Thursday, January 31, 2008

Bob's Currency Focus - 18:00 GMT

Bernanke’s gift of a further 50 basis points to the markets Wednesday was soured by S&P’s report that some of the credit ratings of the major bond insurers might be downgraded. The Dow industrial average had been up 200 points after the Fed rate cut was announced, but it lost these gains to close modestly in negative territory. The FOMC statement yesterday was virtually the same as that released a week previously and with the emphasis again on downside risks to growth, it is probable the Fed Funds rate will drop to 2.5% by March and possibly go as low as 2% before the summer. Inflation concerns have been pushed to one side and the Fed is prepared to gamble on the logic inflation must ease in a slowing economic environment. There is of course no guarantee this will happen as evidenced by the quarter 4 GDP report, when growth slowed to a 0.6% annualised rate while at the same time core inflation rose to a 2.7% annualised rate. The US is officially in a period of stagflation and one which could worsen significantly yet - $100 oil was hit for the first time in January. Let’s be clear, given inflation is actually on the rise and well above an acceptable level and the fact the US has a negative savings rate, the Fed is wreckless because the committee is not looking at the longer-term picture. But should the economy narrowly avert a recession or if growth gathers pace later this year against a backdrop of falling inflation, Bernanke will be hailed a saviour and a hero. But even in the event of such a miraculous medium term outcome, the next generation of Americans will spend a further generation paying off the stockpile of national debt amassed thanks to the short-sightedness of Messrs. Greenspan and Bernanke.

The pair has traded in very volatile fashion all of Thursday, bouncing between 1.48 and 1.49. As we saw Wednesday, the euro is again meeting selling pressure above 1.49, but each retreat thus far has coincided with a rise in risk aversion as global stock markets fell into the red. If we do see a sustained period of rallying in stocks, then the euro could benefit from this positive momentum and challenge the lifetime high at 1.4966 within the next 24 hours. The euro will never have a better chance to hit 1.50 and it got a boost today when the euro-zone flash estimate for consumer price inflation in January returned a 3.2% annualised rate, against the 3.1% in December. This is the highest rate on record and is sure to keep an already hawkish ECB on alert and rule out the possibility of a change in policy when the Monetary Policy Committee meets next week. Other data out of the euro area Thursday was mixed – economic and consumer sentiment fell rather sharply in January, while in Germany, the jobless and unemployment were much better than consensus. In the US, the jobless claims number for last week rose sharply, to the highest level in 29 months, stoking fears we may get a disappointing non-farm payroll number on Friday. Personal spending in December rose by the slowest pace since June, growing 0.2%. Personal income rose 0.5%. The core PCE inflation gauge was unchanged at 2.2% and the Chicago PMI came in lower than expected for January, but the PMI did register above 50 and at least signalled some expansion in the important Illinois industrial region. The dollar will struggle to push the euro below 1.48 today, unless there is a further spike in risk aversion. The euro itself needs to close above 1.4870 to set up a possible challenge of the lifetime high tomorrow. Friday is another high risk day with US non-farm payrolls at 13:30 GMT and the ISM Manufacturing Index at 15:00 GMT. The euro area Manufacturing PMI at 09:00 GMT is unlikely to have any market impact, unless it differs greatly to the estimate released earlier in the month. Oddly enough the euro may benefit most from positive US data, i.e. a consensus non-farm payroll number and a better than expected ISM PMI. A negative non-farm number or a decline in the ISM PMI will fuel concerns that the US is already in recession and a subsequent rise in risk aversion could send stocks tumbling and boost the dollar in the short-term. Strategy: buy euro on dips towards 1.4770, with upside price limits of 1.4840, 1.4870, 1.49, 1.4920, 1.4950 and 1.50. Short stops won’t work Friday because volatility will be high, owing to the high risk data due out in the US.

