Bob's Currency Focus

EUR/USD Review
We have witnessed one of the most remarkable dollar rallies in recent times over the past couple of weeks, as the greenback has made record gains against most of the other major currencies. There has been virtual meltdown in GBP/USD and AUD/USD in the past 10 days, while the euro itself is now trading over 11 cents below the high it hit against the dollar in early July. The euro shed 4 cents alone in a 24 hour period into last Friday. The sharpness of the move has taken many in that market by surprise, but what is even more surprising is the fact that it does not appear to be justified by any major shift in economic fundamentals. There are a number of reasons for the strong rally at this time:

1) Liquidity seems to have been drained from the currency market at the moment (August holiday factor) and it does not take big volumes to shift currencies. With the trend already having shifted to the greenback a fortnight ago, the drop in liquidity is allowing exaggerated market moves, which is disproportionably benefiting the dollar. The dollar is so significantly overbought that a corrective reversal could easily manifest in a 5 cent rally in the other direction.

2) The sustained drop in commodity prices is resulting in a direct flip of trades that had worked for major funds in the first half of the year, with oil, gold, commodity currencies and EUR/USD being the big losers. Those who believed oil prices were a simple consequence of supply/demand issues are now nowhere to be seen as the speculative bubble that oil prices had become bursts spectacularly, with a barrel of crude plunging by $34 in the last 4 weeks. Depending on how far the decline in commodity prices has to go, this may determine how far the dollar’s rally might go.

3) Jean Claude Trichet’s monetary policy statement on August 7. The ECB President did make several references to an increase in the downside risks to growth in the euro area when delivering his policy statement on August 7 last. In reality, the ECB, rightly or wrongly, has not changed its policy stance as its primary concern remains the upside risks to price stability and Trichet again stated the ECB had ‘no bias’ with respect to monetary policy. However the markets responded to Trichet’s statement as if it were surprisingly dovish and sent the euro decidedly lower.

4) Eurozone economic data has pointed to a troubled euro economy for a few months but markets chose to ignore that data, preferring instead to focus on a struggling US economy and a detached from reality ECB that kept telling markets that the euro area economic fundamentals were sound. The ECB’s rate hike in July could go down as a gigantic faux-pas by a Governing Council that is clearly lacking economic foresight. Markets are now reassessing the outlook for the euro area economy and interest rate differentials going forward, which is weighing on the euro. The Fed’s policy of trying to stimulate economic growth in the US is now being rewarded by currency markets that don’t like what they see elsewhere. Of course the aggressive nature of the Fed’s rate cutting is largely responsible for the sudden run-up in commodity prices that in turn made inflation shoot up across the globe, but it now looks that this inflation spike was also a bubble and Central Banks like the ECB and Bank of England have been found wanting because they continue to fail to recognise this fact.

5) Carry Trade unwind. With some Central Banks, notably the RBA and RBNZ moving towards easing interest rates, the narrowing in rate differentials has resulted in a significant liquidation of carry trade positions in the past week. EUR/JPY is the most loaded carry trade currency pair in the basket and it has come off by over 5 yen in the past week, hurting the euro against the dollar, which has advanced against the Japanese currency. EUR/JPY is still very much over-valued in a historical context and if the carry trade comes under increased pressure, this would mean a greater sell off in EUR/JPY would pit the euro even lower against the US dollar.

6) Technical considerations. When EUR/USD broke below 1.5283 on Friday morning last, the pair went below a key technical support that had held since last March and this essentially opened the floor underneath the pair, with the next key line of support not seen until 1.4615. The pair also went below the 200 day moving average and the dip below this level has many traders now believing the longer run trend has reversed in favour of the dollar. The technical breakout has led to a loss of confidence in the euro and in some part explains the extended decline we have seen.

