Thursday, July 10, 2008

Bob's Currency Focus

The euro has performed remarkably well since last Thursday, when it shed 2 cents against the dollar after a less hawkish than expected monetary policy statement from the ECB. The pair has moved within a 1.5610 to 1.5750 trading range since Friday and if anything, the euro has looked the more bullish, with the market seemingly ready to jump on any reason to offload the dollar. An Iranian missile test Wednesday morning saw oil prices stall their recent decline and this has given a bearish tone to the greenback. Poor trade and industrial data out of Germany and France was ignored by markets. German exports fell a sharp 3.2% in May, from April, the 3rd month in 5 that exports have contracted, while the French trade deficit for May was wider than forecast and industrial production came off by a whopping 2.5% in May. The euro’s ability to shake off poor economic data is becoming too much of a habit of late and it is a classic case of nervous currency markets favouring directional trends over economic facts. The US dollar has been unable to sustain any rally it has undergone all year for very long and dollar bulls are proving themselves to be fear-driven creatures, jumping off the train at the slightest hint of weakness or price stalling. The G8 concluded in Japan with leaders failing to make any mention of the weak dollar, something else which has in essence given license to traders to sell the US currency without fear of market intervention. ECB President Jean Claude Trichet, in his address to the European Parliament on Wednesday, sounded much more hawkish than he did last Thursday after the rate setting meeting, and this encouraged further euro buying. The euro currently stands at 1.5710 and while there is little value in buying the single currency at these prices, any rally above that sees price go above 1.5760 might generate greater momentum and send the pair back up to 1.5820. The pair is due a retreat back to 1.55 at least, but the dollar needs something to spark the move. Bernanke addresses Congress on Thursday and any hint of a future rate hike in his testimony will fuel a strong dollar rally. There is very good medium term value in selling down EUR/USD on prices near 1.5750, because of the significant downside risks for the euro economy in the months ahead and the fact the ECB’s growth forecasts may prove to be over-optimistic.

Sterling has bounced off a low of 1.9672 Wednesday to rally to 1.9836 against the dollar early Thursday, before retracing back to 1.9750. UK economic data disappointed again this week and sterling’s rise has more to do with a broadly weaker dollar than a stronger pound. The Nationwide consumer confidence survey for June reported another dip in consumer sentiment, the index falling to 61 from 65 the previous month, while HBOS reported house prices fell 2.0% alone in June. In addition the UK trade deficit was reported to have widened to £7.5B in May, marginally above expectations. Data out of the UK over the past 3 weeks has been depressing and points to an economy that is teetering on recession. However, sterling has hardly budged during this time and if anything it is now trading higher as traders bet the BoE will not cut rates while inflation is a threat and markets have priced in an actual hike in the coming months. In a normal economic cycle, the pound would now be pummelled, but the currency is currently evading collapse because the Bank of England’s hands are tied and traders are opting to persist with sterling because of its attractive yield of 5.0%. The MPC on Thursday, as expected, left rates unchanged and the Committee refrained from issuing an accompanying statement. Markets are currently rewarding higher yielding currencies, regardless of economic data and outlook and in this scenario sterling is likely to hold within current ranges, although there remains the risk of speculators going after the currency in the near future, because of the dismal economic picture in the UK. The dollar must break below 1.9650 to have any chance of pushing the pair back to the lower end of the range and the year’s lows under 1.94, otherwise the pair may well move between 1.97 and 2.00. The value trades are selling down on prices above 1.98. Sterling should be able to hold the euro below 80 pence, unless there is some hint of monetary policy easing from the Bank of England.

The yen is lower against every major currency on Thursday even though equity markets plunged in New York on Wednesday evening and the European bourses are trading between 1% and 2 % lower on Thursday. This apparent disconnect is the strongest evidence available that investors are now more concerned about yield than they are about growth and currency risk. The euro is trading close to its lifetime high against the yen even though European equities have collapsed over the past 6 weeks and economic data out of the euro area has been significantly sifter than that out of Japan. The carry trade seems determined to march on and the only event that might undermine it at the moment is if there is a sustained and convincing retreat in commodity prices, or evidence of a another major bank failure. It is fruitless buying the yen in this environment and the value trade is to buy the dollar against the Japanese currency on dips towards 105 and below 106. If Ben Bernanke’s testimony in front of Congress on Thursday gets the thumbs up from US stock markets, expect the yen to face another sell-off later today.

The loonie had one of its best days in weeks against the greenback on Wednesday, gaining almost a cent, although it failed to penetrate below the 1.01 line. Broad dollar weakness and a bounce in commodity prices helped the loonie gain some impetus. Housing Starts in Canada came off slightly in June, but were I line with forecasts and the data underscores that Canada’s housing sector is essentially free of the financial crisis currently ravaging the US housing sector. The loonie is likely to remain contained within a 1.0070 to 1.02 price range until Friday’s employment report. Another positive employment report could help push the loonie higher against all other currencies, especially if oil prices continue to trade at elevated levels, while a negative employment number could spark a significant sell-off and see USD/CAD return to 102.50 at least. If data is in Canada’s favour, look for the euro to drop to 1.58 by week’s end.

Bob B - Jul 10

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