Tuesday, May 20, 2008

Bob's Currency Focus - 12:15 GMT

The euro has hit a high for the month on Tuesday, reaching 1.5673, with the dollar retreating broadly across the board. Rocketing oil prices are having an adverse impact on the dollar over the past week and it will probably take a sustained reversal in energy prices to provoke a meaningful rally for the greenback. German producer prices came in twice as high as expected for April and with costs spiraling everywhere at present, the inflation threat is fast becoming the dominant market influence. Of course the trigger for the current rally in oil was the Fed’s monetary easing policy which began last September and while this policy has helped to ease the credit crisis, it has also resulted in a significant increase in the cost of living for everyone, thanks to the frenzy-like rally experienced in commodity prices. The impact on consumer discretionary spending should not be underestimated, even if equity markets have failed to notice the threat to date. Consumer and business sentiment indicators should be watched very closely over the coming weeks as these will give more of a current market insight than actual growth and output numbers. Germany’s important ZEW survey, released Tuesday, pointed to further decline in confidence on the part of investors in May. The result was a surprise as a marginal improvement was expected. This did not stop the euro rally and the single currency is currently trading at more than a cent up on the day. There is no chance of a rate cut from the ECB in the immediate future and with inflation further on the rise, it is a rate hike that is beginning to look the more likely. There is the possibility of a push to 1.5720 for EUR/USD, before a sharp pullback to below 1.55. The US calendar is relatively bare this week with Producer Prices today and Friday’s Existing Home Sales the highlights. There are more significant indicators out of the euro area this week – the German Ifo survey is released Wednesday and the preliminary readings for the May PMIs are out on Thursday. The euro is overvalued, even if dollar confidence is low and any downside surprises in the Ifo and PMI numbers could trigger major rallies to the downside for EUR/USD.

Sterling has benefited handsomely from a dollar retreat and cable rose to 1.9665 earlier today, up almost 2 cents from last night’s close. There was no data out of the UK and sterling’s surprising rally is thanks to an influx of funds into the high yielding currencies and a fall in confidence for the dollar. The pound is unchanged against the euro, down against the franc and up against the yen. The fundamentals have not changed and the fact remains the UK economy is slowing and economic data is deteriorating, so sterling remains exposed to sharp sell-offs, on any meaningful rallies, particularly against the dollar. Attention tomorrow will switch to the Bank of England’s minutes from their May meeting, when they are released at 08:30 GMT and with inflation riding high, a hawkish set of minutes seems likely, possibly ruling out a rate cut in June. Inflation is an issue for all Central Banks at the moment, but the high inflation threat is likely to offer nothing more than temporary protection to sterling, given the eroding growth fundamentals in the UK. Cable should be sold down on any rallies close to 1.9770 and a return to 1.9400 is a high probability over the course of this week. There is little value in buying the euro against sterling at present prices, although a break above 80 pence could trigger a momentum-driven rise to 81 pence. Sterling is exposed on the yen and Swiss crosses, if stock markets extend their declines through to Wednesday.

The yen has made modest gains against the dollar Tuesday, but has lost against every other major currency as the Bank of Japan stands pat on interest rates. The Central Bank also today warned of the downside risks to the economy, thereby ruling out the prospect of a near-term rate hike and fuelling a new wave of carry trades. The Aussie dollar has risen to Y100 today despite a sharp decline in equities in both Asia and Europe, while the euro has risen to Y163. While risk appetite remains high the yen is going to struggle to make any headway and it will be prone to immediate sell-offs on any significant rallies. The dollar is currently hemmed into a 103 to 105.50 price range, but the smart money is buying the pair on dips. The euro is over-extended against the yen and while there is a chance of a rally to Y165, there is the risk of a return to Y158, especially if the decline in stocks continues as a theme this week. AUD/JPY should be watched closely as this is the standard bearer for the carry trade and a rally that extends to above Y100 could spark a further wave of carry buying, particularly for the high-yielders.

