Bob's Currency Focus - 16:00 GMT

EUR/USD
The euro came off a little Friday, following an unprecedented rally of over 3.5 cents on the previous two days. The pair has spent most of the day hovering close to the 1.47 line, the single currency in decline, having failed to breach resistance up at 1.4780. There has been little in the way of meaningful economic data Friday and traders are now positioning themselves ahead of next week’s Federal Reserve meeting on Wednesday. Legitimate questions about the wisdom and necessity behind this week’s emergency rate cut in the US remain unanswered and Ben Bernanke’s already fragile credibility is coming under increasing scrutiny. The panic sell-off Sunday night and Monday of $60 billion of stock indices futures by the French Bank Societé General (the employer of rogue trader Jerome Kerviel) is reported by much of the media today as having been a major contributory factor to Monday’s mayhem on global stock markets. Any hint of a link between this and Ben Bernanke’s decision the very next day, to suddenly cut US interest rates by the highest margin in history, is sure to be the stuff of legends and no doubt will be transformed into a blockbuster movie in the not too distant future. The US economy is either in recession or it is being talked into recession by the Fed and it will be most interesting to see what the FOMC have to say in their statement next Wednesday. Next week also sees the release of the latest US employment data and if this report prints positive, against the backdrop of a further rate cut next week, Mr Bernanke will stand accused of serving Wall Street’s immediate interests ahead of the longer-term interests and sustainability of the US economy.

Bernanke will be damned if he does and damned if he doesn’t next week and as financial markets are expecting a further 50 basis points cut, it will be a surprise if the Fed does not deliver. It may prove more beneficial in the longer run were rates to be kept on hold on Wednesday, because to cut rates to 3% now is going to leave the Fed with very little charge left in the battery to face the challenges in the months ahead. The euro will have its best chance of reaching the coveted 1.50 price handle next week, although there will possibly be reluctance to force the price through until traders see what the Fed decides. Strategy: buy euro on dips towards 1.46 with upside limit prices of 1.4720, 1.4770, 1.4820 and 1.49. We will look at the lie of the land again Monday.

GBP
Sterling has had its best week of the year by far, gaining 3 cents against the dollar and half a penny against the euro, while the sterling crosses on the yen and Swiss franc have also done very well. There was no data out of the UK Friday but the pound uses its current momentum to push the pair to the key 1.9850 price level. A strong close near to this price Friday could see sterling rally to the 2 dollar line next week, with the dollar likely to be lightly supported ahead of the Fed’s rate decision on Wednesday. There is scope for a possible move to 2.01, the high breached just before the New Year, but cable’s fortunes depend as much on risk aversion levels remaining contained as they do on a defensive dollar. I am still bearish on the UK currency and am reluctant to buy it at all and prefer to wait for the best time to sell. Once the attention shifts after the Fed next week, the focus will very much be put on sterling again and the currency is going to come under selling pressure, particularly if economic data remains soft and with the Bank of England most likely to cut rates at its February rate setting meeting. I prefer to stay away from cable until after the Fed rate announcement. The euro dropped to 0.7408 today and there is the potential for a fall to 0.7350, if stock markets remain robust up to next Wednesday and the appetite for high yielding currencies remains high. Strategy: Stay on sidelines until after Fed meeting, but if risk aversion levels do rise again stock markets decline sharply), sell down on prices from around 1.98 with limit prices of 1.97, 1.9660 and 1.9580. Trade with a stop loss just above 1.9850, because if that price gives, cable could quickly move to the 2 dollar line.

Yen
The Japanese currency has had an up and down day, losing heavily earlier in the session but rebounding as European stock stumbled to the close. Traders are now quick to offload the low-yielding yen which is hampered by the prospect of a further Fed rate cut next Wednesday, leading to carry traders exchanging the yen for higher yielding currencies like the pound, Australian and New Zealand dollars. The euro bounced back to Y159 early in the European session, an extraordinary turnaround given the pair had fallen to Y152 twice this week. They yen has found some support at the Y108 level against the dollar, but if this price gives way, either today or early next week, we could see Y110 reached by next Thursday, if the Fed does cut rates again on Jan 30th. We could also see a total capitulation of the Japanese currency next week, across the board, if stock markets remain stable and risk appetite intensifies. EUR/JPY is likely to reach Y160 by the middle of next week, but entering the market at the current price is not without risk, given the still fragile sentiment on global markets. There is however never a shortage of takers of risk when it comes to shedding the yen, when market conditions stabilises, so it is certainly worth buying the euro against the yen when prices move to extremes (close to Y152), as it is the dollar (when the dollar falls close to Y105). Strategy: Buy EUR/JPY on dips towards Y155 – Y156, with upside price targets of Y158, Y159 and Y160.

