Thursday, May 15, 2008

Bob's Currency Focus - 15:30 GMT

US stock markets are proving themselves to be immune to bad news of late and today’s data: disappointing industrial production numbers for April; an increase in last week’s jobless numbers; negative net treasury capital inflows for March; near-record high oil prices, have failed to spook investors with the US industrial averages all trading flat at the time of print. The dollar is holding its own against the euro, although the pair did rise towards 1.5550 this morning after a thriving set of GDP numbers out of Germany. The euro area own annualised GDP figure for quarter 1 was seen at 2.2%, against a 1.9% forecast, meaning the euro area economy grew at a steady pace in the first 3 months, despite the turmoil across the Atlantic. The problem with GDP data is that it is old history as soon as it is released and while today’s results are encouraging, more recent economic data out of the eurozone points to a significant deterioration in the performance of the euro economy in quarter 2. Add to this the presumption that the Fed is done cutting US interest rates and it is difficult to find good reason to aggressively sell the dollar off against the single currency. While some analysts attempt to suggest US inflation was under control following yesterday’s CPI data release (core at 2.3% and headline at 3.9%), the fact remains inflation is well above what should be the Fed’s tolerance rate, at a time when the US economy is in protracted period of stagnant growth and there is little cause for cheer. This news should prove to be positive for the dollar in the medium term though, as it suggests US interest rates may begin to rise as soon as a real pickup in growth is evidenced. Expect EUR/USD to remain trapped in a 1.5287 to 1.56 price range for the foreseeable future, but the better trade would appear to be to sell down on failed rallies close to the 1.56 price band. Friday’s US housing starts and building permits data will be important for gauging immediate dollar confidence, but it is unlikely to have a huge impact, unless the actual results are sharply different to the forecast. There is potential for a dip to 1.5350 by Friday, but it is safer to sell on prices closer to 1.5550, to avoid being caught on the wrong side.

The data keeps on getting worse out of the UK and what is really worrying for sterling is the fact Wednesday’s spike in consumer price inflation (from 2.5% in March to 3.0% in April) failed to lead to any meaningful rally in the pound and indeed cable came within 0.3 cents of hitting the year’s low, which was registered way back in January. Cable looks certain to move downwards through the remainder of this year and the pace of the downtrend is most likely to be dictated by US data. The Bank of England has a very difficult task on its hands with UK inflation and growth now accelerating in opposite directions. The Bank’s measly offering of 0.75% in rate cuts in response to one of the greatest credit debacles ever to have hit the economy could see Governor King and his colleagues vilified if commodity-driven inflation now pushes the UK economy over the brink, into a prolonged period of stagflation and into recession. If the Bank of England was to take a leaf out of the Fed’s book, then the MPC might proceed and cut interest rates even in an environment of rising inflation. The problem is that the current bout of global inflation has been largely created by the Fed’s recent round of policy easing and aggressive rate cutting by other Central Banks might only exacerbate the inflation issue. The UK economy has bleak outlook through the rest of this year and the trading opportunities look to be on sterling shorts. 1.96 on cable should be a decent barrier on the upside and any rallies that come near this price line offer good selling value. Downside targets are 1.9430 and 1.94, but look for 1.9337 to be taken out in the coming days, opening the way for a decline to 1.92, as early as next week.

The yen has taken on a decidedly weaker tone this week, losing out significantly to the euro and the dollar as traders seem happy to run with the ‘worst is over’ theory and sell the Japanese currency at each opportunity. The yen has gained modestly today with global stock markets marginally in the red, but it is still 2 cents off Monday’s opening price against the dollar, while the euro is trading between Y162 and Y163, well above recent average price levels. The dollar now looks comfortable trading in the 104 to 105.50 price region and that pair could push up a notch next week, is risk tolerance aversion remains low. There remains huge complacency on the part of investors, particularly with oil prices again edging near recent highs and there is always the danger of a sudden liquidation of positions which would see the yen appreciate rapidly. There is no value in buying the dollar on prices close to Y105 and traders are best advised to wait for dips back towards the 103 price region. The euro is overpriced against the yen on anything above Y163 and a sell down from above this price level offers good value, with the prospect of a decline back to 1.58 over the next couple of weeks. Tonight sees the release of quarter 1 GDP data out of Japan but the data is unlikely to have a major market impact, with global risk tolerance the current driving factor behind the currency’s movement.

The loonie is the best performing of all major currencies this week, having pushed the dollar back to the parity line and sending the euro back below 1.55. The recent rally is owed exclusively to rising oil prices with the loonie once again the subject of major commodity-driven speculative buying. The Bank of Canada must be wondering what it has to do to curb the loonie’s rise, with the 1.5% in rate cuts delivered since December appearing to have made little difference. If the current commodity price acceleration is indeed a bubble, Canada’s economy could be in for quite a nasty shock over the upcoming quarters. Manufacturing shipments in March declined 1.6%, but this was offset by a 2.9% rise in new orders. There is no further data out of Canada this week and the loonie’s fate is likely to be determined by oil prices. We could see a possible dip to below 0.9940 against the greenback, but it is highly dangerous to sell USD/CAD at current prices given the likely prospect of sharp reversal, with a return to at least 1.02 highly likely. When oil prices finally begin to retreat, the loonie should enter a prolonged period of decline. Strategy: Buy on dips towards 0.9960, with upside price targets of 1.0070, 1.0130, 1.0170 and 1.0220.

Bob B - May 16