7) Russia and Georgia. On Friday the euro had its worst day ever against the dollar, since becoming a hard currency and while there were other factors at play, the 5 cent decline between Thursday and Friday coincided with the outbreak of hostilities between Russia and Georgia. This will not have helped the single currency, given the proximity of the EU to both countries. This probably accelerated the flow of safe haven funds into the dollar.


So where now for EUR/USD? The pair is very much oversold but in an illiquid market situation, anything could happen in the short run. There is no known support for the euro right down to about 1.4620 and given the whiplash fashion in which the market has moved of late, it is not beyond the bounds of possibility that we could see the pair slide to that level before we enter a genuine period of consolidation. Two releases this week will have a bearing on short-term direction: Wednesday’s Retail Sales out of the US and Thursday’s GDP data out of the euro area. It is conceivable the GDP data could reveal a horror story for the euro area and if the number is markedly lower than forecast, it could send the euro tumbling. The euro may have a battle to reach 1.50 before then and could find itself being sold off on any rallies towards this key mark, ahead of the US Retail Sales figures. However, given the brutality of the move to the downside, a sizeable correction upwards cannot be ruled out, especially if the euro can earn some momentum and if it pushes above 1.50 and holds there. It is a dangerous market to trade given the pair has not settled into a new trading range and the fact liquidity levels appear to be running so low.


GBP
Sterling has had an absolute nightmare against the dollar over the past 10 days, losing an average of almost a cent a day. All technical supports to the downside have given way and cable is now trading at a 2-year low. There is no arguing the current dollar rally is overdone, yet when one looks at the economic fundamentals out of the UK, it does not inspire sterling buying, even at bargain basement prices. A visit to 1.85 is now on the cards, possibly by the end of September, although this may come after a corrective retracement to at least 1.93. Even a 0.6% jump in the annual inflation rate to 4.4% in July was not enough to engineer a sterling rally. Indeed the pair sold off after the release of this data on Tuesday, which tells us in the current uncertain economic climate the market is currently more interested in currencies that are backed by growth stimulating policies like the dollar than in currencies with restrictive monetary policies like the euro and the pound. The woeful economic data out of the UK over the past few months has finally caught up with the pound and the UK currency is now vulnerable to being targeted by speculators that may see it as a soft target. I would like to see some period of consolidation before re-entering the market on sterling, but those who retain shorts on cable should move stops down to around the 1.9350 price level, which is just above the 2008 high which gave way last Friday. A corrective rally is overdue and it is dangerous to sell at current prices below 1.90, unless employing stops close to 1.9150.

JPY
The yen has more than held its own since losing the Y110 handle to the dollar late last week. While the dollar has gone on to trounce the other majors on Friday and Monday, it has hit a wall against the Japanese currency, failing to break above Y110.40. The yen is befitting from a wind-down in carry trades triggered by the decline in commodity prices, which is helping it retain its strength across the board. The shift to monetary policy easing by some Central Banks is narrowing the rate differential outlook on many of the yen crosses, which is lessening the appeal of carry trades. However, Japanese domestic economic data has been poor of late and Qtr 2 GDP released later tonight should tell us the Japanese economy contracted in the last quarter and signal it might be in technical recession right now. The yen will not be damaged to any great extent unless the data is so bad that it initiates an argument for a Bank of Japan rate cut, which seems unlikely given rates in Japan are already a lowly 0.5%. The medium term to longer term value trade on the yen crosses is still with EUR/JPY which remains close to historic highs. The pair should be sold down on any advances to the 168 / 169 price region and given the softness shown lately by the euro there is the prospect of a retreat in EUR/JPY to at least 160 before the end of the September.

CAD
The loonie is now trading at levels against the greenback last seen this time last year, around the 1.07 price handle. Last Friday’s employment report which revealed the commodity-rich Canadian economy shed over 50K jobs in July was an eye opener and suggests the economy is struggling even more than originally thought. The decline in commodity prices has hurt and given the bullish tone of USD/CAD, there is every prospect of the pair reaching 1.10 in the near-term (next month), with the possibility of a return to 1.15 by year end, if commodity prices continue to fall. I said last week that the loonie did have scope to appreciate against the euro to 1.60. Well, it has gone to as low as 1.5870 today and there is room for a return to 1.56 over the next week as greater confidence in the US economy could help the loonie appreciate against the major European currencies, as well as against the yen.

