcements. Also, December’s Durable Orders in the US rose 5.2% on the month, well ahead of expectations for a 1.6% increase, lending some support to the dollar. US Consumer Confidence declined in January according to the latest survey from the Conference Board, but the number was marginally better than forecast and this too reinforces the argument that the US economy may not be in as bad a shape as many would have us believe. The Fed will be privy to Friday’s payroll numbers as they deliberate over the next 2 days and there is a distinct probability if the payroll number is reasonably positive, the Fed may only ease 25 basis points tomorrow. The euro is likely to push higher prior to the Fed announcement, in anticipation of a 50 basis points cut, and if it edges past 1.4825, it will be perfectly positioned to take out the lifetime high at 1.4966. Today is all about positioning ahead of Wednesday’s key events, but the euro does offer good interim value on any dips to 1.4660, given the downside risks to the dollar for the remainder of this week. There is also the chance of a major dollar backlash later in the week, particularly in the event of a 50 basis point rate cut and positive employment data, as positional investors could see it as an ideal time to back the greenback, because the longer play rate outlook for the dollar Vs the other leading currencies may have shifted dramatically in favour of the dollar. Strategy: short-term buy euro on dips towards 1.4660 with upside price limits of 1.4770, 1.4790, 1.4820, 1.4870, 1.4920 and 1.4950. Moves stops to tight positions just ahead of Fed rate announcement Wednesday, if not out of market before then.

Cable rallied to its highest level in almost 4 weeks, reaching 1.9928 this morning, before retreating to 1.9870. Although over-priced against the dollar, the pound is benefiting from increased risk appetite and a surge in demand for high-yield currencies in advance of the Fed’s policy statement. Cable could yet rise to 2.01 by late Wednesday or early Thursday, before another sharp leg to the downside commences. The pound managed to send the euro back to 0.7415 this morning, but was unable to hold all its gains and the single currency has appreciated back to 0.7430. The CBI Distributive trades survey for January printed better than expected, particularly the forward looking component, with UK retailers more optimistic on outlook for the next month. The UK data calendar is rather sparse this week and we have to wait until Friday’s CPI manufacturing index before we get any real market-moving data. Between now and then sterling’s direction will be determined by US data and market reaction to the Fed’s rate announcement. If there is indeed a euphoric rise for the pound, it will be short-lived because once this week’s data is out of the way in the US, the focus for sterling will shift to the Bank of England meeting next week, when UK interest rates are expected to be cut. Later this week we could have a glorious sell-down opportunity on cable, but EUR/GBP shorts should be seeking to exit the market by the end of this week, as that pair is likely to rally in favour of the euro next week. Strategy: Wait for Fed rate announcement Wednesday and don’t rush in to sell. If cable rallies to 2.01, sell down with limit prices of 1.9870, 1.9770 and 1.9660.

The yen is virtually unchanged Tuesday across the board, as traders are reluctant to become over-loaded on carry trades for fear the Fed disappoints markets Wednesday. If the Fed does not deliver a 0.5% cut, we could see a negative stock market reaction and downturn and a new bout of carry selling. Economic data out of Japan overnight printed quite positively with the unemployment rate unchanged at 3.8%, household spending surprisingly up by 2.2% in December and retail sales also increasing 0.2% last month, though this was a consequence of higher gasoline prices. We will probably see the yen retreat against the euro and the dollar in advance of tomorrow evening’s key announcement and it could turn into a rout for the Japanese currency if the Fed cuts by 0.5%, because risk tolerance is likely to rocket, temporarily at least, encouraging traders to use the yen to fund carry positions. It is not a good time to be long yen, but the currency will bounce back if 1) the Fed does not cut by 0.5% or 2) US employment data on Friday disappoints and stock prices go into retreat. I see potential for the euro to return to at least Y160 by tomorrow evening, before the next leg down. Strategy: Buy EUR/JPY on dips to between Y156 to Y157 with limit prices of Y158, Y159 and Y160. Have stop losses moved to a tight position prior to Fed, if not out of the market before then.

The loonie has defied the fundamentals and continued its rally Tuesday, breaking parity with the greenback, while most other currencies were moving sideways. The loonie has now appreciated 4% against the US dollar in the past week. It is a remarkable rally by any standards, but all the more remarkable given it comes immediately in the aftermath of a second successive rate cut from the Bank of Canada, with further rate cuts on the way, a 2-year low in core inflation, negative employment growth in December, a contracting industrial sector according to the latest business PMI and increasing concerns over the health of both the US and global economies which will limit demand for exports from Canada's export-dependent economy. Even today the country’s quarterly manufacturing survey reports pessimism amongst Canada’s production companies, with the expectations index for production this quarter falling to -14 from a flat reading in the last quarter. So why against this background of worrying data and events is the loonie suddenly soaring and outperforming every other major currency in the world? Perhaps we need to ask the managers of some of the sovereign wealth funds for their straetgies, or perhaps it is merely an impulsive rally in response to record high gold prices and elevated oil prices, or perahps a celebration of the fact the US is entering recession and Canada is not, yet. Leaving the thin holiday trading move for the currency aside, the fundamentals for Canada have shifted very significantly since the loonie last broke below parity and it is difficult to see how the current burst in support is a) justified and b) sustainable. It is probably the last hurrah before the pair finally sets off more firmly in the opposite direction. Technically the pair could fall as low as the 0.9756 price we saw in late December, before rebounding. Data this week holds plenty of downside risk for the US dollar, so it is not be a good idea to go long USD/CAD until the major events of the week are out of the way. If you are sitting on positional long USD/CAD trades, you will be left biting your nails for the whole of this week, but sit tight. Strategy: Hold off until after Fed. Do not go long on USD/CAD until current correction fizzles out. EUR/CAD looks to offer good value below 1.47, as the loonie’s rally aainst the euro was accentuated by the loonie’s drive to parity against the dollar. Caution is needed however, for while we may soon see a rapid return to 150 for EUR/CAD, the pair may first go lower this week.

Bob B - Jan 29

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