ECB Cuts Rates when Stock Markets are at Record Highs

The ECB took Financial markets by surprise when it announced a 0.25% cut in its core interest rate on Thursday. Most analysts, including yours truly, expected rates to remain as they were and indeed few expected rates to ever dip below the 0.50% rate announced earlier this year. It is obvious the ECB is less than impressed with the limp growth being experienced in the Eurozone, and with inflation running at a meagre 0.7%, the European economy is in danger of slipping into a Japan-like decade of economic stagnancy and deflation. Indeed we can say we are already half way along that road.

But is the ultra accommodative policy of the ECB enough to help Europe reverse course? Experience elsewhere would suggest not. Japan's lost decade occurred at a time when the Bank of Japan kept interest rates close to zero, printed money at will and facilitated a carry trade that saw the Yen kicked around in currency markets. Despite the exhaustive efforts of the Bank, apart from exporters, there was very little economic uplift in Japan's domestic economy and the country has spent the best part of twenty years in a deflationary rut.

So can Mario Draghi & Co. avoid the economic chasm that so engulfed Japan for much of the past twenty years? We are five years in and thus far the omens are not good. The ECB and the Eurozone are running out of options and unless European consumers begin to find work and find the propensity to spend, then stagnation will become denigration and to déja vu we are doomed.

Given the German influence within the ECB and its strong resistance to quantitative easing as a method of economic stimulation, the Eurozone is highly unlikely to follow the same path as Japan, the US and the UK in rolling out the printing presses, simply to appease the flawed political lines of economic argument. One thing we have learned over the past five years is that quantitative easing has had minimal positive impact on real economies across the world and it has merely acted as a tool by those at the top end of the financial tree to stoke the fire in financial markets.

Since the economic collapse five years ago, virtually the only place where we have seen inflation, and indeed heightened inflation, has been in stock markets, commodity markets and in a range of other financial instruments. Indeed many of the increases in these markets are hyper inflationary and are totally out of synch with consumer experience and with the normal rules of economic supply and demand. To be fair there are two very real contributory factors leading to the growth in major stock indices, one being that the lack of credit on the ground has squeezed out a huge chunk of the SME market in favour of cash-rich conglomerates, and the other being that sustained growth in the developing world has hugely benefited multinational PLCs.

However there remains a huge disconnect between the growth in stock markets as against GDP growth in the real economy which suggests financial markets are due a very significant correction downwards. Investors in stocks should not take the ECB move on Thursday as a positive sign for the medium-term outlook for stocks. The ECB is not the line of either first or last defence for financial markets in the same way the Fed acts as the great protector of Wall Street. And with ECB rates at a level under which there is no scope, when the trap door opens under the weight of inflated stock markets, there will be little to nothing the ECB can do, even were it as inclined as the Fed to intervene.

Apple, Google and the Tax Holidays on Offer in Ireland

Much has been written in the past two weeks about apparent anomalies in the tax regime in Ireland and the ability of two of the biggest corporations in the world – namely Apple and Google, to exploit these anomalies to their advantage, i.e. to avoid paying taxes to the tune of Billions of dollars, to any tax authority, anywhere, for many years. Neither company has broken any law, rather, both have jumped on the incredibly generous tax laws which operate in Ireland, a country that enables large multinationals to register their entities in Ireland while not having to be tax resident there, nor indeed tax resident anywhere.

There have been many vocal objections within Europe in recent years to Ireland’s lowly corporation tax rate of 12.5% which is significantly lower than the EU norm. However, despite the protestations, Ireland managed to convince the Troika during the bailout talks 2.5 years ago that Ireland had to retain this tax rate to ensure the sustainability of existing business operations from multinationals in the country, a sector that currently provides upwards of 150,000 jobs in a county with a population of around 4 million people. The fear was that if this tax rate was increased significantly, it would trigger an exit of multinational firms from the economy, and further depress an already stuttering economy, thus exacerbating the country’s already dire debt problems.

However, the Apple and Google story really has nothing to do with Ireland’s corporation tax rate. Even if the corporation tax rate were 35% (as in the US), this would not have made much difference to the actual tax take Ireland would have netted from either company, as Apple and Google only pay nominal tax in Ireland, reported as being just 0.05% and 0.14% respectively of total income channeled through their Irish entities. The tax anomalies that exist in Ireland permit a company to register there, but if the entity is managed from outside the Irish jurisdiction, it can be deemed to not be tax resident in Ireland, thus the corporation does not have to pay tax to the Irish State for the operations of these companies. In the case of Apple, three of the Group’s main revenue generating companies are registered in Ireland, but are tax resident in Bermuda, where there is no tax. Using this arrangement, Apple managed to restrict its overall tax liability across the globe in 2011, to just 1.9% of the Group’s income. Apple is a US conglomerate with its Headquarters in Silicon Valley, and given the corporation tax rate for American registered companies is 35%, it is easy to see why certain people in charge of the legislature in the US might get quite exercised on this issue.