Bob B - Aug 12

Bob's Currency Focus

EUR/USD
The dollar has pushed the euro to below the 1.55 price handle on Tuesday and a convincing break below here could trigger a steeper decline in the days ahead, possibly setting up a near-term test of 1.5283. Central Banks take centre stage this week, the Fed kicking off proceedings with a rate announcement later today, while the ECB issue their latest monetary policy statement on Thursday. There is certain to be no change from the Fed and with instability in the financial sector still a primary concern, it is most unlikely Bernanke & Co. will shift from their neutral policy stance, despite reservations from a number of the Fed’s hawks in recent weeks. It is possible that at least 2 members might decide to vote for a rate hike today, but they are likely to be outgunned by the majority, although the hawks’ inflation concerns may have to be accommodated by way of a stronger worded statement. There are only 10 voting members in today’s FOMC vote. Prior to the Fed’s statement release at 19:15 GMT, we had the ISM services index which came in at 49.5, ahead of a forecast for 48.6. The reading is still below 50.0, so it indicates contraction in the non-manufacturing sector, so it offers little in the way of positives for the dollar. The past week has seen a waft of softer economic data out of the euro area and with a significant contraction in the manufacturing and services sectors, declining exports and a further depressed consumer, the euro zone looks to be pushing towards a recession. Oil prices have fallen below $119 this morning and with commodity prices in general falling sharply over the past month against a slowing global economy, the ECB decision to hike rates in July is starting to look like a possible mistake. However don’t expect a climb-down from the ECB just yet and indeed if just to maintain the Governing Council’s credibility, ECB President Jean Claude Trichet is unlikely to turn dovish on inflation, although he is likely to back away from any suggestions of possible future rate hikes. The markets may place the ECB in a more neutral position this week, regardless of what Trichet says and this could see the euro retreat even further, particularly if oil prices continue to fall as this would ease inflationary pressures in the euro area and give the ECB room to ease rates later in the year. A break below 1.5460 should see us drift to 1.5350 and ultimately see the April low of 1.5283 taken out. It is conceivable it could happen this week.

GBP
Sterling has come under sustained selling pressure in the past week as wave after wave of soft economic data has finally weighed on a pound which had taken on a Teflon ‘nothing-sticks’ trait over the past 2 months. The break below 1.9650 on cable yesterday could be significant and we may now see the dollar push the pound back towards the year’s low at 1.9337. The pair dropped to 1.9528 this morning before recovering towards 1.9570 and the next important line of support on the downside is at 1.9460. June’s Industrial Production (-0.2%) and Manufacturing output data (-0.5%) for the UK was much lower than expected, while a July services PMI reading of 47.4 (slightly higher than the 47.1 print last month) is hardly a cause for celebration as it signals further contraction in the dominant services sector. With the Manufacturing and Construction PMIs deeper into contraction last month, the UK economy looks to be accelerating towards recession. The current slide in commodity prices, if it is sustained, could hurt the pound badly as it is commodity price inflation which is preventing the Bank of England from cutting interest rates. The Bank meet this Thursday and while the Committee should cut rates immediately to help stimulate the UK economy, the MPC is certain to stand pat, as the Committee is dominated by short-sighted Central Banks hawks, incapable of looking beyond a current month’s consumer price inflation report. There is absolutely no reason to buy sterling at present other than against the euro if one believes the euro economy is in as equally a bad predicament as that of the UK, but even that is a risk, because the UK’s over-dependency on the housing and financial sectors means the UK economy is likely to decelerate at a much faster pace than that of the euro area. The pound should be sold on any failed upside rallies against the dollar and there is every chance of a sub 1.90 price on cable by the end of September.

