Tuesday, February 26, 2008

Bob's Currency Focus - 19:00 GMT

The dollar tanked across the board Tuesday and the euro is now within reach of the lifetime high at 1.4966. The pair currently trades above the key 1.49 line. So what has changed to bring about this situation? The euro got a boost from Germany’s Ifo business survey for February which surprised to the upside and suggests the German economy at least remains resilient in the face of a US slowdown. Stock markets appear to have grown immune to bad news and are ready to rally on any hint of a positive. This increase in risk tolerance is resonating through currency markets with the dollar being targeted because of its negative rate outlook, versus the euro in particular. A rate cut by the ECB is off the agenda for the foreseeable future, following today’s Ifo report. US data again disappoints with consumer confidence hitting a 5-year low in February, producer prices increasing by twice the forecast in January and house prices falling by the most in 2 decades in December according to the most recent Case Shiller report. The euro looks poised to once again take on 1.4966 and attempt to vault the 1.50 price handle. Its chance may come on Wednesday, if Fed Chief Bernanke, in his testimony to the House Monetary Policy Panel, signals further aggressive rate cuts may be on the way. There is no value in buying the euro at present prices, given it is at a price level from where it had failed to progress on 3 previous occasions. Dollar sentiment is so negative right now it is difficult to see where a downside rally is going to come from. It will most likely take a rise in risk aversion and a downturn in stock prices to trigger it. Strategy: Sell down on prices close to 1.4930, but place a stop loss above 1.4966. Hold other short positions, in anticipation of a reversal.

Cable has advanced to 1.9850 as the pound seized on broad-based dollar weakness to push the pair close to the year’s highs, which are around 1.9957. UK economic data printed weak though it got lost in a cloud of dollar gloom. Total Business Investment in Quarter 4 was a negative 0.5%, against a 0.9% gain in quarter 3. The CBI Retail survey for February posts a sharp decline in confidence by retailers and signals there are difficult months ahead for the retail trade. Cable’s ability to reach 1.9957 may be dependent on the euro hitting 1.50 against the dollar. If the euro prevails it will spark a fresh bout of dollar-selling which will benefit the pound and should see cable return to the 2 dollar mark. I remain bearish on sterling but prefer to see the current dollar sell-spree pass before getting too involved in the market. Cable has now rallied 5 cents from last week’s low and it is difficult to see it going much higher on fundamental grounds. Comments today from the Bank of England’s Rachel Lomax were generally supportive of sterling – she intimated the Bank’s hands may be tied because of rising inflation. However if data continues to disappoint, markets will price in expectations of further rate cuts. The rise in risk tolerance is protecting sterling against the euro, as traders pour money into the higher-yielding pound and EUR/GBP should be able to slide to 0.75 in the short-term, so long as the interest in carry trades persist. Cable should be able to hold below 1.9957 bar another dollar collapse and a sell down on prices near this price would seem to offer the best value. Other short positions should be held in anticipation of resumption to the downside. Strategy: Sell cable on prices close to 1.9957 with downside price targets of 1.9730, 1.9670, 1.9605, 1.9550 and 1.95.

The yen has held up remarkably well Tuesday as currency markets have been dictated by dollar weakness rather than preference for riskier assets. The yen has gained over 70 pips against the dollar and has held its own against the euro, though the single currency is again trading above the key Y160 price line. The only major currencies the yen has lost ground against today are sterling and the Canadian dollar. Stocks have now rallied strongly over most of the past week and may be due a reality check, i.e. correct downwards, something which would benefit the yen. Wednesday will be an important day for the immediate direction for the yen, because if stock markets react negatively to Ben Bernanke’s semi-annual testimony on monetary policy, the yen will be the principal benefactor. It is not worth selling the yen ahead of tomorrow’s speech, particularly as a capitulation by the dollar against the euro (to 1.50) will also trigger a sharp pullback in USD/JPY. I recommend avoiding the yen for the present, because we are at a critical juncture across currency markets and the yen’s direction will very much depend on the immediate fate of the dollar.

Every USD/CAD bull on earth is wondering what has hit them in the past 36 hours. It was not outlandish to have expected a rise to 1.03 this week as we look ahead to an expected rate cut from the Bank of Canada next Tuesday. Instead we have seen as sharp a reversal as the market has ever witnessed with the loonie soaring by 3% and 3 cents in under 2 days. We cannot put it down to US dollar weakness because the loonie has also surged by over 2% against every other major currency, including the other commodity currencies. There was no economic data out of Canada and the Bank of Canada members due to speak today had not even uttered a word before USD/CAD had collapsed to 0.9850. Would day traders really buy the loonie in such volumes in the absence of data and days before an expected rate cut? No! It is a very curious market move and borders on the ridiculous. We have witnessed similar moves in the recent past of course, something which makes shorting the loonie an occupational hazard. Liquidity involving the loonie poses very serious questions at times like this and logic is very much out the window. A return to over $100 oil prices will help justify a strong loonie, but the currency is trading well above its real value. Wait for a bottom in USD/CAD to form before entering the market again. There may be an attempt to take out the December low at 0.9855. Strategy: Wait!

Bob B - Feb 26

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