Tuesday, June 3, 2008

Bob's Currency Focus - 12:30 GMT

The euro has staged a recovery Tuesday, pushing back above 1.56 against the dollar with the dollar being hurt by a Wall Street Journal report that US investment bank Lehman Brothers needs to raise extra capital while the euro is boosted as markets anticipate a firm stance on inflation from the ECB in its policy statement this coming Thursday, following a jump in the annualised inflation rate to 3.6% for the single currency economy. Quarter 1 GDP for the euro area was revised to 0.8% today from the 0.7% originally reported last month and producer prices in the euro area rose a record 6.1% on the year in April , something that is sure to fuel further hawkish rhetoric from the ECB. The ECB could decide to up the ante this week given the explosion seen in fuel costs over the past month and this could see the euro advance, even if the move is temporary. There is little value in selling the euro ahead of the ECB, given the underlying risks, although any advance back towards 1.58 offers good sell down value. US data has proven to be more robust than expected over the past week but the critical test will come this Friday with May’s employment report. Wednesday’s ADP employment report and the ISM services PMI will give the market some direction ahead of Friday. All told, we are likely to remain in a tight range ahead of the ECB on Thursday, but any gains earned by the euro on Thursday could be cancelled out by a better than expected non-farm payroll number on Friday. With the rate outlook quite uncertain at present, i.e. rates are expected to be kept on hold in both jurisdictions for the foreseeable future, the risks over the medium term remain to the downside because of the elevated value of the euro and the potential for further deterioration in euro area economic data. Keep a close watch on Wednesday’s Services PMI from the euro area because if it dips below 50, it will shake confidence in the single currency ahead of the ECB on Thursday.

Sterling is mostly unchanged Tuesday after giving up much of last week’s gains in a single session on Monday. Economic data out of the UK continues to get worse and after a flat reading yesterday for the manufacturing sector in May, the construction sector on Tuesday reported its steepest decline in 11 years in May. Add to this the woes currently being experienced by the UK financial sector and we begin to see an economy on the brink. Wednesday’s CIPS services PMI reading will complete the economic picture ahead of Thursday’s Bank of England meeting. If this reading reports a contraction (<50) in the non-manufacturing sector, we could see sterling nosedive ahead of the MPC rate announcement on Thursday. Sterling is essentially being protected by the MPC’s hawkish stance on inflation with markets pricing out the prospect of any imminent rate cuts, but a sharp deterioration in economic performance could erode that confidence in the currency and send it into freefall, particularly against the dollar. Cable does not offer any value on prices over 1.98, given the stresses in the UK economy and the fact the US Fed is more or less done cutting rates and the pair should come under ongoing selling pressure on prices above this level. A break below support at 1.96 could see the pair slide all the way back to 1.94 later in the week. If the Bank of England surprises markets and cuts rates this Thursday, then expect sterling to sell off broadly across the board.

The yen advanced again on Tuesday but has failed to hold onto its gains and is currently trading lower against every other major currency as risk appetite outscores risk aversion in the currency markets, despite global stock markets trading in the red for the past 24 hours. There is little in the way of domestic data out of Japan this week and the yen’s fortunes are wholly dependent on broader risk sentiment with the demand for carry trades likely to keep the currency under pressure. The dollar keeps bouncing back from any dips in the USD/JPY exchange rate and the value buy is on this pair, with dips towards 103 offering good short - medium term value. If US data surprises to the upside this week and stock markets recover, the dollar could rally to above Y106 for the first time this quarter. The euro offers little value at current prices and while EUR/JPY could approach Y165 around the time of the ECB meeting later in the week, this may offer a good sell down opportunity, with the possibility of a return to 1.58 over the next month. The yen remains under pressure against the high yielding aussie and kiwi dollars but any prick in the commodity price bubble would see these pairs plunge and they offer little medium term value.

The loonie gave up parity against the greenback for the first time in 2 weeks on Monday but has steadied today as the US currency failed to extend its rally beyond 1.0026. Friday’s negative GDP number is unlikely to be forgotten so quickly though and with a Bank of Canada monetary policy meeting on the horizon next week, the loonie may likely come under further selling pressure, particularly if oil prices retreat. A rate cute now seems likely next Tuesday, even if the Bank keeps it to 25 basis points. The strength of the loonie now appears to be a bigger risk to the Canadian economy than a US slowdown, as Canada’s economy underperformed the US economy by a full percentage point in the first quarter, despite the well-documented woes in the US. The Bank of Canada must be very worried by the fact the loonie has failed to depreciate at all despite rate cutes equalling 150 basis points since last November and an economic performance which now registers as the worst across all G8 countries for the past 6 months. It seems speculators cannot easily be dissuaded from buying the loonie or Canadian energy and resource stocks while commodity prices are on the rise, regardless of how the domestic economy performs. This Friday’s labour figures for May will be an important gauge for the economy, although it may not greatly influence the Bank of Canada’s decision next Tuesday. Fear over a potential rate cut is likely to lead to an exodus of Loonie longs over the next week and we should see a climb to 1.02 between now and then for USD/CAD. The euro could also extend its gains against the loonie this week as the ECB meeting on Thursday is likely to reaffirm the divergent positions of the two Central Banks.

Bob B - Jun 3

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