Friday, April 25, 2008

Bob's Currency Focus - 14:30 GMT

The euro has peaked for now and with speculation rising that a rate cut from the Fed next week could be the last before then pausing, many traders are reluctant to pour back into the euro in the run-up to that event. The euro has lived a charmed life in recent weeks because the penetration of the 1.60 price barrier was achieved because of an aggressive determination by a more illiquid market to see the mark being hit, moreover any radical shift favouring the euro in the underlying fundamentals. The ECB’s hawkish stance remains intact but the meteoric rise in energy costs has put paid to any idea the Fed might be cutting interest rates to 1% in the coming months. Even were the ECB to stand pat for the remainder of this year, US inflation risks would suggest that, after next week’s Fed rate decision, we are unlikely to see any great widening of US and Euro zone interest rates through to the end of the year. A strengthening dollar would have the impact of dampening global inflation and if growth data in the Euro zone continues to soften further, the likelihood of an ECB rate cut before the end of the year would rise and the euro will go into reverse gear. Traders will still be willing to jump on the euro on any dips in the short-term because the single currency’s rapid rise since last September has made the currency look too much like a sure thing to many, come what may. If the Fed signals a pause in rates in its latest statement next Wednesday, presumably after having cut the Fed Funds rate to 2%, then the euro will be in trouble and the peak of 1.6015 hit earlier this week could begin to look like a colossus. Between now and then we may range between 1.55 and 1.5750, but if the dollar breaches the 1.5550 support level, the pair could conceivably fall to 1.5341, the point which is the next proven level of euro support. Whether 1.50 or 1.60 will give way first could very much depend on the Fed’s statement next week.

Sterling has held its own over the past two days at a time when the US dollar has appreciated sharply against other currencies. The pound is in effect benefiting from the fact other currencies have been excessively over-extended against the dollar and the close-out of a large quantity of these positions has seen many currencies, the euro and Swiss franc in particular, lose out spectacularly. This has automatically pushed up the value of the pound against its European rivals. However, if the dollar falters again, sterling will likely fall against the euro. Quarter 1 GDP out of the UK was in line with forecast, rising 0.4% on the quarter and 2.5% on the year. The UK economy, despite the ghastly picture painted, performed reasonably well under the circumstances and has out-performed the US economy significantly thus far this year. The problem for sterling is that there is a consensus view that the economy is going to deteriorate from here and that the housing sector is going to plunge deeper into crisis. The Bank of England is going to be under pressure again to cut rates when it meets in May and as long as the rate differential outlook continues to disfavour sterling, the pound will feel the heat, particularly following any rallies. If the euro continues to fall against the dollar it might help the pound push the euro back to 78 pence, otherwise a broader euro rally is likely to see a return to 80 pence. Cable offers little value above 1.98 and offers an opportunity to sell down on prices close to 1.99. Cable could possibly fall to 1.95 next week, if the Fed signals a shift in policy towards a pause in rates, after next Wednesday’s FOMC meeting.

The yen has gained 2 yen against the euro in the past 2 days but its gains are wholly attributable to a stronger US dollar which has seen a close-out in over-extended positions on the euro, while it has also benefited from a fall in commodity prices which has led to a shaving of carry trade positions, particularly in AUD/JPY and NZD/JPY. Last night’s CPI data release in Japan revealed that inflation in the world’s second strongest economy rose to an annualised 1.2% in March, in line with expectations, yet at an unprecedented level for an economy that has been gripped by deflation for much of the past 7 years. If the worst of the credit crisis has passed, a return to normality could raise the prospect of an increase in Japanese interest rates later in the year. Aggressive selling of the yen on longer-run positional grounds could be a mistake, especially against the euro. In the short-term however the yen could find itself on the defensive against the US dollar and we could see USD/JPY rise to 108 in the next couple of weeks, if the Fed hints at a pause in its monetary easing. A sharp decline in commodity prices will protect the yen as it will benefit from the subsequent unwinding of carry trades. The euro offers little or no value on any prices close to Y165 and this is the one pair where the yen may still offer real value, but the yen’s wider fortunes will depend on the reaction of global markets to the Fed’s policy announcement next week.

The loonie has performed exceptionally well over the past two days and has recouped all of the losses it incurred (against all currencies except the greenback that is), after the Bank of Canada cut the overnight lending rate by 50 basis points to 3.0% on Tuesday. The Canadian currency still carries appeal to investors as long as commodity prices remain relatively elevated. Oil has bounced back Friday following two days in retreat and this has boosted the loonie, along with a new inflow of funds back into North American assets. There was no domestic data out of Canada Friday. USD/CAD remains range-bound between 1.00 and 1.03 and offers good value for bids on prices close to 1.0050 and for sells on prices above 1.0250. Most of the price action this week has been in the 1.01 to 1.02 price region with bias marginally favouring the upside. If the US Fed signal a pause in its easing policy next week, the Bank of Canada is likely to follow suit and this could spark a major loonie rally against the euro and the yen.

Bob B - Apr 25

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