Sterling is largely unchanged Thursday and cable is consolidating in the 1.9850 to 1.9950 price region. Traders are reluctant to try and challenge the 2 dollar line ahead of Friday’s non-farm payroll data from the US. Sterling’s ability to once more sustain a period of trading above the 2 dollar line is probably dependent on whether the euro can break above 1.50 against the US currency. A failure by the euro to penetrate 1.50 could signal a low for the dollar for now and ultimately mean the only way for cable to go is down. Indeed with the Bank of England meeting on Thursday next likely to focus the minds of traders through the whole of next week, cable will probably return closer to 1.95 by then, unless there is a capitulation by the dollar tomorrow. Even if cable does rally to above 2 dollars, it is likely to meet resistance at 2.01 so there is certainly value in selling cable now at prices above 1.99, with the intention of holding the positions until next Thursday, when the Bank of England are likely to announce a rate cut. There will be calls for a 50 basis points cut next week with markets calling on the Bank of England to take their lead from the Fed and to be aggressive. I said last week we should avoid selling cable through the key events this week and until the current upside rally had peaked. We have now had 3 days where price has traded above 1.99 but sterling has failed to earn the necessary momentum to move higher. Of course a broader dollar collapse Friday could change all that, but cable could easily reverse sharply in the other direction, if the US data prints the other way. UK consumer confidence remained near record low levels this month with the Gfk index coming in at -13, against -14 in December. House prices fell 0.1% in January according to Nationwide, which is a somewhat better number than most of the other house prices indices we have seen this month. Against the euro, sterling could benefit if there is a sharp sell-off of the single currency against the greenback, but because of the a possible rate cut next week, it is not wise to buy the UK currency now. I remain bearish on the pound and see value in selling down cable on levels above 1.99. Strategy: Sell cable on prices above 1.9920, with price limits of 1.9840, 1.9770, 1.97, 1.9640 and 1.9550. If very much risk adverse, wait until the non-farm and ISM numbers print in the US on Friday.

The yen done remarkably well Thursday as the Fed’s latest declaration of policy easing failed to rally stock markets and thus the Japanese currency was spared a sell-off. If stocks do bounce back in the next few days, the yen will be forced into retreat, with the key barriers of Y108 against the dollar and Y160 against the euro up for grabs. The high-yielding Aussie and Kiwi dollars have been performing well and this demonstrates there is plenty of risk appetite in the marketplace, despite the ups and downs we have witnessed in the past 10 days. Friday is a major risk day with US employment and manufacturing data due for release and very poor prints will tend to favour the yen, as it will likely lead to an appreciation in low-yielding currencies. In economic data out of Japan Thursday, manufacturing expanded at the same pace in January as in December, but housing starts were down 20% on the year this month, highlighting major disconnects within the domestic economy. Traders should hold off buying or selling the yen until after Friday’s non-farm payroll report, although a strong stock market close on Wall Street Thursday and a follow-on in Asia overnight could send the yen backwards. Strategy: Wait until after Friday’s data and if the non-farm number is negative sell EUR/JPY if price is close to Y159, with limit prices of 157, 156.50 and 1.55.

The loonie reversed course and fell sharply Thursday, though it staged a comeback this afternoon, to trade a full half cent below its worst levels of the session. The failure to close below 0.9920 Wednesday, having gone as low as 0.9872, meant USD/CAD started today on the up. The greenback must close out today’s session well above the parity line if it is to have a chance of continuing the uptrend through to the weekend. The surprisingly high jobless number out of the US today frightened loonie supporters as a softening labour market in the US poses a major threat to the consumption of Canadian exports. For its part, Canada recorded a mere 0.1% growth in November, underscoring the economic slowdown is a North American phenomenon and not just a US one. The loonie is still trading 3 cents better than the price it was trading at early last week, so we could see a sizeable heave upwards in USD/CAD again Friday, especially if the US data is poor and recessionary-like, resulting in a rise in risk aversion and a drop in appetite for commodity currencies like the loonie. the Bank of Canada’s Jenkins did not say anything new in his address to the House of Commons Wednesday evening, but the line of questioning highlighted concerns about the widening spread in US and Canadian interest rates and this hurt the loonie late last night. I’m not inclined to buy USD/CAD until we are sure price is firmly established above the parity line, so we shall wait and see what tomorrow brings before resuming our buying trend. I am however still holding my long USD/CAD positional trades, with a S/L at 0.9750 and a limit price of 105.

