Wednesday, April 23, 2008

Bob's Currency Focus - 12:30 GMT

1.60 has been breached
The euro crossed the 1.60 line on Tuesday April 22nd 2008 for the first time ever. It is worth noting that it only took the euro just under 2 months to go from 1.50 to 1.60. Previously it took 5 months for the euro to appreciate from 1.40 to 1.50, while it had taken all of 10 months to move to 1.40 from 1.30. To what can we attribute the acceleration in pace of the euro’s appreciation against the greenback? Undoubtedly the Fed’s aggressive policy of monetary easing against a static and stubborn ECB has been the primary driver, yet the quickening pace of the dollar’s demise in recent weeks is adding a new dimension – extreme complacency. The failure of the world’s major Central Banks to address the alarming price distortions being witnessed across both currency and commodity markets has only served to feed this complacency and has led to greater price distortions and rampant speculatively-induced inflation, at a time when the global economy is by all accounts slowing. It is no coincidence that oil prices spiked towards $120 a barrel on exactly the same day as the dollar ceded another key price level to the euro. We now have the bizarre situation where a high euro, rather than curbing inflation, is in fact fuelling it. Energy and food prices are rising as the euro rises, but at a much faster pace, forming major price bubbles across nearly all the commodity classes. Global inflation will only slow this year if we see a dollar recovery, simply because global inflation is being driven by commodity prices, which in turn are priced in dollars that is under sustained attack. Were the ECB to be ultra-brave and be creative in its policy outlook it might see that a softening in its policy stance would trigger a dollar rebound, which in turn would prick the price bubble in the commodity classes and drive global inflation lower, not just for the US, but also for the euro zone and the wider globe. Most ECB policymakers however are traditionalists and creativity is not part of their make-up.

The dollar declined across the board Tuesday as yet another poor set of housing sales numbers raised concerns as to whether the housing slump has yet hit a bottom and supporting the view that the world’s largest economy is now in a protracted recession. In the euro zone, the flash estimate for the services PMI in April came in higher than expected, while the manufacturing PMI was lower than expected. The composite index is seen as unchanged from March and this will be used as evidence by the ECB that its current monetary policy stance is the right one. Of more concern is the fact that consumer spending in France fell sharply by 1.7% in March. Tightening credit conditions, lower confidence and rising energy and food costs is having an adverse impact on the consumer, at least in the euro zone’s second biggest economy. The euro’s rise to 1.60 yesterday was inevitable given the solid support eh euro has gained on any dips against the dollar in recent weeks. We have not heard too many strong complaints from the euro area and it may well be that traders will be given a free ride to take the pair possibly towards 1.62, before the market looks more closely at value again. However a failure to sustain a price above 1.60 could be read by many that the euro has peaked for now and a sharp reversal back to 1.57, or even lower, is possible over the coming days. It is high risk to buy the euro at current price levels, given the correlation between the dollar and oil prices at the moment. Any sharp reversal in oil prices is likely to trigger a wave of selling on EUR/USD. Oil prices need to be followed closely in the coming days, as the commodity’s current spike is driven almost entirely by speculative interests and Nymex came closer to hitting an unprecedented $120 a barrel on Tuesday. Strategy: Look to sell down EUR/USD on value grounds, taking prices close to 1.60. Place a stop above 1.6060.

The Bank of England minutes surprised Wednesday when they revealed there was a 3-way split in the vote on interest rates earlier this month. Only 6 members voted for the 25 basis points cut which was subsequently adopted, 2 members voted to stand pat and one member of the Committee (Mr Blanchflower) preferred a 50 basis points cut. Doubts have been raised about just how aggressive the MPC will be in cutting rates in the coming months and this helped give sterling a temporary lift this morning. In other data released today, the BBA reported that March saw the lowest number of mortgage approvals on record, the figure falling to 35.4K from 43.9K a month earlier. The UK housing sector is in a major downward spiral and Thursday’s retail sales numbers for March will be crucial for determining where interest rates may go to next. Cable looks to be way over-priced anywhere near 2.00 and even a temporary dollar revival could easily see the pound plunge back towards 1.96. The euro is also inflated in value at the moment and it is not worth buying the single currency against the pound on prices above 0.80. Strategy: sell cable on prices above 1.9950 with price targets of 1.9810, 1.9760, 1.9725, 1.9675 and 1.9620. Place a stop loss above 2.0025.

The yen has struggled to make inroads over the past week and has fallen to a multi-month low against the euro (164.96). It has held its own against the dollar in recent days having dipped to 104.65 last week, but the yen is trading a long way off the highs it hit last month. Many traders believe the worst is behind us in terms of the credit crisis and the appetite for carry trades is on the rise and this is something that has seen the Aussie dollar in particular rise spectacularly against the yen in the past week. Of course with the US likely in recession and a slowdown accelerating elsewhere, this complacency may be premature and ill-placed and we may still see a significant spike in risk aversion, particularly over the next 2 weeks, when key data releases are scheduled out of the US. The best value trade for the yen is against the euro and will not be difficult for the EUR/JPY pair to return to Y160 from the highs around Y165 seen over the past 24 hours. Japan’s trade surplus narrowed significantly in March and it has deepened concerns the world’s second largest economy could follow the US into recession because of its dependency on the export sector. The yen could benefit from a sell-off in commodities which would diffuse the carry trade and send the Japanese currency significantly higher against the high-yielding currencies such as the Aussie and New Zealand dollars. Strategy: Sell EUR/JPY on prices close to Y165, with target of Y161.

The Bank of Canada cut rates by a further 50 basis points on Tuesday, bringing the base rate to 3.00%, down from the 4.5% from late last year. The Bank’s statement hinted at further rate cuts but said it was dependent on the performance of the US economy. There is confidence that domestic demand in Canada is holding up well despite the sharp downturn south of the border. The statement has removed the word ‘imminent’ in terms of the pace of its easing policy, which suggests rates could remain on hold at the next meeting, unless there is a sharp deterioration in the performance of the economy. The loonie is now very unattractive on yield grounds but remains supported by high commodity prices and the currency is unlikely to capitulate while oil prices remain so elevated. The loonie is also likely to appreciate sharply against currencies such as the euro and the yen, if the US economy were to show signs of a rebound. Canada’s interest rates have been cut thanks to the US economy’s malaise and a sharp rebound in the US economy will see the loonie strengthen. The biggest risk to the loonie in the short-term is any sharp reversal in oil prices, which would see the loonie sell-off intensify, primarily against the US dollar. For now, the currency is range-bound and there is value in buying USD/CAD on dips towards the parity line, with the upside currently capped at 1.03.

Bob B - Apr 23

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