Similarly, in the UK, the House of Commons were informed two weeks ago, that Google Ireland paid tax of just €70 Million on sales of €47 Billion between 2005 and 2011. Google’s sales in the UK were channelled through its Irish company and Google essentially paid no tax in the UK on UK sales. Google availed of the same tax loophole as Apple, whereby it funneled revenues from non-Irish operations through Irish subsidiaries which although registered in Ireland, were not deemed tax resident in Ireland. The funds then made their way to a Bermuda registered Google company, to avail of the 0% tax rate on offer there. The House of Commons committee subsequently branded Google ‘devious’.

So who is to blame for the tens of Billions of dollars in lost tax revenue? It is hard to blame the companies themselves directly, as ultimately the function of corporate companies is to maximise the wealth of their shareholders. There is an argument that both Apple and Google come up short in terms of displaying corporate moral responsibility, whereby they have deliberately avoided paying their fair share in tax contributions back to the economies that contributed most to their success. However most corporations will generally operate within the legal parameters set for them, and if the legal parameters come up short, and this provides an opportunity, then most companies will take such an opportunity if it helps it to preserve and grow its wealth for shareholders.

The Irish Government has been at pains over the past week to state Ireland is not a tax haven and that the government does not do deals with companies on the tax liability a company must pay. However the fact is that Ireland deliberately operates an accommodative policy surrounding legal registration and tax residency and this accommodation is used by scores of multinationals to avoid paying tax in other jurisdictions. This has nothing to do with the low corporation tax regime already operating in Ireland. Apple and Google between them provide about 6.000 jobs in Ireland and these jobs are obviously deemed more important to the country than the very significant tax revenue the country could earn from both companies, and indeed from other multinationals, were these companies forced to pay corporation tax on all earnings channeled through all their Irish registered entities.

The European Union could introduce a rule that all companies registered in the European Union are automatically liable for tax at the tax rate applicable in the jurisdiction in which the company is registered, closing off the Irish loophole that permits a company to be registered as a legal entity in one country, while being resident for tax purposes in a separate jurisdiction. Of course the EU, US and other major governments could also determine that, for tax purposes, IP has to be registered in the country of origin of the IP, as opposed to being registered in some remote island and thereby by proxy, this would force large multinational companies like Apple and Google to radically rethink their policy in relation to corporate responsibility and tax and their overall economic contribution to all society.

Bob - May 27th 2013

Jamie Dimon's Two Fingers to Governance

What is going on at JP Morgan Chase?

Despite the multiple scandals that has plagued the broader Banking sector in recent years and the more recent 'London Whale' trading scandal, where JP Morgan blew billions of dollars of investors money, JP Morgan Bank has spectacularly demonstrated its inability and reluctance to embrace strong leadership and transparency by voting down a proposal to separate the key corporate roles of Chairman and CEO. As to why this proposal needed to go to a vote by shareholders in the first place, says a lot about Jamie Dimon's own personal agenda within the Bank and his rather alarming indifference to best practices in governance. What is he afraid of? What has he got to hide? Why does he not want to be accountable to anyone within the Organisation?

Even undergraduate students that study business studies and corporate governance will know the critical importance for the separation of the CEO and Chairman roles in an organisation. The Board's job is to oversee the performance of management and to hold management to account. How can the Board carry out this function if the Chairman of the Board happens to also be the Head of Management (CEO). Given the Chairman sets the agenda for Board meetings and is the most powerful and influential person on the Board, how can the Board function in any meaningful or effective manner, if the Chairman also happens to be Management's chief representative and defender on the Board.

The fact a publicly listed Bank the size of JP Morgan Chase is even allowed to retain a CEO and Chairman as the same person does not say much for the regulatory authorities in the US. In many countries this would be a breach of governance practice and the Bank would be expected to provide an explanation in its Annual Report for the breach, and to provide details on what it is doing to rectify the transgression. Many of the failings of international banks during the financial crisis had to do with core governance failures and the failure of Boards to rein in management, when risks in the sector began to escalate.

JP Morgan Chase may well argue that it outperformed and outlasted most of its competitors during the Banking crisis, but that does not give Mr Dimon a license to be answerable to nobody and to both manage and govern the bank as he sees fit. If he is truly proud of the job he has done, he would be open to transparency and accountability, and welcome a non-executive Chairperson to evaluate his performance and to report back independently to the Bank's shareholders. Ultimately one has to ask what is the role of the non-executive Directors on the Board of the Bank and if these Directors believe it enhances their corporate reputations to sit on such a dysfunctional Board structure. How effective can the Remuneration Committee be if a member wishes to question the remuneration package afforded to Jamie Dimon? Dare they strike it down? They can hardly revert to the Chair for guidance, or support.

The number one requirement in good corporate governance practice is the separation of the CEO and Chair roles. Any organisation that fails this simple test is a long-term recipe for disaster and should be seen as a significant risk for would-be investors. JP Morgan Chase is an Institution where strong ego wins out over strong governance. Step clear!

