Wednesday, January 30, 2008

Bob's Currency Focus - 17:30 GMT

The pair briefly moved above 1.48 this morning, but got pegged back following the US ADP employment report which suggested this week’s non-farm payroll number may print better than expected. The ADP report showed that as much as 130,000 new jobs were added by the private sector in January, significantly above the 40,000 forecast. The advance reading for quarter 4 GDP in the US was then released and with the economy seen as having only grown at an annualised paltry 0.6%, this raised expectations the Fed will not hold back this evening and will deliver a 0.5% rate cut. GDP for the whole of 2007, at 2.2%, was the lowest since 2002 and to make matters worse, core inflation in quarter 4 rose to an annualised 2.9%, which means the Fed has a very difficult balancing act to perform – how to stimulate growth while keeping inflation in check. The Fed has stated its intention to err on the side of growth and for this reason, expect the Fed to deliver a 0.5% rate cut today. Anything less will be taken as a disappointment, although the Fed may be privy to key data not due for official release until later this week and if the Fed falls short of expectations today and cuts by only 0.25%, it may be a signal that this data is going to print much better than expectations. The inflation concern is however a very real one and it will be a surprise if there is not some dissent from inflation hawks in the vote, especially from Governor Poole, if a 0.5% cut is today’s result. The dollar is sure to come under short-term selling pressure in the event of a 50 basis points cut, but today’s announcement could mark a watershed for the dollar going forward, because it could put the Fed ahead of the curve, while all other major Central Banks remain firmly behind the curve. EUR/USD could hit 1.49 today and if it manages to hold above this level, 1.50 could be hit either today or tomorrow. Looking beyond this week’s events risks will switch from the dollar to the euro and I cannot see much further appreciation in the single currency, so traders need to be alert to a sharp reversal. If the Fed does not cut rates at all today and issues a hawkish statement placing greater emphasis on inflation risks which is unlikely, expect EUR/USD to capitulate to 1.46 and below. Strategy: It is dangerous to enter the market to purely trade the Fed news, because major volatility after the announcement could take out most stop losses anywhere near the market price. The value trade may be to buy EUR/USD on dips towards 1.4750 before the announcement, with target prices of 1.4880, 1.4920 and 1.4950. The stop should be below yesterday’s low of 1.4738.

Cable rallied to above the 1.99 for the second consecutive day, stalling at 1.9948 before retreating back to 1.9860. Data out of the UK was not exactly encouraging with mortgage approvals for December falling more than expected and consumer credit narrowing significantly more than forecast. Cable is gaining only because of negative dollar sentiment ahead of the Fed decision this evening and there is still the potential for a spike to above the 2 dollar mark, if the Fed delivers a 0.5% cut, as anticipated. Sterling has come off against the euro Wednesday, the single currency rising modestly to 0.7435. We also learned today that Bank of England Governor Mervyn King has been reappointed for a second 5-year term, despite the harsh criticism directed at him for his sloppy handling of the Northern Bank crisis. The Bank of England meets again next week and the MPC is widely expected to cut rates by at least 25 basis points, having left rates on hold earlier this month. Sterling will start to come under pressure once the dust settles after the Fed’s monetary policy announcement. I am bearish on sterling but don’t see any value entering the market ahead of today’s major risk event. I prefer to see where cable goes between now and tomorrow before contemplating re-entering the market. Strategy: Hold fire until after markets settles following Fed rate announcement. We shall revisit tomorrow.

The Japanese currency has been targeted and sold off ahead of the US interest rate announcement, with carry traders expecting a 0.5% cut tonight which they believe will drive up demand for high-yielding currencies, like the Aussie dollar, Kiwi dollar and sterling. A 0.5% cut today is likely to force the yen to back-pedal for a couple of days and the dollar could rise to Y109, with the euro likely to jump back above Y160. However the rate cut is not the result of a good news story, very much the opposite in fact, so it is only a matter of time before risk aversion levels rise and the yen is back in vogue. Industrial Production in Japan rose 1.6% in December against expectations for a 2.0% rise, disappointing markets. There is increasing talk over the past week that Japan is also on the verge of a recession, with Goldman Sachs particularly negative in its assessment of the world’s second largest economy. The sombre outlook for both the US and Japan has thus far failed to dampen commodity prices, so the yen looks poised to continue its short-term retreat. Strategy: If long on EUR/JPY, set target limit to Y160. If the Fed comes up short of a 0.5% rate cut expect the yen to appreciate. Short yen positions should be exited before Friday, but be ready to exit in a hurry today (place stops in advance) if the Fed does not cut by 50 basis points.

The loonie steamroller show goes on unchecked and earlier today the Canadian currency pushed the greenback down to 0.9920, a 4-week low. The loonie has made gains against all the major currencies again today as the current bounce in the currency extends, despite fears of a US recession. The loonie is now set up to force the US dollar back to the 0.98 price level, if we get an aggressive cut from the Fed today. The currency has advanced 4% in a week and looks decidedly bullish, even if there is no economic data supporting the move. The current market perception that commodity prices can continue to rise indefinitely against a backdrop of recession in the world’s two largest economies and that the Canadian dollar can soar in this environment is a nonsensical one. Commodity prices are going to soon switch into reverse gear, which is a major negative for the medium term and long-term prospects of the loonie. For now, the loonie is on a high and I would not bet against the greenback being forced back below 0.9850 today and 0.9750 may even be tested before the week is out. The loonie has appreciated a further 0.4% against the euro Wednesday and the pair is now hovering below the 1.47 price level. Bank of Canada Deputy Governor Paul Jenkins is due to speak on the economic impact of a strong Canadian dollar in the House of Commons at 20:20 GMT. I remain bearish on the loonie but will sit out today’s key events. Strategy: Wait for market to settle after Fed rate announcement. We will review the situation on Thursday.

Bob B - Jan 30

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