Wednesday, March 5, 2008

Bob's Currency Focus 18:00 GMT

The dollar is now proving a drag on US equities with major investment funds pumping their money into commodities instead of into stocks. Crude oil is up $4 Wednesday, copper is up 4% and gold is up $25 to a record price above $990. The weak dollar is not only causing higher inflation but it is now causing major financial market volatility with investors running scared of the beleaguered currency. The US dollar index hit a record low for the seventh consecutive session today. The euro hit a lifetime high for the 6th day out of seven, spiking sharply to hit 1.53. The euro had traded as low as 1.5145 earlier this morning. The euro’s spike coincided with comments issued by the President of OPEC who blamed high oil prices on a ‘mismanaged’ US economy. The comment could be taken as a direct criticism of Fed Chief Ben Bernanke, whose aggressive policy of interest rate cuts and dollar intransigence has led to cheaper money flooding into commodity classes, thus creating an asset bubble in both hard and soft commodities. US data was mixed Wednesday with the ISM non-manufacturing report printing better than expected, though the sector remains in contraction, while the ADP employment report estimates the private sector shed a net 23,000 jobs in February. The services PMI for the euro area had earlier printed exactly in line with forecast (52.3) while retail sales figures for January at 0.4% were also bang in line with estimate. Thursday and Friday are crucial days for the euro/usd pair with the ECB rate announcement tomorrow and February’s non-farm payroll number in the US on Friday. Given the sharp appreciation in the euro over the past week, the ECB will be under pressure to soften its policy tone and at least give some hint of a possible rate cut in the coming months. If the hawks get their way, another inflation-biased statement could be enough to send the euro to 1.54. Tomorrow’s meeting could prove to be one of the most important ever for the Committee. Rates are certain to remain unchanged, so eyes and ears will be firmly fixed on ECB President Jean Claude Trichet when he delivers his policy statement at 13:30 GMT. The dollar could benefit from a correction ahead of the meeting, if a bout of profit-taking sets in, with some traders looking to get out of the way ahead of the main event. The euro has found very strong support in the 1.5140 to 1.5160 range and this forms an immediate line of support. If an upward bias is maintained ahead of Thursday’s ECB statement (i.e. price remains above 1.5250) it could prove ominous for the dollar.

It has been an eventful day for cable with the pair hitting a low of 1.9720 this morning before rebounding by almost 2.5 cents. Sterling is currently trading comfortably above the 1.99 price area. If cable can hold its position above 1.99 into the Bank of England rate announcement tomorrow, we could see a break above the 2.00 line for the first time this year, if the Bank do what is expected and stand pat on interest rates this month. The non-manufacturing sector expanded by more than expected in February and when today’s PMI is looked at together with Monday’s manufacturing PMI, it suggests the industrial sector is proving to be resilient in the face of a major credit crisis and a slowing housing sector. Sterling could potentially earn a relief rally after tomorrow, which may benefit it more against the euro than against the dollar, depending on what happens with the ECB. I remain bearish on sterling in the medium to longer term but see no value in selling the currency against the euro or Swiss franc at present price levels. If selling down cable a stop should be placed just above the 2 dollar line because a break above this level could trigger a sharper rally to the upside.

The only currency which has fared worse than the US dollar today is the Japanese yen, at the time of print. Appetite has risen for riskier high-yielding currencies as stock markets stage a recovery. The yen, being the preferred funding currency of the carry trade, has been the principal loser. The US dollar has returned to Y104, while the euro has sailed over Y159 Wednesday, recording its single biggest day’s gain against the yen in six weeks. If the stock market rally carries over to the Asian session, the yen will retreat further, particularly against the commodity currencies. Markets remain volatile however so any sudden shift in direction could see the yen recover sharply. The best value trade on the yen right now is a sell of EUR/JPY as a rise in risk aversion in the coming days is likely to see a significant decline in that pair. Strategy: Sell EUR/JPY on prices above Y159 with limit targets of Y158, Y157.50 and Y157.10.

The loonie has gained against every other major currency today as the commodity currency shakes off the Bank of Canada 50 basis point rate cut with arrogant ease. The loonie has shown itself to be largely immune to interest rate decisions in recent months and it is the only major currency that has not been adversely affected by whatever the Bank of Canada might throw at it. Broad dollar weakness and rising commodity prices has seen the loonie push the dollar back to 0.9860 Wednesday, over one cent below the price the greenback reached on Tuesday. As long as this disconnect persists between commodity prices and a slowing global economy, the loonie looks destined to be well supported. The Bank of Canada did clearly state further easing was on the way, something which may limit the extent to which the loonie can appreciate. However a weak close below 0.9850 today could see recent lows revisited later in the week, especially if Friday’s employment data from both the US and Canada proves more positive for Canada. I am bearish on the loonie but just don’t like the market at present, with unpredictable erratic moves commonplace. For that reason I am inclined to hold off coming into the market for now, at least until after this week’s major risk events. Any dips below 1.50 on EUR/CAD offer good buy value for those waiting to pounce on an opportunity. Strategy: Wait until market USD/CAD settles and a sense of normality returns.

Bob B - Mar 5

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