Bob - May 22 2013

Market Watch: Canadian Dollar

Is it time for the Canadian Dollar to make a significant correction against its Australian counterpart?

The Canadian dollar is traditionally one of the more difficult currencies to predict in terms of medium to longer term movement, given direction is principally dictated by a number of factors outside the confines of the Canadian economy and the monetary policy moves of the Bank of Canada, namely 1) the general trend in global commodity prices and 2) close affiliation and thus link to the performance of the US economy and the US dollar.

It is thus a risky currency to trade, although over the past 12 months it has generally traded within a fairly confined range against the US dollar, while trading a little stronger against the Euro for all of 2013. The Canadian dollar has not had anything like the same inflated gains achieved by the Aussie and New Zealand dollars since the turnaround in global financial markets, but this is thanks to the much more accommodative interest policy adopted by the Bank of Canada, as against that adopted by the Central Banks in Australia and New Zealand. Interest rates in Canada have remained at 1.00% while the higher rates on offer in the Aussie dollar (3% + up until recently) meant that any speculative holding trade involving commodity currencies has generally gone on the Aussie dollar. The recent sharp fall in metal prices and the reduction in overnight rates (to 2.75%) announced by the Reserve Bank of Australia last week has triggered some dilution in this holding trade, and the loonie is now up 5% against the Aussie in the past month. However, the pair are due a further correction given the Aussie is still trading almost 30% higher against the loonie than when the pair last traded at a fully corrected price back in early 2009. Of course the problem with being bearish on the AUD/CAD pair is the punitive overnight cost of the interest rate differential (2.75% Vs 1.00%), but the signs do indicate this pair should make a significant move downwards, certainly down to 95 and possibly down to 90, through the course of this year.

But, and this is an important but, the Canadian dollar will only make significant gains against the Aussie on the back of a move downwards in AUD/USD, and thus a good hedge to take on in tandem with a sell of AUD/CAD, is to sell USD/CAD. While not the perfect hedge, it will significantly reduce the risk of holding AUD/CAD in the medium term, while the interest rate differential in selling USD/CAD is in the traders favour (0.25% Vs 1.00%). This strategy is for an initial 3 months.

Ted - May 15 2013

Austerity and ECB Policy

Last Thursday the ECB announced a 25 basis points reduction in its overnight rate bringing interest rates to 0.50%, the lowest level they have reached in the Euro era. An accommodative policy has been adopted by the Federal Reserve, ECB, Bank of England since the Financial crisis in 2007-2008, but all the evidence suggests this policy has failed miserably to stimulate many of the major economies in the developed world, with contraction again the dominant force in Europe and Japan, while the US experiences a moderate recovery. The Euro area economy contracted at an annualised rate of 0.6% in the final quarter of 2012, while Japan contracted at a rate of 0.4%. The UK economy grew by a slight 0.6% annualised rate in the first quarter of 2013, while the US economy expanded by a more impressive 2.5% in the same quarter.

Little to none of the cheap money being fed into the bank chain from the top of the hierarchy by the Central Banks is making its way into the real economy - i.e. by way of retail bank support and lending to small businesses and end consumers. If the people that are the lifeblood of the economy are starved of cash and disposable income, then the real economy is missing the basic stimulus it needs to grow and the Central Banks need to reassess its policy, or, more importantly, reassess how the institutional banks are interpreting their policy. Owing to flagrant indifference of the banking sector to the Central Bank's policy intentions, any trickle of funding that does currently make its way from the banks to the real economy usually brings with it a vastly inflated interest rate tag, just to reinforce the fact that accommodative monetary policy is not accommodative where it is needed. None of this money is available at an affordable price where it is needed most.

But if the cheap money being ushered out by the Central Banks is not going into the real economy, where is it going?

Answer: Into risk assets such as commodities, bonds, even equities. How? The institutional banks are borrowing cheap money from the Central Banks, such as the Fed, ECB and Bank of Japan, and rather than making this money available for end borrowers (the original intention of the Central Banks), the Institutional banks are diverting the cheap funds from the Central Banks into their own investment channels, to speculate on higher risk investments in the hope of a more profitable and quick return. For the most part this tactic has worked over the last 3 years with largely exaggerated price increases achieved in commodities and equities, while sovereign bonds in many defunct European countries are now achieving close to record yields for investors. The added political lobbying by bank interests of influential governments within the European Union has helped to safeguard bond investments, as the EU currently prohibits sovereign debt write-downs and the burning of major bondholders exposed to Europe's burgeoning sovereign and banking debt. Any country that might consider straying from this policy is threatened with expulsion from the Euro.

