Thursday, February 14, 2008

Bob's Currency Focus - 17:30 GMT

Ben Bernanke, in a prepared statement to the Senate Thursday, indicated economic outlook for the US economy has further deteriorated. The Fed stands ready to cut rates even further to boost faltering growth the Fed Chairman hinted, contending inflation will moderate through this year, although risks remain, as evidenced by the run-up in oil prices in late 2007. There is nothing new in Bernanke’s statement but it reaffirms market expectations for another 50 basis points rate cut in March. This has helped undermine the dollar. In fact the greenback has struggled all day against all majors, with the exception of the yen, and the euro rallied to 1.4640 just before December’s US trade data was released earlier in the day. The US trade deficit narrowed by more than expected while last week’s jobless number printed moderately better than expected. The revival for equities this week and the subsequent rise in risk tolerance put the dollar under pressure again, as traders revert to the old habit of using rate outlook to determine price direction. Quarter 4 GDP in the euro area halved to 0.4% from the 0.8% pace set in Quarter 3. The annualised growth rate came in at 2.3%, just above the forecast 2.2%. There are no market-moving data releases through Friday and the dollar will be guided by underlying sentiment and risk aversion levels. Sentiment appears to have turned against the US currency again with better than expected quarter 4 GDP reports from Japan and Europe reigniting the decoupling theory. If stock markets retain the upbeat momentum, the euro could force a challenge of resistance in the 1.4660 price region. A push through this level could see the euro trading back above 1.47 within the next 24 hours. It may take a sharp sell-off on Wall Street Thursday to see the pair reverse course and move back towards 1.4540. There may be some value in selling down on prices close to 1.4660, using a tight stop above this level, but right now momentum does favour the euro.

No domestic data was released in the UK Thursday and the pound has continued its ascent against the dollar, thanks to in no small part to Mervyn King’s intervention Wednesday, when the Bank of England Governor poured cold water on expectations for an aggressive policy from the Bank of England. Cable rose to 1.9730 this afternoon, up 4.5 cents from the level it sank to immediately after the Bank of England announced a 25 basis points cut in interest rates last Thursday. Regardless of what Mervyn King may say, it does not alter the implied weakness of recent data and the perception the Bank of England is well behind the curve. Mervyn King’s twinkle-toe approach is a striking contrast to the size 14 boot approach donned by Fed Chief Ben Bernanke. Considering headline inflation in the US is running 2% higher than that in the UK and both economies have uncertain futures in 2008, it is unlikely both approaches are correct. We shall find out who deserves the kudos in due course. Cable could push to 1.98 in the short term, if the dollar remains weak across the board, but the pound will attract decent selling pressure on prices above 1.9730. I am bearish on cable above this level, even if there is a chance the pair might go higher in trying to carve out a near-term peak. The pound may be able to temporarily force the euro back below 0.74 with the prospect of a move to 0.7350 next week. If risk concerns begin to haunt markets again, the pound will tend to lose out more than the euro, given the strength of recent gains. Strategy: Sell cable on prices above 1.9720 with target prices of 1.9660, 1.9620, 1.9580, 1.9550 and 1.9510.

The yen struggled early Thursday with the positive momentum seen in equity markets Wednesday spilling over into Asia overnight, prompting investors to pile on carry trades at the expense of the low-yielding Japanese currency. The currency has since battled back to just below 108 against the dollar when the Industrial Averages on Wall Street slipped into the red. The yen is moderately weaker against all other majors today and the euro is back trading above Y158. Quarter 4 GDP in Japan surprised everyone when printing at 0.9% against a forecast of 0.3% and the annualised rate came in at 3.7% against the forecast 1.7%. It’s something of a mystery how economists came to get the forecast so badly wrong but the Government played down the data’s significance this morning, focusing instead on growth concerns for 2008. Don’t be surprised to see the GDP numbers revised downwards next month. The GDP data did not boost the yen as the currency has of late become largely immune to domestic economic data and instead the currency went into reverse gear as traders used the unit to fund carry trades. The market has clearly turned against the yen for now but if we see another sustained period of equity sell-offs, the currency will quickly be back into vogue. For now, the tendency will be to sell the yen off rallies, and the market will want to push the dollar to Y110 in the near-term, probably also leading the euro to return to Y160. There is risk in selling the yen at current prices because of ongoing market volatility and it may be wiser to wait for dips towards Y106.50, if price does go there. Strategy: Wait!

No matter what way you look at this latest Trade Report it is deeply worrying and points to more aggressive action being required from the Government and the Bank of Canada, if the country is to have any chance of being competitive in a slowing global economy. The total value of Canada’s exports declined by 3.1% in December, but in pure volume terms exports actually fell by 6.5%. The only major sector to record a gain in exports was the energy sector and that was thanks entirely to price inflation. In pure volume terms natural gas and crude petroleum exports were flat. At $2.4 billion, December’s surplus is the lowest since November 1998, while the trade surplus for 2007 as a whole was the lowest since 1999. In constant dollar terms Canada’s exports to the US fell 1.3% in December over November, while exports to its major trade partner were down 10.8% from December 2006. The US accounts for 80% of all of Canada’s exports. Imports rose in December by 0.7% but because import prices rose 3.4%, import volumes actually fell by 2.7%. Today’s report indicates there is a significant disconnect between Canada’s recent employment report and production outlook. I have always maintained labour is a lagging indicator and what today’s report signals is that Canada could be facing major job losses in the months ahead, if the slowing trend for the country’s export volumes persists. Canada’s exports to economic blocks outside the US also fell significantly in December, so the US slowdown can’t be put forward as the reason for the decline. The Canadian dollar which rocketed by 17% in value in 2007 is the principal reason. The loonie refused however to lay down after today’s report as traders continued to prefer using rising commodity prices as the driver for the currency’s value. With oil back up at $94.50 a barrel, the loonie is attracted widespread support. Having briefly touched above parity, USD/CAD has then declined back to 0.9937 as the pair retained its bearish tone. The euro rose briefly to 1.46 against the loonie this morning but the single currency too was forced to retreat to 1.4550, even on foot of that very weak Trade Report. I prefer to steer clear of USD/CAD for now but do like the euro for value on prices below 1.45. Strategy: Buy EUR/CAD on prices around 1.45 with upside price limits of 1.4580, 1.46, 1.4630, 1.4670 and 1.47. If holding longer-term USD/CAD long positions, the stop loss should be held below 0.9750.

Bob B - Feb 14

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