Thursday, February 7, 2008

Bob's Currency Focus - 18:30 GMT

We have had an incredibly volatile session Thursday as stock markets in Europe plunge and the ECB moves to a more neutral stance, thus sending the euro into freefall. ECB President Jean Claude Trichet said council members neither argued for a rate cut, nor for a rate rise. This is a significant change from the last meeting, where some members were calling for a rate hike. The decision out of today was the same, but the shift in tone suggests the ECB may be positioning itself to cut rates at some future date. The euro has been trounced by every other major currency today with the exception of sterling, as the pound also went into reverse after th Bank of England cut rates in the UK and gave a downbeat assessment of the economy. Markets are in a confused state however because despite the plunge in stock markets, the high-yielding Aussie and New Zealand dollars have surged and the yen has depreciated against the US dollar. The dollar has forced the euro back to below 1.45, gaining almost 1% on the day. US economic data again disappointed with last week’s jobless claims number coming in higher than expected, while December’s pending home sales number fell 1.5%, against a forecast decline of 0.5%. German factory orders decreased 1.7% in December, but this was slightly better than forecast. The euro needs to recover quickly back towards 1.46, otherwise the dollar looks set to push the pair back to the 1.4310 low seen last December. The dollar’s advance this week is hardly deserved on the evidence of recessionary data out of the US, but with the yen remaining more or less static in value this week, the dollar has suddenly become the preferred ‘safe haven’ currency. The euro’s best chance of an impulsive rally later Thursday is if we see a recovery in US stocks on Wall Street. It is dangerous to enter the market today given current levels of volatility, but having declined by 500 pips since last Friday’s peak, the euro may offer some short-term value on Friday, once the current dollar rally bottoms out. Strategy: Wait!

The Bank of England cut rates by 25 basis points as expected, but, rather more surprisingly, the MPC issued a detailed statement, highlighting downside risks for both the domestic and global economies, as well as raising concerns about the medium-term outlook for inflation. Sterling originally gained a bounce after the announcement was made, as a rate cut had already been fully priced in, but then the pound collapsed as the Bank’s bleak assessment was taken rather indifferently by stock markets and accelerating a sell-off in European stocks. Earlier this morning a report out of the UK revealed manufacturing output declined 0.2% in December. Industrial Production also fell, by a more marginal 0.1%. The UK economy is clearly struggling at present and the Bank of England’s actions, although a help, may not be enough to avert a more serious economic downturn. Cable fell to below 1.94, down 2 cents on the day, while sterling is unchanged against the euro, the other major currency to be pummeled today. We have done pretty well from cable in the past week, since we initially recommended selling down from 1.9920. However, while still bearish on the currency, there is little value at present prices, so the best advice is to wait for a bounce in the pair to back over 1.96. Sterling should be able to push the euro back to 0.74 in the short-term, with the single currency coming under broader selling pressure. Strategy: Sell cable on rallies towards 1.9650 with price limits of 1.9540, 1.95, 1.9440 and 1.9395.

There has been a bizarre turn of events Thursday with the yen depreciating significantly against the US dollar, even when major European Stock markets were closing out their trading sessions down an average 2%. Traders have been loading carry trade positions all day on AUD/JPY and NZD/JPY, ever since the Bank of England announced a rate cut at 12:00GMT. Investors risk nerve has held thus far, helped in no small part by a modest bounce in US equities this afternoon. The Kiwi dollar is currently up 1.7% against the yen, with the Aussie dollar up 1.4%, while the greenback is up 1% against the Japanese currency on the day. The yen is virtually unchanged against the euro. The dollar does not offer any value against the yen on prices close to 108 while risk is a major issue, so this remains a good entry point for selling down. We have seen the pair spend the week sparring in the 106 to 108 price region and the two currencies should remain within this trading range until we see risk aversion levels cool somewhat. Strategy: Sell USD/JPY on prices near 107.80 with downside price limits of 106.80, 106.50 and 106.20. Place a stop loss above 108.10.

The loonie has made significant gains against the euro, pound and the yen, but it was forced to give up modest ground against the greenback. There was no domestic data out today and markets await Friday’s key employment report for January which is key to discovering whether the Canadian economy is managing stay afloat at a time when the US tinkers with recession. Today’s warning on growth risks out of Europe is not good news for the outlook of the loonie, a currency that is dependent on the wider economic growth story. In the past week we have seen the South African rand and the Norwegian Krone come under intense selling pressure, but thus far the other major commodity currencies of the loonie and the Aussie and Kiwi dollars have been spared the rod. All three of these currencies are likely to come under increasing threat in the near term, especially while volatility and risk aversion levels remain high. All three currencies are defying the underlying fundamentals which point to an at best ‘uncertain’ outlook for the global economy. The loonie today is trading 2% higher against the euro than it was this day last week. If Friday’s employment report prints another negative number, the loonie will be hammered and the greenback should rise back towards the 1.0350 by the middle of next week. However, a better than expected number and a steady unemployment rate could see the loonie push the greenback down sharply to test that critical 0.9920 support point. Strategy: wait for Friday’s employment report as this is the key to determining confidence for moving in one direction or the other. Hold onto those positional USD/CAD longs.

Bob B - Feb 7

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