The loonie has been on a remarkable rally over the past week, gaining substantially against every other major currency, with the exception of the Aussie dollar. On Tuesday USD/CAD hit a low of 0.9874 and is currently trading just above this price level. Economic data has proven to be of only secondary importance to commodity prices when determining price direction for the loonie and the Canadian currency is the benefactor behind a major speculative drive in the past week. There are some important data releases out this week, with consumer price inflation and retail sales numbers out on Wednesday and Thursday respectively. Even a poor set of data numbers may not derail the loonie as it has shown itself to be pretty much immune to adverse economic data throughout this year. Any prick in the commodity bubble would be much more damaging for the loonie’s immediate fortunes and a reversal in oil prices could signal a sharp retreat in the Canadian currency. A dip below 0.9850 is possible today but a sharp return back above the parity line for USD/CAD is most probably in the coming days. The euro looks to offer good value against the loonie on any dips to or below 1.54, with a probable return to 1.56 later in the week.

Bob B - May 20


Anonymous said...

Can you comment on the current (circa May 20, 2008) environment for CHFUSD ?

Is this something you analyze frequently ?

I think it is very interesting in relation to EURUSD, especially if the two (EUR and CHF) ever diverge from their current lockstep...

Unknown said...

The Swiss franc is still treated as a carry currency, even though Swiss interest rates are higher than those in the US and it tends to be sold off aggressively when risk tolerance is high. USD/CHF can be very profitable if one calls the direction right as it can move more than EUR/USD, given the relationship to equities and risk aversion. It is more difficult to call intraday in a volatile environment, but in the medium term I would be inclined to be slightly bullish on USD/CHF over the medium term and to buy it on dips. However, I don't think equity markets reflect the deteriorating economic fundamentals and credit market risk at the moment and a sudden dose of reality could see the Swissie revisit recent highs against the dollar, ie.. USD/CHF plunging to 0.98 again. But it would likely be temporary and we could witness a return to 110 by the end of the summer as the dollar embarks on a retracement path. If equities do push lower, following the exaggerated rise over the past 2 months, EUR/CHF should fall to 1.55, or even 1.50 as the outlook for the Swiss economy is much better than that for the euro one.

Bob B

Anonymous said...


I am not a currency trader - rather, I am using CHF to hedge long term weakness in the dollar for my own personal finances.

With that in mind, I chose CHF instead of EUR because I think the swiss economy is more stable and stronger than Europe as a whole.

It's interesting that CHF is still considered an active carry trade - I thought it had all been relegated to JPY at this point. This is just icing on the cake, I guess, because a carry trade unwind would be even more in my favor.

It is my opinion that Buffets trip to Europe to consider European companies (read: euro-denominated assets) for the first time is a long term bearish signal for the dollar. So even in the face of day in or day out CHF weakness vs. the dollar, I think I will just hold on to them for the long term.

Comments ? Thanks for your interesting blog.

Unknown said...

I believe you made a wise choice in choosing the CHF ahead of the euro, because Switzerland has a much healthier current account balance and being a sole economy, it does not have the added risk of constituent economic diversification which is a threat to the euro.

I do believe the dollar will rally, potentially strongly, in the second half of this year because:

delayed contagion could see the euro economy and UK economies slow dramatically through the rest of the year, resulting in the interest rate outlook over the next 12 months favouring the dollar and this will result in a sell-off of the euro and pound. In this environment, assuming the Swiss economy reamins strong, the Swiss franc will do better against the euro and pound than it might against the dollar.

2) The commodity bubble may burst spectacularly and the dollar will soar as an easing in global inflation will make it more likley that interest rate cuts will be cut more aggressively in other jurisdictions than they will in the US. The current spike in oil prices is not sustainable and it is not reflective of a slowing global economy, even if over the longer run (years) oil is destined to rise further.

3) If things continue as they are and commodity prices keep rising, inflation is going to become a major issue, requiring monetary policy tightening at a time when growth is faltering. The risks of such a scenario to the global economy are enormous and it may well be that Central Banks will agree to intervene in the foreign exchange markets to help prop up the dollar. It is much easier for the world's central banks to justify such a move from a fundamental perspective when the Fed has come to the end of its easing cycle (as opposed to being in the middle of it), which it looks to have done right now.

I would be very cautious being short on the dollar right now, given the risks for a medium-term recovery. Some currencies have simply appreciated too much against the greenback in too short a space of time (primarily CHF, EUR, AUD, CAD) and a period of respite is required for all.

Buffet should have arrived 2 years ago.