Monday, July 14, 2008

Bob's Currency Focus

Currency markets are very volatile at present with the fallout from stock markets and commodity markets essentially dictating the short-term direction of all the major currencies. Economic data is hardly getting a look in as panic of financial market collapse in the US becomes the over-riding factor. One striking observation from the past few weeks is that the euro has replaced the yen as the market’s preferred ‘risk aversion’ currency, when stresses are undermining global financial markets. The primary reasons for this is the single currency’s more attractive higher yield and a hawkish ECB. All of the high yielding currencies, in particular sterling and the Aussie dollar, have done particularly well in the past month, despite the crash in global stock markets. The yen is the worst performing currency during this period, which is something of a major surprise, given the yen steamrolled everything before it during the last 3 bouts of major risk aversion in March, January and last August. Sentiment surrounding the US dollar is at an all-time low because of the Fannie Mae and Freddy Mac mortgage lending crisis in the US and because oil prices refuse to let up. Traders are using every ounce of bad news to push up the price of crude and thus put downward pressure on the dollar, which in turn gives added impetus to the spike in prices for the wider commodity class, creating a vicious cycle. It may take direct market intervention to break this cycle because commodity investors are not being deterred by the global economic slowdown theory, while confidence in the wider financial market system is at an all-time low.

The euro is knocking on the door of the lifetime high of 1.6016 and while we have seen a slight retreat on Monday, the dollar came unstuck at support at 1.5840 and the pair has since advanced back towards the 1.59 line. Markets shrugged off the announcements by US Treasury and US Fed in terms of declaring financial support for the ailing mortgage lenders Fannie Mae and Freddy Mac and it is going to take something more special to regain confidence in the US financial system. Another poor economic print from the euro area Monday saw Industrial Production in May plunge by 1.9%, although this was slightly better than the forecast decline of 2.3%. Economic data is taking a back seat at present as dollar sentiment is effectively driving this pair and that sentiment has never been more negative. Tuesday sees the release of the latest ZEW investment sentiment survey from Germany and producer prices in the US, but neither is likely to have any real impact and of more importance will be the testimony before Congress by Fed Chairman Ben Bernanke in the afternoon GMT and any planted comments that may come from governing members of the European Central Bank. The euro looks dangerously overvalued but while it remains so close to the 1.60 price line, traders will want to try and challenge the record highs set back in April. On the other hand any vocal interventions by Central Bankers could send the pair spiralling back 200 points. It is best to stay on the sidelines until the pair settles down somewhat, although medium to longer term traders might see value in selling down on any prices close to 1.59.

Producer prices came in slightly below expectations in June but it still has not prevented output prices from climbing the most in annual terms in 10 years. While economic activity may be depressed, prices certainly are not and markets are using price inflation to keep the pound well bid, in hope of a rather unlikely rate hike from the Bank of England in the coming months. Tuesday’s consumer price inflation numbers for June will be critical for the pound and the market has already priced in an annualised CPI rate of 3.6%, and anything significantly lower than this will hurt the pound. Like the euro, the pound offers no value on current prices against the dollar, but it is likely to continue to trade in the higher trading range of 1.9650 to 2.0050 until there is some shift in the goalposts. Investors are weighing in behind the pound on yield grounds and also because the euro looks over-priced, but it is dangerous to buy cable on prices above 1.9850, even if the pair does go higher in the short term. Cable is likely to come under increased selling pressure the closer it gets to the 2 dollar mark, particularly if economic data continues to disappoint and points to a more marked downturn for the UK economy. The euro does not offer any value above 80 pence and EUR/GBP could easily decline towards 0.79 if there is a broader US dollar recovery that sees the euro sell off more than its UK rival.

The yen has resisted a sell-off on Monday despite a strong recovery in European stocks, ahead of the US bell. Some profit-taking on the euro has seen EUR/JPY return to the 1.59 line, having hit a lifetime high earlier in the session of 169.65. The US dollar is back to where it started the day at 106.26, giving up all of the day’s earlier gains. Markets have gone cold on the Fannie Mae and Freddy Mac rescue package already, which does not augur well for risk aversion as we go deep into the US trading session. The yen needs to appreciate back towards the 105 mark against the dollar, if it is to have any chance of joining the euro in severely punishing the US currency. The Bank of Japan has a rate announcement on Tuesday morning and it is certain to signal no change in rates and it is also unlikely the Bank’s Governor will signal future rate hikes when he attends his Press Conference, given the precarious economic situation in the world’s second largest economy. The yen will continue to trade on dollar sentiment and it may continue, for the time being at least, to pay second fiddle to the euro when risk aversion levels are on the up. Any dips towards 105 would offer some decent dollar buying opportunities, given the speed at which the market has been willing to sell off the yen in recent weeks. The yen is undervalued on all the crosses and the only one with some semblance of value is NZD/JPY, which has hardly moved in the past month.

The loonie has powered its way to 1.0050 against the US dollar on Monday and made smaller gains against the other leading majors, as commodity currencies meet renewed demand. Oil prices rising to record highs have not hurt the loonie, while increased concerns about the US financial system are making Canadian assets look a safer bet. Friday’s marginally negative labour report has not harmed the loonie as the labour force has proven itself to be resilient amid troubling times. Volatility will remain high with the loonie and it will struggle to break parity against the greenback, while North American currencies remain largely on the defensive. The Bank of Canada has a rate announcement on Tuesday and the Central Bank is likely to leave rates unchanged for the second consecutive meeting although the accompanying statement will need to be monitored carefully because if there is emphasis on rising inflation it could signal a rate hike in the months ahead and help fuel a strong loonie rally. The likelihood is the Bank of Canada will remain neutral and the impact should be minimal on currency markets. The euro returned to over 1.61 against the loonie early on Monday, before retreating back below 1.60. There is still potential for a return to 1.58 in the days ahead, if we witness a broader euro sell-off.

Bob B

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