CAD
The loonie advanced by 2% against the US dollar Thursday, on a day when there were no economic indicators released and following a report published by the Bank of Canada, which downgraded its growth outlook for 2008 to 1.8%, from the 2.5% forecast last October. While there was general greenback weakness Thursday, the loonie’s appreciation is difficult to understand because the currency also advanced by 1% against the euro and by more than this against most other leading currencies. Friday’s inflation data was softer than expected with the Bank of Canada’s core inflation rate falling to 1.5%, the lowest reading in 2 years and gives muscle to the Central bank to further cut interest rate in the months ahead. This would normally be damning for a currency and see it go into freefall, but not the loonie today. Having retreated for a 5 minute period, the currency was soon trading at the point at which it was at just before the print. There are some of those mysterious forces we have seen before resurfacing and driving the loonie in recent days and the currency has suddenly grown decidedly bullish. The loonie is now trading over 3 cents better against the greenback than where it was on Tuesday around the time of the Bank of Canada announcement. There is a determined push to drive the pair to below parity once again and with the dollar likely to be vulnerable next week with the Fed expected to cut rates once more, this will widen the rate differential even further in favour of the Canadian dollar and USD/CAD bears may be able to force price down towards the 0.9756 price level seen over the Christmas holiday period. Strategy: I remain bearish on the loonie but I’m holding off on going long until I see the current correction bottom out. EUR/CAD looks to offer value on prices close to 1.47, although there is danger right now because if the loonie breaks below the parity line against the US dollar, the euro could possible fall to 1.45 against the Canadian currency by the middle of next week. If you have long-held positional trades on USD/CAD, you will need to bring your stop loss to below 0.9750. Next week could be a rollercoaster but the event calendar looks to favour the loonie, although it should also bring to a conclusion the loonie’s current burst of strength.

Bob B - Jan 25

Bob's Currency Focus - 17:00 GMT

Risk tolerance levels have risen appreciably today with traders prepared to buy into the high yielding currencies en masse, although significantly the yen has held its value against the dollar. The dollar has pretty much collapsed against every other major currency however, with a rise in equities equalling a license to sell the dollar. We have witnessed an aggressive bout of dollar selling Thursday, with the US currency falling broadly across the board, particularly against the Canadian dollar which has been on the rampage for most of the day. Stock markets in Europe are higher by 4%-5% on average as buyers frantically try to get a piece of the action, following heavy losses earlier in the week. The US currency is now a significant target on yield grounds – offering a mere 3.5% yield and with the Fed acting in isolation to calm markets and expected to cut rates again next week by a further 50 basis points, the dollar is very vulnerable. The dollar’s best hope of defence is if risk aversion levels remain high and stock markets resume their decline. It is a sad situation when a country’s currency is only seen to be of value when global share prices nosedive, but that is the very real outcome of the Fed’s policy of acting so aggressively and acting alone. The ECB and the Fed are poles apart in their line of thinking, as confirmed by ECB council member Alex Weber today, who stated it was ‘wishful thinking’ to believe the ECB might contemplate cutting interest rates. Markets remain fragile however and a spark either way could trigger further volatile periods that could send currencies sharply in either direction. The commodity currencies are particularly susceptible to sharp moves, given they have already recouped all the losses incurred earlier this week.

