Wednesday, April 30, 2008

Bob's Currency Focus - 15:30 GMT

Trading has been somewhat tentative on Wednesday ahead of the Fed’s monetary policy announcement later this evening. The dollar has managed to retain most of the gains earned from last week and pushed the euro to as low as 1.5526 this morning, before the euro rallied to send the pair back to where it started the day, i.e. 1.5565. Economic data out of the euro area continues to soften and today’s inflation estimate for April, which printed at 3.3%, is down from 3.6% in March. This suggests any notion of an imminent rate hike from the ECB is not part of the equation. Germany’s employment data for last month also printed softer than expected and with euro area business confidence plunging to the lowest level seen since 2005 (according to the latest economic survey from the EU), the euro is going to find it difficult to regain the sort of momentum that saw it rise to a record 1.60 just last week. US GDP data for Quarter 1, reported up a paltry 0.6% on the year, had little market impact and the immediate direction of the dollar will be determined by the US Fed statement later this evening. A 0.25% cut looks assured, but all eyes will be on the accompanying statement. There have been suggestions of a pause after tonight’s policy announcement, something which is certain to benefit the dollar in the short to medium term. It is conceivable the Fed will deliver a 50 basis points cut, especially if the Fed intends to signal the easing cycle is over. The FOMC members will be privy to the latest employment numbers, due for publication this Friday, and this could determine what way the Committee leans today. The euro is vulnerable for a retreat to 1.5280, at least, if the FOMC statement favours the dollar. There is also a risk the Fed may signal it is not yet done in this easing round and it might choose to point to ongoing risks for US growth prospects, something that could spark a major dollar sell-off. There is no real benefit in trying to trade Fed’s hand and the market’s subsequent reaction and my advice is to stay away from the market until the dust settles.

Cable has been trading erratically within a 1.96 to 2.0024 price range for the past few weeks, with neither side able to establish control. However, with so much bad news priced into the dollar already and the interest rate differential outlook for the 2 currencies looking to favour the dollar in the medium to longer-term period, it is very dangerous to buy cable on prices close to the 2 dollar mark. In fact, if the Fed point to a pause in interest rates following today’s rate decision, sterling could come off more than most currencies given the Fed decision is likely to have little bearing on the direction of UK interest rates, which are headed lower regardless. UK house prices are slowing at the fastest pace in 12 years according to the latest survey from Nationwide and this survey comes hot on the heels of similarly bleak house surveys earlier in the month. The Bank of England meets again next week and a further rate cut is certain to be on the agenda, even if the two established hawks on the MPC voted against a rate cut at the last meeting. If US data this week supports a pause in US interest rates, then cable could move to 1.95 by Friday. Of key importance to the pound will be Thursday’s CIPS manufacturing index. If this prints higher than expected, then it could cast doubt on a Bank of England rate cut next week and it might earn the pound some respite, if temporary. The euro has finally some under some selling pressure and the pound could push the single currency back towards 78 pence yet again, although the pound is likely to come under heavy selling pressure after any meaningful rally.

The yen was sold off sharply against the dollar during the early part of the US trading session with many traders gambling the Fed will signal a pause in its monetary policy. A bounce in global stock markets has also hampered the Japanese currency which sold off broadly, particularly against the high yielding currencies like the Aussie dollar, New Zealand dollar and sterling. The Bank of Japan kept Japan's rates on hold at 0.5% earlier today and the Central Bank downgraded its GDP forecast for 2008, from 2.15 to 1.5%. In other domestic data out today, industrial production slipped by 3.1% in March from a year earlier while household spending was down by 1% over the same period. If the Fed gives a more upbeat assessment of the US economy for the remainder of the year, then the yen could become the biggest loser with traders likely to target the USD/JPY carry and attempt to send the pair back towards 108 over the next week. If the Fed disappoints markets and we witness a fresh bout of risk aversion, the yen will benefit. There is blatant complacency in the carry trade, which is somewhat premature given global economic data has in fact been deteriorating and not getting better. There is no value in trading the yen ahead of the Fed announcement and perhaps even less still to trade it immediately after the rate announcement is made. The yen offers best value on EUR/JPY with a return to Y160 likely on value grounds alone, even if there is a sudden yen sell-off this evening.

The loonie has performed remarkably well this week and it has made significant gains against the euro and the Swiss franc, having hit major lows early last week. The loonie pushed the euro back as far as 1.5618 this morning – at one point recently the euro was worth 1.63. The loonie is benefiting from a market assumption that a pause in US interest rates translates into a pause for Canadian interest rates, but if the assumption surrounding the Fed fails to hold true this evening, expect the loonie to retreat against the euro. GDP in February fell by 0.2%, following a 0.6% rise in January. Input prices rose sharply in March but because consumer prices remained mooted, it means producers are not passing on the bulk of these increases to Canadian consumers, probably because of the increased competition from South of the border. USD/CAD remains the most range-bound pair of all the majors – trading between 1.00 and 1.03, but the risks are that the pair could push higher in the medium term, so buying on dips to around 1.0050 may be the best strategy for now.

Bob B - Apr 30

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