For the institutional banks it is a no-brainer. Why lend money to the man on the street or to someone starting up in business, with the risk that entails, when the option exists to direct this money into a 6% yielding bond, a speculative fund investing in oil futures (up 50% since 2009), or gold (still up 113% in the past 4.5 years despite a recent sell-off) or equities (The Dow is up a massive 130% in the same period). A 5-year term loan given to a small business might yield 18% over 5 years and is not without risk, while a mortgage given to an end consumer might yield 40% after 20 years. The differential gap in terms of potential yield between investment risk and lending risk is something of a moral dilemma for institutional banks, but not one they lose any sleep about, and when push comes to shove it is lending to the real economy that is losing out to speculative investment. Of course what this means is that with cheap and free money barging its way into riskier assets, these assets have grown at a rate which is completely out of synch with growth in the underlying economies and thus the aforementioned assets are completely overpriced in real economic price terms and the run-up in prices is unsustainable, and many of these assets are soon headed for a serious downward correction, if not crash landing, in the not too distant future. Oddly enough, given the impact of political bullying and potential ECB intervention, sovereign bonds within the Euro area may be at the lower end of this risk investment scale.

So what does this mean? Central Banks are accelerating a policy of providing cheap money to banks so these banks may use this money to invest in risk instruments rather than lend this money to the real economy. The net result for many of the underlying economies is economic contraction as government austerity measures intensify and fuel costs continue to inflate, thanks largely to the speculative investment which the Central Banks are inadvertently helping to fuel. Cash-starved businesses in developed economies are being run aground and unemployment in Europe is now at a Euro era high at 12.1%. Japan's Central Bank is currently undertaking desperate measures to try to discredit it own currency with the result that the currency has fallen 28% against the dollar in the past 8 months, while the Nikkei has soared 63% since the middle of November. The price moves in Japan are totally at odds with the economy's lack of economic growth and its underlying fundamentals and the price moves appear more fictional than real. It just does not seem plausible that such moves can occur and be representative of the economic facts. But of course they are not representative of the real economy, rather they are representative of the repatriation of cheap funds originating from the speculative children (banks) of accommodative Central Bank policy, as their fund managers race trigger-happy across the globe, in an avaricious chase for big profits from risky assets.

Why are institutional banks allowed to borrow money for half nothing from the ECB, Bank of England, Bank of Japan and the Fed, when this cheap money is not finding its way into the real economy and is not being used to help the economies of the Euro, UK, Japan and United States? The reason is simply because, despite the near-collapse of the banking sector in Europe just a frighteningly short time ago, the ECB and other major Central Banks have failed miserably to impose the proper regulatory procedures required to keep the money distribution policies of banks under control. It is incredulous that the ECB itself has not imposed stricter rules and monitoring procedures, for tracking cheap funds being poured into the banking sector, given the strict rules it has imposed on the Governments of the Euro area, forcing an era of severe and heretofore unseen levels of austerity, for most of the citizens of the Euro area. Is it that the ECB, and Central Banks generally, are run by bankers whose modus operandi is for the benefit and growth of banks, moreover the real economy and its citizens?

Bob - 7th May 2013

The Dollar, Bernanke and the Golden Goose - Are they Coming Home to Roost?

It is interesting to note the top three headlines on CNBC business news this evening:

‘Why are Investors so Worried about a Stronger US Dollar’

‘Fed will Keep Rates near Zero through 2010’ says Bill Gross

and

‘Rates to Remain Low’ says Ben Bernanke

Why is it that such mundane speak is making headlines all of a sudden (apologies to our other Bob on the floor)? Well it’s like this: last Friday the dollar had its only significant one-day rally in 6 months and early on Monday the unthinkable happened, i.e. the dollar sustained a rally into a second day, something that has been rather unheard of since last March. This has put the frighteners on many institutional investors, most of whom have made large profits on the back of a weak dollar, and basically on nothing else. If your reason for financial living begins to be questioned or it is beginning to wear thin, you look to your usual suspects - financial leaders like Ben Bernanke and Bill Gross to reaffirm your (albeit fundamentally flawed) strategy and have them undermine the counter view. This is exactly what has happened today although in Gross’ case he was merely putting his own spin on what Bernanke himself had just said. Why rein in the wisdom and direction of a herd when the good shepherd is on your side?

And why the sudden need to pull the rug from under the dollar? The reason is simple – Friday’s jobs report reveals that in November the US shed the lowest number of jobs it has lost in any month since the recession started 2 years ago. The marginal 11k loss caught most analysts by surprise, with even the most conservative data watchers having predicted a job loss of at least 100k. To compound matters, the number of jobs lost in October was revised downwards by a further 80K, thus the jobs report across the 2 months was far less negative than nearly everyone had anticipated.