JPY
The yen has more held its own in recent days as a drop in commodity prices has led to a paring of carry trades. The US dollar has thus far failed to breach an important technical indicator at 108.50 and while this price level holds, the yen could potentially make more significant progress against the euro and the high yielding Australian and New Zealand dollars. While lower commodity prices can help raise risk tolerance levels and fuel a rally in stocks which is generally negative for the yen, a retreat in commodity prices brings closer the prospect of interest rate cuts, particularly in the euro area, UK and Australia and a narrowing of the rate differential outlook is a positive for the yen against most currencies, with the exception of the US dollar, where rates are likely to remain on hold. Tonight’s Fed rate announcement is a major risk event for the yen because if the Fed prove to be more hawkish and threaten a possible rate hike in the coming months, then this could be sufficient to see the dollar rise to 109. The reaction of stock markets will be important as an adverse reaction in equities would see risk aversion rise and this will offer some short-term protection to the Japanese currency. The value trade of all the yen crosses is on EUR/JPY, which still trades close to lifetime highs, despite a sharp deceleration in the performance of the euro area economy. This pair should be sold down on any advances to 169 and there is every chance the pair will slide back to Y165 in the very near term. If the Fed’s statement this evening is not dollar supportive, the greenback will find it difficult to break out to the upside of the recent trading range and USD/JPY could spend the next week trading largely within a narrow 106.80 to 108.50 price range.

CAD
The loonie’s resilience has finally been broken by the greenback and on Tuesday USD/CAD broke out above 103.70 for the first time this year. This signals the pair is now most definitely in an uptrend and we could witness a very quick move to 105, with 108 being possible by the end of the month. Today’s Fed rate announcement will be crucial however as the greenback needs a hawkish bias to gain greater momentum. If the Fed stands pat and keep a neutral policy stance, the fate of USD/CAD over the next month will most likely rest with commodity prices, primarily oil. This Friday’s employment report out of Canada will also be important for gauging possible direction of Canadian interest rates and another negative employment number would hurt the loonie. Look for consolidation in the 103.70 to 105 price region over the next 2 days and only a break below 103.70 would mean a possible trend reversal in favour of the loonie. A rebound in oil prices would offer the Canadian currency some much-needed protection. The loonie is oversold on many of the crosses, particularly against the euro and there is some scope here for a pullback to 1.60.

Bob B - Aug 5

Bob's Currency Focus

EUR/USD
After a waft of weak data the euro eventually succumbed to selling pressure this week, although it staged an impressive recovery from late Wednesday, coming off a low of 1.5522, to trade at a full cent above this level on Thursday morning. The single currency was buoyed to some degree by today’s inflation print for July, which at 4.1% is the highest rate on record, since the ECB came into existence. With the ECB’s target inflation rate at 2%, some market analysts still believe there is scope for further rate hikes from Trichet & co. There is greater evidence however that the euro economy is decelerating at an alarming pace and divergence issues between the euro’s major economic blocks is likely to become an increasing concern over the coming months. US data has mostly surprised to the upside over the course of the past week but the real test will come with Friday’s non-farm payroll number. Thursday’s GDP figure is unlikely to have any sustained impact, given its historical context and the fact the number will be distorted by the Government’s stimulus package which helped prop up consumer spending in May and June. The Initial claims number for last week will be monitored closely as an indicator of what Friday’s payroll number might look like. Oil prices rocketed by almost 5 dollars on Wednesday and if this triggers a new bout of oil buying, the dollar is going to struggle. There are so many factors at play in the market at present and plenty of uncertainty about the direction of the major economies and interest rates, while a worsening credit crisis still looms large in the background. In this environment it will be difficult for either the dollar or the euro to make huge progress without facing some headwinds. Upside surprises in GDP and the non-farm payrolls, together with falling oil prices, is what the dollar needs if it is going to end the week on a high. The biggest risk to the euro in a broader sense could come from any negative comments from ECB council members (admission that the growth slowdown is worse than ECB had anticipated) or destabilising comments from French or Italian government officials about the ECB or euro. The range should remain 1.55 to 1.5660 for now, with Friday’s non-farm number being the key scheduled event which could push the pair beyond the boundaries. There is definite value in selling down on any rallies close to 1.57.

