Monday, June 30, 2008

Bob's Currency Focus

EUR/USD
Eurozone inflation has surprised on the upside, with the flash estimate for June coming in at an annualised 4.0% rate, against 3.7% in May and a forecast 3.9%. Whatever doubts may have existed about the ECB’s intentions this week have all but vanished and the Governing Council seems certain to raise rates to 4.25% when they meet on Thursday next. Opposition to the move has been mooted and the question now is not a case of whether the ECB will raise rates this week, but rather a case of whether this week’s rise will be the start in a new series of rate rises. The ECB has backed itself into a corner and markets have priced in a further rate hike by September with some analysts now expecting up to 3 rate hikes by the end of the year. Normally this would be very bullish for the currency and indeed the run-up in the euro over the past few weeks has paid testament to this. However we are now looking at a situation where the ECB will be raising interest rates at a time when there is zero or negative growth in the euro zone. An increase in interest rates will serve to expedite the economic slowdown and could potentially derail the euro later in the year. In the short-run this prospect is unlikely to deter traders, whom will want to challenge the 1.6016 high this week. The dollar is being driven by commodity prices, which in turn are influenced by the EUR/USD exchange rate, so with yield differentials set to widen, the immediate outlook for the dollar is not bright. There are a few caveats though, most notably the PMIs out of the euro area on Tuesday and Thursday Vs the US data counterparts. Also, we are dangerously close to further vocal market intervention, as spiralling oil costs sends global stocks plunging and further pits the US economy into recession. Monday sees the end of quarter 2 and some profit-taking is likely to stall the euro’s advance today, but it will continue to be bought on dips in the run-up to Thursday’s ECB. Friday’s US non-farm payroll is unlikely to play a major role in influencing currencies this week, even if we do witness some short-term volatility, because US Fed policy looks set to remain on hold for the foreseeable future. Key resistance on the upside is at 1.5840 and if that gives way, it will leave the way open for euro bulls to push to the illustrious 1.60 price mark. EUR/USD is trading at an uncomfortably high level around 1.58, yet the current risks look to be to the upside and the wise option may be to avoid the pair altogether until after the ECB on Thursday.

GBP/USD
UK mortgage approvals and mortgage lending figures fell to record lows in May, while consumer confidence has sunk to a 16 year low in June against a backdrop of falling house prices and runaway energy costs. Normally such damning data would be sufficient to send sterling packing for a couple of cents against the dollar and over half a penny against the euro, but sterling has found some back teeth in the past week and the UK currency is virtually unchanged on Monday, holding onto the significant gains it made last week against the greenback. There are a few possible reasons for this new-found resilience, one being that we are at the end of the second quarter and profit-taking has led to a liquidation of a large volume of sterling shorts, thus propelling sterling artificially higher. If this is the real reason, then expect sterling to decline, possibly sharply, from Tuesday, as we enter quarter 3. Another plausible reason is the resurgent appetite for high yielding currencies as investors are hedging against a climate of rising inflation and retreating equity values. Sterling is competing again on yield grounds as markets have written off any prospect of rate cuts from the Bank of England this year. The medium to longer term outlook for sterling remains grim however because larger funds are unlikely to want to channel long play funds into a currency where the economy is pretty much tanking. If the CIPS manufacturing and services indices, due out on Tuesday and Thursday, report a contraction in the respective sectors for June, expect sterling’s recent revival to hit a wall. We need to see cable fall below 1.98 to sell the pair again, because while price remains above this support level, bias remains to the upside. The euro could take a run at 80 pence this week against the UK currency, given an expected widening in the rate differentials. Short sterling positions on EUR/GBP could begin to stack up again from Tuesday.

USD/JPY
The yen has been dragged and pulled across the currency markets Monday, first pushing the dollar below Y105 during the morning, only to see the dollar rebound to over Y106 in the afternoon. The euro too has recovered from a low of Y166.08 in the morning to retake the Y167 price handle. Risk aversion, prominent during the Asian session, has given way to complacency as short-term players look for yield and are snapping up USD/JPY and EUR/JPY on dips. Tonight sees the release of the Bank of Japan’s quarterly Tankan Survey, one of the few indicators out of Japan that can really influence the currency market. Thanks to a Reuters slip last Friday, when the news agency inadvertently and prematurely broadcast the quarterly Tankan report results, the market already knows the survey reveals increasing pessimism about the economy and it will help cement the view that the Bank of Japan will not be in a position to start raising interest rates any time soon. The yen is not going to be able to undertake any sustained rally unless we witness a structural breakdown in EUR/JPY. That seems unlikely in the coming days with the rate differential set to widen in favour of the euro on Thursday, so the value trade remains being long on USD/JPY, particularly on dips towards Y105. There is a chance that risk aversion levels could rocket during the week, if the ECB rate announcement has an impact of destabilising the dollar and sending oil prices soaring to even higher record levels.

USD/CAD
The loonie has had a bad day at the office Monday even though GDP was reported to have risen by 0.4% in April, following a contraction over the previous 3 months. The greenback has benefited from profit-taking at the end of the quarter which has seen commodity currencies pare some of the recent gains, and this has hurt the loonie. But it is difficult to see the USD/CAD moving outside of the recent 0.9920 to 103.20 price range anytime soon and the greenback will come under selling pressure on any gains beyond 102.50. In fact Tuesday could witness a sharp reversal in the pair’s direction, if Monday’s greenback rally is nothing more than a profit-taking exercise, which seems likely. Traders should use the opportunity to exit previously stranded USD/CAD longs, rather than use it as an invitation to start going long on the US dollar. Tuesday is a holiday in Canada and this week sees a very light calendar with Friday’s IVEY PMI the only other release of note. Oil prices will continue to be an important influencing factor for the loonie and expect USD/CAD to trade between 1.0050 and 1.0250, with the risk of a breakout to the downside, if the ECB this week helps oil prices to surge. The euro offers no value against the loonie at present values (>1.60), but it is best to wait until after Thursday, before making a decision to enter the market on this trade.

Bob B - Jun 30

2 comments:

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