So why is such positive news proving worrisome for US investors? Why is 'not so bad' news bad for stocks and commodities (Gold fell almost $50 an ounce last Friday). Surely in a year where there has been zero to cheer about down on Main Street some little bit of respite in the labor market would be taken positively by markets, markets that are meant to represent these same economic facts and prospects? The problem of course is that financial markets do not represent economic facts, not currently in any event. There is a massive disconnect between main street and Wall Street, something that has only widened dramatically this year, despite major assurances from Messrs Bernanke and Company following the financial market collapse last year. In just six 'primarily recessionary' months Ben Bernanke and his cohorts have managed to fuel an asset bubble in stocks and commodities which in normal boom times would take 8-10 years to build. By bending over backwards and sideways, and somersaulting over the Chinese and other US debt holders, Bernanke has pumped enough ‘money for nothing’ into the system to trigger a 60% plus rally in US stocks between March and November and to infuse sufficient panic about the US ‘well being’ that investors have flooded into all forms of anti-US wellbeing financial instruments like gold, oil, every other dollar denominated commodity known to mankind and every single currency that is not a US dollar or a US dollar proxy (such as the Yuan). The resultant depletion of the value of US denominated assets relative to other currencies is quite staggering in the context of it only taking 6 months to get there. Loose fiscal policy from the US Administration and almost limitless free money from the Fed has enabled unrepentant investment banks and other greed-driven financial institutions to say thanks by creating an enormous bubble in financial markets, the likes of which has never been seen before.


The much publicized recovery we hear about every day on CNBC and Bloomberg is another one of those recoveries that is unfortunately divorced from economic reality (we love Maria Bartiroma but pretty please they need to change those other records). Hedge fund managers are falling over themselves (many on the airwaves) to try and justify their reckless trades and investments and thus the lauding of them folk Bernanke and Gross, who always seem to serve the interests of financial markets in those high gloss towers over the economic coalface down on Main Street (well, at least Bill has a colourful reason, albeit a selfish one, but our Ben was supposed to have read the black and white pictures in those 1930s annuals). If Ben or anyone looks at the latest Commitment of Traders Report on gold, we find that there is currently almost $28 billion of speculative long positions on gold (all managed funds) against only $860 million of short positions. This means a staggering 97% of speculative trades are betting that gold is going to continue to rise in value against 3% that believe it will fall – it hit $1226 an ounce last week. Such biased positions are not sustainable in the long run. They never are. Gold is very close in bias terms to where oil was in July last year before it crashed. Other notable extremes exist for many other related instruments including silver, the Aussie dollar and the Swiss franc. Trichet used to warn of such investment extremes before but even he has gone to pasture on this one, although he is the most consistent vocal on the needs for a stronger dollar, whatever that means. Tim Geithner's vocal interventions for a stronger dollar are laughable efforts and usually tend to lead to the dollar being sold off more sharply. US policy on the dollar is kinder garden stuff and when we hear officials advocate a strong dollar it usually can be translated as meaning 'a weak dollar please, but not so weak today as it might be please - (tomorrow).'

In a market where we have instruments with anything from a 2:1 to a 30:1 bias against the US dollar, it does not require sound economic reasons for market players to buy the dollar to initiate market chaos and to force a meltdown of asset prices. It simply requires a reality check on the part of those over-zealous investors (currently the majority) and to see an inevitable move on their part to the exit stalls. When a huge Stadium becomes overcrowded panic can set in more readily and a stampede could ensue, without warning. Bernanke and the world’s governing body (Central Bankers) have once again failed to patrol this particular Stadium and their general ignorance to events and their total inability to learn any lesson from what happened just 12 months ago means that the next fatal episode will lie at the door of their layer of command. They are the upper hierarchy of the global banking system, and they will be responsible for the next bubble-bust and financial crash, soon to be visited upon us, barring a miracle. Let us just hope this particular goose does not turn out to be a Bernanke roast that ends up on our table this Christmas.

We may need Bill Gross to give up the day job and work them airwaves again to keep Ben's goose at bay (mind you, it must be tough to have to manage the world's largest bond fund during a time of great economic distress, yet have all the time in the world to talk on TV). Way to go, Bill.

Bob B - Dec 7, 2009

Has the RBA lost the plot?

The Reserve Bank of Australia's decision to raise interest rates earlier this month led to a massive 8% rally in the Australian dollar against the US dollar over the past two weeks. The Australian dollar has now rallied over 50% since early March, a rally so sharp that it raises very serious questions about the currency's credibility as a reliable asset form. The currency has now seen a combined 100% swing in its valuation (50% each way) against the US dollar over the last 15 months. The Australian economy has weathered the recent recession better than all developed economies, experiencing only a temporary negative dip in GDP. How then does this explain the massive volatility in the country's currency? One thing is does demonstrate to us is that the value of the Australian dollar has very little or nothing to do with the actual performance of the Australian economy and its trade volumes, but more to do with the speculative greed driven by the 'money for nothing' monetary policy of the US Federal Reserve (and the Bank of Japan before it). The loose monetary policy of the US is seeing speculators (many of them major US investment banks) use the dollar as a funding currency to essentially sell the dollar in favour of any liquid asset that is not the US dollar. So while hundreds of thousands of American citizens find themselves being made redundant every month, hundreds of billions of the free money being given to US banks by the Fed, supposedly to stimulate the US economy, is instead being used to speculate against the US dollar and in effect bet against a credible recovery in the US, thereby triggering a rather rapid acceleration in the depletion of the wealth of the US population. The ridiculous price surges being witnessed in commodities and many currencies has absolutely zero to do with the economic principles of demand and supply and everything to do with highly leveraged risk and the unchecked and unregulated transactions of large hedge funds and investment banks.

