Monday, June 23, 2008

Bob's Currency Focus - 16:00 GMT

The euro on Monday gave back all of its gains from Friday following a poor run of data releases. The timeliness of this data could not be more significant, given the ECB is expected to a deliver a 0.25% rate hike when it deliberates next week. Germany’s monthly Ifo business survey, an important business sentiment measure for the euro area’s largest economy, fell more than expected in June, the index declining to 101.3 from 103.5, against a forecast decline to 102.5. A more damaging release came in the form of June’s preliminary PMI readings for the euro area’s manufacturing and services sectors, both of which recorded a contraction (<50) and the combined composite PMI index is now seen at 49.5, the lowest reading in 5 years. Some pressure may now be put on the ECB to suspend next week’s signalled rate hike, although the ECB is likely to stand firm against opposition and raise rates by 0.25%, if only to protect its credibility. Concerns are beginning to grow about the health of the euro zone economy and the next 10 days could prove to be a defining period for the single currency. If the Fed acts tough this week (policy statement due out on Wednesday), i.e. the FOMC points to future rate hikes, followed next week by a ‘stand pat’ ECB or an ECB which states the July rate hike is a ‘once off,’ then the euro could capitulate and we could be at 1.50 within the next 2 weeks. For now, the dollar must break below 1.5460 if it is to have any chance of giving euro supporters a bloody nose in the short-term. A break below 1.5460 should pave the way for a retreat to 1.5350 ahead of the Fed on Wednesday evening. Markets need to be on their guard for comments from members of the ECB Governing Council in the next few days, because any softening in tone ahead of next week’s key rate setting meeting will badly hurt the euro. Expect direction to gravitate more towards the lower end of 1.53 to 1.58 trading range over the coming days, with euro supporters needing a more dovish sounding Fed to boost the single currency. Between now and then, sell on any rallies back towards 1.56, with downside price targets of 1.5480, 1.5410 and 1.5360. A tough policy stance on inflation from the Fed could force the pair down to test the near 4-month low at 1.5287.

Cable has proven itself to be the most lucrative of the major trading pairs over the past few months, with the pair essentially bobbing between 1.94 and 1.98 on an ongoing basis. The pound burst from its lows near 1.94 a week ago to almost hit 1.98 on Friday, thanks almost exclusively to a stunning set of retail sales figures for May, released last Thursday. As to whether one can believe the numbers is another thing, particularly when it coincides with a slowdown in money supply and a further deterioration in UK house prices. The market has gone off the idea of imminent rate cuts from the Bank of England, with some analysts even forecasting a rate hike in the near-term, and this is protecting the pound, for now. Sterling has given back almost 2 cents against the dollar on Monday as the US currency picked up gains across the board. UK data is on the light side this week, with Thursday’s Nationwide House prices likely to be the only real market moving release its side of the Atlantic. The pound’s fate over the course of the week will be determined by the markets reaction to US data and to the Fed’s statement on Wednesday next. US data has been soft of late and there is no reason to suspect anything different this week, particularly from Tuesday’s Consumer Confidence index and Wednesday’s Durable Orders numbers. Any sustained falloff in oil prices will prove to be negative for the pound as it could temporarily erode global inflation, fears which are preventing the Bank of England from cutting interest rates. Key support levels to watch are 1.9460, 1.94 and 1.9335. Anything that leads to a decline to below 1.9335 will mean a major rethink for the pair’s trading range. Barring a very tough Fed statement, cable should be contained within recent trading ranges, but the preferred trade is to sell down on any rallies above 1.9750. Target downside prices are 1.96, 1.9550, 1.9480 and 1.9410.

The yen has failed to make inroads today and it has ceded Friday’s gains to the dollar. It has strengthened modestly against the euro, but only because the euro is coming off the back of some very weak economic data on Monday. With inflation the key influencing factor, yield outlook is the principal driver for currency markets right now and with no rate hikes in Japan probable this year, the low-yielding Japanese currency remains a favourite sell. This is clearly demonstrated by the fact the yen has fallen rather sharply against every other major currency in the past month, despite a significant unravelling in global stock indices. The currency is clearly undervalued, particularly against the euro, but it will struggle to make any headway against the majors in the short-term, unless we see a dramatic unwinding in the EUR/JPY cross. Any hint of an imminent rate hike from the Fed, when it deliberates this week, is likely to push the dollar higher against the yen and could open the way for a move to Y110, possibly even by the end of this week, particularly if US economic data is more robust than expected. The safest trade involving the yen probably remains a ‘bid’ on USD/JPY, when the pair dips towards Y107 or below. The yen’s exchange rate will continue to be dictated by interest rate expectations elsewhere, rather than by domestic economic data out of Japan.

The loonie has essentially been stuck within a 101 to 102 trading range for the past week, with the dollar once again failing to make any real impact while momentum was on its side. The loonie is being protected by soaring oil prices and last Friday’s better than expected retail sales numbers from Canada reveals the economy has yet to capsize under the weight of a strong domestic currency. The loonie/greenback pair is lacking direction right now, though it has taken on more of a bearish tone in recent days. But the risks for USD/CAD probably lie to the upside this week, given the possibility of some hawkish rhetoric from the Fed, the risk of a retreat in oil prices and a light economic calendar in Canada. Weak economic data out of the US over the next few days could push the pair either way, as soft US economic data is not generally a positive for the loonie, because of the importance of the US economy to Canada’s huge exporting sector. There is evidence over the last week that petro traders are back on the loonie and the currency’s wider fate this week should be dictated by oil prices. 1.01 has held in recent days on USD/CAD and any price close to this level does offer a decent entry price for buyers, given the upside risks coming later in the week. Traders should be wary and use a short stop as a break below 1.01 could trigger a rapid return to the parity line. Longer run positional traders should just hold out on their long USD/CAD positions and wait for a return to 103.20 at the very least.

Bob B - Jun 23

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