EUR/USD
The euro has pushed back above 1.47 for the first time this week and having broken through resistance at 1.4720, seems poised to reach the 1.48 and set itself up for another challenge of the lifetime high, which is currently at 1.4966. Few people are going to wish to buy the dollar ahead of the Federal Reserve’s second rate announcement in a week next Wednesday, and the only downside risk for the euro is a capitulation on stock markets which leads to a flow of ‘safe haven’ funds back into the dollar. Germany’s important Ifo business sentiment index came in higher than expected in January and higher than the previous month’s reading, meaning increasing talks of a US recession and a soaring euro is certainly not yet denting business confidence in Europe’s largest economy. Us economic data out Thursday showed jobless claims fell to a 301K last week 20K better than forecast, while existing home sales declined further to a 4.89 million rate in December against a forecast of 4.95 million. There is no market-moving data out Friday and direction will be dictated by sentiment, which remains dollar negative, unless there is a sharp decline in equity prices. Strategy: Buy on dips towards 1.46, with upside price targets of 1.4720, 1.4750, 1.4815, 1.49 and 1.4930. Keep on eye on the Wall Street industrial averages and if there is a major decline, do not enter the market.

GBP
The pound has had a solid day, rising over 0.8% against the dollar and virtually unchanged against the euro. The only economic data out of the UK Thursday was the BBA mortgage approvals number for December, which fell to 42,100 from a downwardly revised 43,900 in November. This didn’t matter on a day when markets were driven by risk appetite for high yielding currencies, as global stock markets rebounded from their heavy losses earlier in the week. Sterling is also supported by a stronger than expected quarter 4 GDP number, released Wednesday, and a hawkish set of minutes from the Bank of England, where it emerged only one committee member voted for a rate cut in January, with the other 8 voting to stand pat. If stock markets do settle through the remainder of the week, sterling should be able to extend its rally against the dollar, ahead of next Wednesday’s Fed rate announcement. I remain bearish on cable but do not believe it worth the risk entering the market ahead of next week’s Fed meeting, at which time rate differentials are likely to widen again. We should see sterling rise to take on 1.9850, which is the key dollar resistance point below the 2 dollar line. If risk tolerance levels are sustained, sterling has the potential to push the euro back to the 0.74 pence line in the near-term. Strategy: remain on sidelines for now.

Yen
The Japanese currency has predictably retreated Thursday with risk aversion on the wane after stock markets surged over the past 24 hours. The yen has held its own again the greenback and the pair is currently trading at much the same price at which it closed Wednesday. Japan’s trade balance narrowed for a second straight month in December, hinting the sharp appreciation in the currency over recent months is having an adverse impact on the country’s exporters. The fortunes of the currency are totally dependent on market sentiment and risk aversion, but if the recovery staged over the past 24 hours persists to the start of next week, the yen will come under tremendous pressure on the carry trade side, with high yielding currencies having the most to benefit from a further rate cut from the Federal Reserve next week. The euro has soared to 157.70 against the yen, meaning a gain of over 500 points since Wednesday. There is no value in buying the yen in the build-up to the Fed meeting, given the underlying risks. There look to be some value in buying AUD/JPY on any dips to below Y92.50 as this pair might easily sail towards Y96 by the middle of next week.

CAD
The loonie has had a remarkable day, even by its standards. It has risen an extraordinary 1.4% against the greenback today and despite the Bank of Canada having cut rates on Tuesday and hinting at further rate cuts, the Canadian dollar is now trading almost 3 cents below the levels it had fallen to on Tuesday. I did state on Tuesday I had a fear the pair were destined for a correction back to 1.0180 or perhaps 1.0050. With risk tolerance levels at fever pitch only 24 hours after the world was apparently going to collapse, the omens do not augur well for the US currency in the build-up to next week’s Fed meeting. There are two events that can save the greenback from an imminent fall back below parity 1) stock markets slump tonight and tomorrow and the rise in risk aversion sends the loonie packing or 2) Friday’s consumer price data out of Canada is soft to the point of being worrying for the Bank of Canada and suggest a 50 basis points cut might be on the cards at February’s meeting. Once next week’s Fed is out of the way and prices have settled and stabilised we should see resumption to the uptrend. The Fed’s shock 75 basis points cut this week has really derailed us bulls to some extent, but we need to be patient, bide our time and wait for the right opportunity to re-enter the market. Those positional traders long on USD/CAD will just have to sit it out, but stops should be returned back below 0.9750, because bears are setting up for an attack on the parity line. Strategy: wait for further directional clarity. A soft core inflation number out of Canada Friday (< 1.5%) is a signal to buy, with a target back above 1.0180 and then 1.0220.