Many Central Banks continue to misread financial markets, primarily because they have not got a clue how they are operated, let alone regulated. The Reserve Bank of Australia takes the biscuit in terms of universal ignorance and shocking misjudgment. We should not be too surprised though as the RBA is the only central bank in the developed world in recent years that intervened to try to prop up its currency at a time when it was grossly overvalued. That episode might go some way to explaining why Governor Stevens chose to hike interest rates at a time when deflation is more of a concern across the globe than inflation. The RBA have a strong Aussie dollar policy and they are prepared to risk the long-run sustainability of the Australian economy in exchange for attracting short-term funds. The US economy has suffered hugely over the past 2 years of recession and the Fed's ongoing accommodative policy of low interest rates is reflective of an economy in protracted turmoil. The most recent current account report out of the US shows the US current account deficit running at 3% of GDP over the past 12 months. The corresponding report for Australia, where the RBA has just risen interest rates, shows a deficit of 3.9%. The disconnects between the Australian dollar, interest rate policy and harsh economic reality are stark and the RBA's continual misreading of the economic world portrays Governor Stevens as a type of Alice in Wonderland type character.

Let's hope his fable does not have a sorry ending, for the citizens of Oz and all its companies that need to export to the outside world.

Bob - Oct 20

The Elastic Band that is the Dollar

The dollar has fallen dramatically in recent months and it took a leg lower in the past week when increased liquidity after the summer holidays saw investors put their money into higher yielding currencies and metals. Despite the usual garb being published daily about the 'dollar being finished' and US debt spiraling out of control, there are some dangerous extremes developing in financial markets again and all the evidence points to financial markets once more being divorced from economic reality. A sharp reversal is inevitable, with the strength and severity of the reversal likely to be determined by the length of time it takes for markets to meaningfully 'correct' or pull back from these extreme levels. The longer it takes, then the more taut the elastic becomes and the more severe the reversal.

Let us look at the key events that lead me to this conclusion.

1) Gold prices.
Gold has risen sharply in the past 2 weeks, to over $1,000 an ounce for the first time since early 2008. Closer examination shows that this increase is not owing to any physical demand for the commodity but by speculative demand from money managers. Open interest hedge fund positions in gold at present, sees over 98% of hedge fund monies being net long on gold. This is an extraordinary extreme no matter how one looks at it and history tells us biased positions do not last forever and the greater the bias the greater the potential for a fall or collapse. Astute money managers should right now be reducing their exposure to gold for this reason, if for nothing else. Gold has the potential to retreat back to $800 or even less within no time, if some event triggers a sale. Central banks could deliberately bring about this collapse in the gold price, if they chose to do so, and there are several reasons why it might be in their economic interests to do so. Gold is traditionally used as a hedge against inflation but currently the globe has a deflationary problem and present and future US market rates do not hint at any looming inflationary issue for the world's largest economy. Gold prices are completely out of sync with interest rate expectations, which indicates gold prices are greatly inflated at current levels. Be warned!

2) Commodity Currencies.
The economic exaggeration currently reflected in equity prices is also evident in the price of commodity currencies. The Australian and New Zealand dollars are up over 40% against their US counterpart since March. The Canadian dollar is up over 20%. The global recovery story is only in its infancy and currency moves of the order of 40% are nonsensical, particularly for the Aussie and New Zealand dollars which represent economies with pretty dire current account deficits. This currency appreciation is based entirely on market speculation. 90% of non-commercial open interest in the Aussie dollar on September 1st was made up of speculative long positions. This represents an unsustainable extreme. It also demonstrates that Central banks have yet to grasp how speculative financial markets are free to derail competitive currency exchange. Central Banks have learned nothing from the recent market collapse and they continue to watch in silence as leveraged speculation in currencies leadings to a pronounced instability in exchange rate markets. The Australian and New Zealand dollars are due for sizeable corrections sooner or later, with both currencies currently punching well above their real exchange rate values.

