Bob's Currency Focus

EUR/USD
Negative sentiment against the dollar hit fever pitch again over the past few days as the Fed’s rather indifferent approach to rising inflation in their monetary policy deliberations this week led futures markets to pare back expectations for future interest rate rises in the US. The dollar has got it in the neck and oil has risen to a fresh lifetime high, close to $142 a barrel. Bernanke’s credibility has been seriously undermined by recent events with the Fed Chairman seen as talking tough but lacking the conviction to follow through on his words. US stock markets are plunging in recent weeks, primarily thanks to the rash policy decisions taken by the Fed over the course of the past 9 months. If the Fed hadn’t handed the ammunition to commodity traders to more than double the price of oil over the 9 month period of its aggressive rate easing cycle, the US industrial averages might not now be facing their worst monthly performance since the age of the Great Depression. While the Fed may be dithering on inflation, the ECB’s bold determination to signal an imminent rate hike a few weeks back, could come back to haunt the Governing Council. Since that statement from ECB President, Jean Claude Trichet, euro zone economic data has pointed to a marked slowdown, with both the manufacturing and services sectors falling into contraction in June and with consumer and business confidence plummeting across the entire euro area. Add to this the fact euro equity bourses have nosedived, a euro which is rising on ECB rate expectations rather than growth fundamentals and all in all you have a situation where one would believe it is the least opportune time for Mr Trichet to announce a rate hike. However, the ECB is likely to be true to its word and we should expect euro zone interest rates to rise 0.25% to 4.25% next Thursday.

The euro is close to the recent resistance line of 1.5840 and barring some sudden reversal, this should come under threat, possibly by as early as Monday. There are some data risks for the euro next week, but on Monday, we have the CPI flash estimate, which is likely to come in at or above June’s record 3.7% rate. If it does, it will more or less seal a rate hike from the ECB next Thursday. If we see further deterioration in the manufacturing PMI (Tuesday) and Services PMI (Thursday), both of which contracted in June according to the preliminary readings, it will put added pressure on the ECB to soften its approach on Thursday. This ECB is particularly hawkish though and it is difficult to see them swaying too much from their recent tough stance, given repeated references by members of the committee to the fact the ECB’s sole mandate is to stem inflation, not to stimulate growth, as is the dual mandate of the Fed and the Bank of England. Traders need to be on the lookout for comments on currencies next week, because of the dollar’s fragile market status and runaway oil prices. Central Bank intervention is most unlikely while the Fed and the ECB are adopting opposing strategies in their respective battles with rising inflation and declining growth. The euro will be vulnerable to a sell-off on EUR/JPY if risk aversion levels remain elevated, while a ‘done and dusted’ policy statement from the ECB would also undermine the single currency, given the extent of gains achieved on the back of a very tough ECB stance. It is dangerous to buy the euro on levels close to 1.58, given all the risks, even if there is a chance of a short-term rally higher. Weak economic data out of the euro zone, some of it very significant, has failed to hold the euro back over the past 10 days, but eventually it will come home to roost, particularly if followed by further soft data next week.

GBP/USD
Sterling has got a timely boost over the past week, just at time when it was being written off. The pound has benefited from a broader collapse of the dollar this week, as well as uncertainty about the euro economy, which has helped fuel a flow of funds into the UK currency. While GDP for quarter 1 was revised down to 0.3% from 0.4%, the current account deficit narrowed sharply during the same period, surprising analysts. The principal reason for sterling’s recovery however has been the Bank of England’s shift in emphasis from growth to inflation, which has markets anticipating the next move by the MPC may be to hike rates. This has helped to attract a new wave of investors that are seeking higher yields, with the 5%-earning pound a favourite once again, if just for the short-term. Ongoing stresses in the housing sector and concerns over activity in the manufacturing and services sectors is likely to prevent frantic buying, although cable now has every chance of hitting the 2 dollar line, ahead of the big-hitting economic releases from Tuesday of next week. It is almost certain UK interest rates will be held at 5% when the MPC delivers its latest policy announcement on Thursday, and the pound’s immediate fate will depend on the fate of the dollar and what the ECB does next week. As long as cable remains above 1.98, an upside bias remains, for now, but that could revert very quickly and cable could find itself back in the middle of the recent trading range (1.94 – 1.98) before the Bank of England even delivers its statement next week.

USD/JPY
The yen broke down several price barriers over the past 24 hours as the Japanese currency has been a principal benefactor of the sudden rise in risk aversion and the market attack on the US dollar. The USD/JPY pair has fallen as low as 106.10, down from the 108.20 it was trading at early Thursday. With the Dow plunging 3% on Thursday evening and oil rocketing to record prices, traders are beginning to offload short yen positions. If the unease continues, the yen could gain appreciably, given the exaggerated price levels which still exist on the EUR/JPY and AUD/JPY carry pairs. News out overnight reveals inflation rose the highest in 10 years in May and while an annualised rate of 1.5% is unlikely to frighten too many traders, it does leave options open for the bank of Japan, if the Bank wished to hike interest rates later in the year. Trading on the yen will continue to be volatile and any sign of a return to stability in stock markets will see the yen quickly fall out of favour. It is dangerous to sell down EUR/JPY ahead of the ECB meeting next Thursday, while there may be some value in buying USD/JPY on dips, when US stocks show evidence of a recovery. The wise move may be to wait until the current downside probe has run its course, however long that might take.

USD/CAD
The loonie has hit fresh highs against the dollar on Friday, taking advantage of a weak dollar and spiralling out of control oil prices. All of the commodity currencies have performed remarkably well, despite the rise in risk aversion over the past few days, but there is an ever-growing opinion that the oil price spike is primarily a bubble and were it to prick at any time, the loonie would have most to lose of all the major commodity currencies. We could see the Canadian currency try to take out the parity line later today, especially as the USD/CAD pair has looked decidedly bearish over the past 2 weeks. Oil prices will continue to form an important support for the loonie, even in the wake of soft economic data. A break through parity could see the pair fall to take on support at 0.9970, where a further break could trigger a sharp retreat to 0.9920. The dollar needs to reclaim the 1.01 line quickly and push the pair past Thursday’s high of 1.0140, if it is to regain any sort of upside momentum.

Bob B - Jun 27

Bob's Currency Focus - 16:00 GMT

EUR/USD
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.

GBP/USD
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.

USD/JPY
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.

USD/CAD
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