Bob B - Jan 24

Market Watch: Central Banks, Outlook and the Decoupling of Responsibility

The emergency cut in the Fed Funds rate by a record 75 basis points Tuesday may not have surprised Wall Street traders, but it is important to note the Federal Reserve is the only major Central Bank that has responded directly and actively to the recent credit crisis and the widespread demise in global stocks. The Bank of Canada did also cut rates Tuesday but this was expected by markets and that decision came out of a prescheduled monetary policy meeting. It is obvious the only reason the Fed acted when it did on Tuesday was to try to avert the type of carnage on Wall Street which had engulfed European and Asian stock markets over the previous 36 hours, when US markets were closed for a holiday. There was no new economic data available to the Fed since Mr Bernanke spoke on January 17, which begs the question as to why the Fed felt it had to act ahead of its regular policy meeting, scheduled for next week. The move Tuesday appears to have been a huge gamble and if it fails to prevent a major sell-off of stocks over the coming days, it will go down as one of the greatest ever blunders by a major Central Bank. The surprise action will have spooked many investors who believe such a drastic move would only be taken if the US economy was already in a recession or on the brink of a catastrophic market crash.

The pre-emptive action will not have gone down well with other Central Bankers who identify the Central Bank role as one of chief policymaker to protect an economy from the adverse effects of inflation/deflation. In the world of the ECB and Bank of England, economic growth stems from sound monetary policy decisions, which in turn are made in the pursuit of inflation control. It is true that the other Central Banks, primarily the ECB and the Bank of England do not share the experience of the Federal Reserve when it comes to averting economic disasters, but the key differential between the two views is that the Fed deems itself to have a dual mandate, one for stimulating economic growth and the other for curbing inflation, while the ECB and the Bank of England are focused exclusively on inflation control / price stability. The ECB in particular are polarised in their thinking and have not wavered in their hawkish stance despite the recent turmoil. The Bank of England for their part are a reactive force and have a history of acting slowly when it comes to making key monetary policy decisions. The UK economy is adjudged by many to be facing much the same economic challenges in 2008 as the US, yet the Bank of England has only eased 25 basis points in recent months against the 175 basis points from the Fed. This is an even more startling difference when one throws into the equation the fact that headline consumer price inflation in the UK in December was running at an annual rate of 2.1%, against a dangerously high 4.1% in the US. The UK also started the current easing cycle at a higher rate of interest than the Fed funds rate – 5.75% Vs 5.25% and with rates now at 5.50% Vs 3.5% respectively, the differential has grown from 0.50% to 2.0%. Clearly the Fed and the Bank of England have very differing views on inflation outlook for this year and while the Fed is prepared to gamble and be aggressive during a period of rising inflation, believing inflation will soften, the Bank of England is not. A major problem for the Fed is that if does acts alone, the aggressive shift in interest rate differentials will see the dollar’s demise extend, imported inflation rise and see the US fall into an a protracted period of stagflation (inflation exceeding growth), something that will terminally damage the economy.

Let us look at the major Central Banks and examine their current policy:

FOMC
Chief: Ben Bernanke
Current Interest Rate: 3.5%
Interest Rate in September 2007: 5.25%
Change since September 2007: -1.75%
Responsibility: ‘attainment of long-run price stability and sustainable economic growth.’
CPI Rate Dec 2007: Headline: 4.1%, Core: 2.4%.
GDP in latest quarter: 4.1% in Qtr 3 2007

Kudos for:
Only major Central Bank to actively respond to major credit crisis which unfolded last August and dropped its key interest rate to 4.75% in September. The Fed was alert to poor economic data out of the US in the final quarter of 2007 and cut rates by 25 basis points in both its October and December meetings. Prevented a stock market crash on Jan 22, bringing forward an interest rate decision by a week, when it announced a cut of 75 basis points in the Fed Funds rate, the largest single-day cut in history.

Marks against:
Accused by many of not having been proactive enough and should have cut interest rates much sooner to stave off the threat of a recession. Inflation is rising at a time when the Fed is easing rates aggressively and Bernanke stands accused of largely ignoring the growing inflation risk. The Fed delivered large rate cuts in September (50 basis points) and January (75 basis points) in response to major dips in stock market prices, as opposed to specific dips in economic data and many see the Fed as the custodian of Wall Street, moreover Main Street. Current Fed policy seen as an irresponsible attempt to force short-run economic growth at the expense of long-run sustainable economic growth which is the Fed’s actual remit. Current asset bubble and credit crisis is the Fed’s own baby in the sense it was born out of the last major set of aggressive interest rate cuts from the FOMC back in 2001, when rates fell to 1%, leading to cheap money and complacency on the part of lenders.