3) Japanese Yen
What has been striking about the past 2 months in particular has been the replacement of the Japanese yen as the world's favourite funding currency (i.e. by speculative risk merchants) by the US dollar. What this means is that carry trades (speculative bets on higher yielding currencies) are now carried out using the US dollar (the dollar has a paltry 0-0.25% yield rate). 3 month libor rates currently have the dollar cheaper than the yen as a funding currency for the first time in many years. Carry trades, while attractive in some ways, are also very destructive to international trade competition as a large volume of speculative bets involving the same funding currency has the effect of depreciating the value of that funding currency, sometimes quite considerably. We also know that market scares lead to unwinding events that can result in a very sharp appreciation in the funding currency. We have seen this over many years with the yen and for now the dollar is the favoured vehicle for carry trades. At present almost 80% of open interest in the Japanese yen is net long, a quite remarkable position given we have had almost 6 months of unbroken growth in stock markets and sustained investment in riskier assets. It is safe to assume that the the bulk of the biased positioning in the yen right now is against the US dollar and any eventual return to impartial positioning, will result in a sharp reversal and a significant rise in USD/JPY. It is almost certain that interest rates will rise in the US before Japan and will rise much more quickly, something that will spark major capital flows from yen to dollars. The market will figure this one out eventuality, sooner rather than later, so look out for a sharp rise in USD/JPY before the end of this year.

PPP
What most speculative traders and daily analysts tend to ignore is purchasing power parity. It is almost incredulous that over a period of a few months an Australian can buy 40% more with their money than a US citizen can in US dollar terms. The prior Aussie rally to over 95 US cents can be discounted as that was driven exclusively by an asset bubble that burst last year. The differential standard of living in both the Australian and US jurisdictions has hardly changed in the past 6 months, yet the exchange rate markets that Central Banks have criminally refused to regulate now sees Australian citizens being able to buy 40% more than US citizens thanks to the unchecked greed of hedge fund managers. Of course we know that this is a false exchange rate, but at the same time it presents a fantastic opportunity for Australians to buy up US dollar denominated assets at a huge discount. Much the same can be said for Japanese and European (non-UK) investors. Because of the weak dollar exchange rate, it is an excellent time for Asian Banks to buy US Treasurys. European bonds are grossly over-priced for the Japanese and Chinese because of an inflated euro (which is over 20-25% overvalued) and the safer option in the longer run is to stick to buying US bills (forget what the doomsday merchants claim for the US, because we have learned in the past 2 years that the US is where it matters and that any negative contagion from there is global). Capital flows will eventually flow back into the US because of the gross imbalance in PPP and it will happen in a very significant way, once evidence of sustained economic recovery in the US is firmly established. The euro is currently benefiting in an environment that sees zero to minimal capital investment in the non-speculative 'real' economy,' but it will find itself out of favour when capital flows begin to pick up in earnest, quite simply because it is way too expensive to invest in the Eurozone. Even in good times, Eurozone economic growth is always a laggard behind the US and Asia.

Bob B - Sep 15, 2009

Disorderly Financial Markets

We have entered a very strange world of whiplash-like shifts in currency prices which has made trading a highly dangerous and totally unpredictable game. Over the past week we have seen record drops in many currencies against the dollar and the yen while in the past 2 days we have seen lazarus-like recoveries for the euro, sterling and all of the commodity currencies. The bounce in stock markets over the past 24 hours does not feel real and given the economic fundamentals are deteriorating further, it is also not sustainable. There have been some farcical episodes on the world’s stock markets with the German DAX gaining 11.28% on Tuesday, thanks primarily to some bizarre trading on a sole component, i.e. Volkswagon. Sterling has gained 20 yen since its lows of last Friday, while the UK currency has earned 10 cents against the dollar since yesterday morning. Add to this the Aussie dollar being up 15% against the yen in a day and the Canadian dollar up 8 cents against the dollar in the past 20 hours and you begin to see just how disorderly and ridiculous the world’s financial markets have become. It is almost laughable, except there are some big monetary exposures behind these huge swings which are proving to be very expensive for those holding them. It is simply not worth trying to trade in these conditions, unless traders are using the swings to unwind previously exposed positions. One should not be fooled into thinking that trends are reversing, they are not. The high yielding currencies in particular could get a hammering later in the week, especially against the US currency.

There is much talk about the Japanese authorities intervening in the currency markets, following a G7 meeting of finance ministers at the weekend, when the subject was discussed. We will not know until after the event if intervention has taken place, but such has been the depreciation in the yen since Tuesday morning that it may well be possible that the Bank of Japan came in and used the global stock rally as an opportunity to sell the yen. One fact is unavoidable though and that is that the yen’s recent appreciation owes nothing to speculators forcefully moving the currency, but rather it is the result of a repatriation of funds back to Japan, as investors liquidate assets which were originally taken out using the low-yielding yen as the funding currency. For this reason, intervention could prove to be useless exercise over the long run as essentially what is happening is that the yen is returning to its base value, having been grossly under-valued for years. The Bank of Japan may even move to cut rates on Thursday in an attempt to curb the currency’s appreciation but again the net result might only be some short term respite. The yen will only truly depreciate again when risk aversion levels abate and investors feel confident to once again fund risky assets in emerging markets through the low-interest yen.

Do not trade in these market conditions! If you must, use 1:1 leverage.