Bob B - Jan 31


Anonymous said...

WTF are you talking about??? The Fed cutting rates doesn't create "debt" for future generations. If anything it reduces debt by lowering the interest burden on debt repayment. Maybe you should stick to currency trading instead of Fed armchair quarterbacking.

Anonymous said...

The Fed is cutting interest rates to encourage further borrowing, which in turn will generate more liquidity in the economy that hopefully will translate into broader economic stimulus. You're living in a fool's paradise dude if you believe the consequence is a reduced the debt burden. People are inclined to borrow more in low interest cycles and less in higher interest cycles. Our housing crisis was born out of the Greenspan bring-em-down 1% stimulation cycle - then when rates rose to 5.25% because of the subsequent inflation cycle, people couldn't repay their mortgages. These are facts dude. It's also economics!


Bob B & Ted B said...

But I am an avid Fed watcher and my background is macroeconomics, so I take more than a fleeting interest in what comes out of the FOMC. Whether we are talking about the Fed, the ECB, the Bank of England or whomever, printing money too cheaply leads to ruin further down the road. There are too many exapmles of this in recent history. Monetary policy should prevent bubbles, not create them. Bob

Jazzers said...

It's not a nice predicament. My big problem is the lack of communication from Bernanke and his cohorts on the major announcements. The funds rate would be 0.75% higher today for sure if stock markets did not have a dose of the s**** last Monday, so that tells me the Fed is most definitely in knee-jerk mode and yup, they's basically making it up as they go along. they should give Ron Paul the job :-)


Anonymous said...

Nonsense. You are all brainwashed by all this doom and gloom Austrian school of economics crap where they think the job of the Fed should be to choke the economy to death with fiscal austerity, and that risk taking and prosperity should be punished. You guys would have fit in well in the Herbert Hoover administration because your seem to be fond of their outdated and throroughly dicredited liquidationist policies that caused this great nation so much pain and suffering during the Great Depression.

Bob B & Ted B said...

You are obviously from the Wall Street School of greed and believe the Fed is there to protect stock prices and bail out greedy investors, rather than protect the wider economy. But if the way forward is to do anything to keep the industrial averages ticking upwards, build up everyone's debt and place the nation's major assets in the hands of foreign wealth funds, then who knows, perhaps Ben Bernanke also sits in your class. The American economy is the humpty dumpty character on Wall Street and he's not looking pretty at the moment in all those Fed bandages and trappings.


Anonymous said...

From Herbert Hoovers memoirs...

"Secretary of the Treasury Mellon, who felt that government must keep its hands off and let the slump liquidate itself. Mr. Mellon had only one formula: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.” He insisted that, when the people get an inflation brainstorm, the only way to get it out of their blood is to let it collapse. He held that even a panic was not altogether a bad thing. He said: “It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people”...

The result of this genius policy? The Great Depression, 25% Unemployment, Bread lines, etc etc.

Yet somehow amazingly there are still people around today (like you) espousing these same failed policies as the cure to our current ills. Truly pathetic!

Bob B & Ted B said...

I did not talk about government. Fiscal policy is the responsibility of government and I wouldn't even attempt to get into the pros and cons of various fiscal strategies. I will leave that to others. Monetary Policy however is something I follow religiously and something upon which I am prepared to offer an opinion. Central Banks cannot fix bubbles. They either create them or prevent them. Monetary Policy typically takes between 1-3 years before the true impact on an economy is felt. For that reason it needs to be proactive and policies which are designed to be reactive to sudden events are probably doomed for failure.

If you have an opinion you want to include as a post with your name, I would be happy to put it up for all to see. All views are valuable, whether we agree with them or not. This blog is not intended as a means of rifling home a biased view, honestly.



Anonymous said...

The European Central Bank needs to get real. The Fed has prevented Europe's markets and economies from crashing. Those economies will crash soon too. wp