What to expect from Fed in 2008: Rates could now go as low as 2.50% by the March meeting and it will then be a wait and see policy from the Fed to see if the gamble pays off, although having pared off most of the interest rate already by then, the Fed will have little in reserve. Will be due most of the credit if US avoids a recession but will have a massive credibility issue hanging over it, if inflation continues to rise in the coming months and the economy moves into a prolonged slump.

ECB
Chief: Jean Claude Trichet
Current Interest Rate: 4.0%
Interest Rate in September 2007: 4.0%
Change since September 2007: 0%
Responsibility: Price stability and to support a "high level of employment" and "sustainable and non-inflationary growth".
CPI Rate Dec 2007: Headline: 3.1%, Core: 1.9%.
GDP in latest quarter: 2.7% in Qtr 3 2007

Kudos for:
Market always knows where the ECB stands on policy and the press conference after each monetary policy meeting is both direct and informative. The ECB sticks to its mandate and is thus far unwavering in pursuit of its policy objectives in the face of pressures from politicians and financial markets. Has kept inflation firmly anchored in the euro area (to the last quarter of 2007) and in the past two years has overseen a period of sustained economic growth for a diverse group of 13 (now 15) nations. It quickly poured funds into markets to shore up liquidity during the financial market crisis last August.

Marks against:
Does not see stimulation of economic growth as its responsibility and it is currently threatening to hike interest rates at a time when the euro economy is slowing. The ECB doesn’t take an official vote when deciding on monetary policy and markets don’t know the extent to which views vary on the monetary policy committee. The ECB has done little or nothing to alleviate the ‘crisis’ that has plagued financial markets since the turn of the year. The ECB helped to make money cheap (interest rates were just 2% up to December 2005) something that has led to the asset bubble which threatens current economic stability.

What to expect from ECB in 2008: Will most likely keep rates on hold for the first quarter but inflation may ease sharply if the global slowdown takes root, thus opening the way for a rate 0.25% cut during the second or third quarter. Likely to have underestimated the potential slowdown in euro growth and will stand accused of not having acted soon enough, although the ECB will claim their only remit was to control inflation.

Bank of England

Chief: Mervyn King
Current Interest Rate: 5.50%
Interest Rate in September 2007: 5.75%
Change since September 2007: -0.25%
Responsibility: 'Monetary stability meaning stable prices - low inflation - and confidence in the currency.'
CPI Rate Dec 2007: Headline: 2.1%, Core: 1.4%.
GDP in latest quarter: 3.1% in Qtr 3 2007

Kudos for:
Presided over a sustained period of remarkable growth in the UK economy. Managed to drive UK inflation down from a 3.1% headline rate this time last year to the Bank’s target 2.0% rate in the Autumn and has since managed to keep UK inflation anchored, when consumer prices were significantly on the rise elsewhere because of the spike in energy and food costs.

Marks against:
Generally reactive and very slow to adopt a policy change. The inflation problem in late 2006/2007 had much to do with the Bank’s original failure to act soon enough, when growth began to expand from early 2006. The Bank handled the whole Northern Bank fiasco (first run on a UK bank since the 1800s) abysmally and this episode greatly tarnished the Bank’s reputation and the reputation of its Governor. With a major credit crisis underway in the financial sector (one of the mainstays of the UK economy), growing evidence of slowing growth, falling retail sales and falling house prices, the Bank of England has since September cut its core interest rate by a measly 25 basis points and is not doing enough to prevent the UK economy from a sharp downturn. Consensus appears to be a difficult position to reach for the Bank of England Monetary Policy Committee, with many split and narrow votes and this has undermined the role and the influential ability of the Bank’s Governor.

What to expect from Bank of England in 2008: The Bank will probably cut by 25 basis points in February but it won’t be nearly enough and events could overtake them, forcing the Bank into an aggressive series of cuts thereafter which could see a further 100 basis points pared off by the summer. If the UK suffers a severe downturn or a recession later this year, the Bank of England will be put forward as the principal culprits, for having chased the hare after it has bolted.

Ted B - Jan 23