GBP/USD
Sterling has shown remarkable resilience against the adversity of shocking economic data over the past month, data soft enough to have pared several percentage points off any other currency. GBP/USD is still trading at the higher end of its trading range over the past few months and the pound has essentially grown immune to weak domestic data. However, it is primarily negatives which are keeping the currency afloat, primarily a market belief the Bank of England will not step in to save the economy and it is believed if the Bank were to do anything it will raise interest rates rather than cut them, adding to the attraction of sterling’s high yield. Nationwide reported house prices fell 1.7% in July, for an 8.1% annual decline, the steepest drop ever in the series. The UK economy looks destined for a certain recession, if it is not in one already, and with the Bank of England uttering hawkish rhetoric, they are clearly signalling they have a very different view to the US Federal Reserve on inflation prospects, so things are going to get a hell of a lot worse in the UK economy over the coming months. Friday’s Manufacturing PMI will be important to gauge if last month’s appalling run of PMIs in the manufacturing, services and construction sectors was an unlucky once-off or the start of an accelerating deterioration in the wider economy. It is highly dangerous to buy sterling against the dollar with the economic predicament facing the UK, even if sterling does even manage to make some short-term gains. In the medium to longer term sterling looks destined for a return to at least the mid 1.80s and a sudden spike downwards in the currency cannot be ruled out, given the downside risks and the pound’s elevated value at present. The downside against the euro should be more limited in the short run as the euro area economy also slows quite sharply. The pound’s direction through to the end of the week will be determined by US economic data, but we should be looking at a return to 1.9650 over the next week. It could happen this week if US data prints stronger than expected and oil prices are subdued.

USD/JPY
The yen has come under modest selling pressure Thursday as risk tolerance levels rise thanks to two very positive days for global stocks. The Japanese currency has been protected to some degree thanks to sell-off in commodity currencies in recent days, which has seen a paring of carry trade positions, especially against the Australian and New Zealand dollars. There is still sizeable complacency in the market though and both the US dollar and the euro look to be overvalued against the yen, when taking into consideration the deterioration in economic conditions, particularly in the euro area. Friday’s non-farm payroll data out of the US will be a major test of risk tolerance and if the number prints much worse than expectations, the yen should be the biggest gainer on currency markets. There is significant selling of the US dollar above Y108.30, but if the US currency does manage to reach 109 by the end of the week it will mark a further step up in the pair’s trading range and we should see Y110 next week. However it is dangerous to sell the yen at current prices, given all the underlying risks, and there is definite medium term value in selling down the euro on any advances by the single currency towards Y170.

USD/CAD
The loonie has failed to penetrate 1.02 against the greenback since the pair sailed over this important price level several days ago. The US currency though has not managed to capitalise on its momentum and has failed miserably to reach 103. The key economic releases out of the US over the next few days will be critical and could be decisive for the future direction of the pair. The only release out of Canada is today’s monthly GDP number for May, but its significance is likely to be dwarfed by the quarterly GDP figure out of the US. Stronger than expected numbers out of the US today and tomorrow (non-farm payrolls) coupled with a further slide in commodity prices could potentially see the greenback rise to 103.77 (the year’s high) and place the pair firmly in a longer run uptrend, which could see the loonie cede 1.05 very quickly. There is some value in buying at present, with a stop tightly below 1.02. If data prints badly for the greenback, then expect 1.02 to give way very easily and the pair should quickly return to 1.0130.

Bob B - Jul 31