Bob B - Oct 29

Currency Markets a Dangerous Sea to Swim

Currency Markets have entered a state of panic these past few weeks and there is very little in the way of profitable trading to be made, with wild swings the norm on any currency pair that includes the US dollar and the Japanese yen. The US dollar in particular has reached valuation levels against some currencies that were unimaginable just 3 months ago. While I had been calling the dollar undervalued since the beginning of the year, the steep nature of the dollar’s rise is greatly out of proportion with the shift in economic fundamentals for the leading currency pairs and the dollar’s rally is now overdone. A glance at the commitment of traders report for any of the past number of weeks, a report that details the number of open currency positions on the Mercantile Exchange, makes for interesting reading as it clearly indicates that the dollar’s current appreciation has little or nothing to do with traders bets on various currencies. The dollar has appreciated as sharply as it has done because of the credit squeeze and the shortage of dollars on the open market and also thanks to the repatriation of funds back into dollar assets, primarily from the emerging markets, as investors unwind their riskier assets.

The end result is a total distortion of currency markets with some of the smaller currencies at or near capitulation status. The yen’s sharp appreciation is one of the major problems and as long as the Japanese currency remains as strong as it currently is, we will not get normality back to the markets. The yen has appreciated over 30% against Australian Dollar since July and is up 20% against most other major currencies in that period, excluding the US dollar against which it has gained 7%. In the past month, the US currency itself has gained almost 20% against the Canadian dollar, its largest trading partner.

What does all this mean for currency traders? It means the market is unpredictable and dangerous to trade. It is largely a fruitless exercise trading intra-day because fear is the King and fear rises or subsides depending upon how stock markets perform and these are currently swinging madly from one side to the other without warning. Technical indicators mean little or nothing in this market with currency prices sailing through support and resistance points as if they didn’t exist. Economic data is also largely ignored as stories about credit problems, bank rescues and fiscal bailouts take precedence.

What should one do? Nothing! Sit on the sidelines until liquidity levels reach something akin to normal. One should also remember that when liquidity levels do normalise, the US dollar and the Yen will come under intense selling pressure. Positional trading is also dangerous right now because while the value trade would appear to be to sell the dollar or the yen, the result tends to be the opposite as both currencies continue to benefit unfairly from the broader market uncertainty and traders can be left holding positions with huge deficits. EUR/GBP is the only currency pair I like at the moment and with neither side having a hold on direction it can be lucrative to trade in either direction. The range looks to be from 0.77 to 0.7850 at the moment and I have also noticed that in recent weeks, the pound usually does better during the morning session while the euro then retaliates during the US session.

Trade safely, if at all in this market, and avoid the dollar and the yen.

Bob B - Oct 21

Market Mayhem

The dollar is on course for one of its best weeks in history, despite a tirade of weak economic data out of the US and a worsening of the credit crisis, with no official approval yet on the US government’s rescue package for the banking system. How can the dollar make such hay in this environment?

The answer is simple. FEAR! Logic abandoned financial markets several weeks ago and now traders and investors alike are living on their wits. The credit crisis has spread across the globe and with liquidity having dried up, markets are much thinner than normal and it does not take much to move them in one direction or the other. It has been all one way traffic this week however with the dollar and the yen taking all other major currencies to the cleaners. The euro at one stage today was down 9 cents from where it was trading against the dollar last Friday. Sterling was down 11 cents against the dollar in the same time. The euro fared even worse against the yen which has been the week’s strongest currency. Risk aversion is at an extreme level and funds are flowing into the low-yielding yen and dollar at a breath-taking pace. The commodity currencies have also been hit hard with the Aussie dollar coming off the worst. The carry trade has been completely liquidated with the yen now trading at multi-year highs against all of the high yielding currencies. We should be close to the bottom in terms of many of these currencies, but logic does not apply in the present market and economic indicators and technical charts have virtually zero influence. The greenback has today hit a 12 month high against the euro, the Aussie dollar and the Canadian dollar.

The euro has been plagued by bailout stories of European banks and this has badly damaged the once teflon currency. The short-term outlook may be unkind to the single currency but when the dust settles, the euro’s healthy current account balance should prevail over the worsening debt situation in the US. The ECB is resisting calls to cut interest rates but with some European Governments taking it upon themselves to resolve the banking crisis, the ECB’s credibility and indeed the euro itself is being undermined.

This is not a market for small traders and intra-day trading and most traders are advised to avoid it until we see some semblance of order once again. If you must trade, employ very low leverage to minimise your exposure and trade pairs that do not include the dollar or the yen. A backlash against the dollar will happen, but only once market players have calmed down and there is some evidence of light at the end of that dark tunnel.

The regular column will return next week.

Bob B - Oct 2

Bob's Currency Focus - Sep 22

What does the US bailout fund mean for currency markets?

Since Friday’s US announcement of an extraordinary fund to allow financial institutions to cash in bad debts in exchange for taxpayer’s money, the dollar has got it on the chin. The creation of a help-out fund totalling $700 billion comes on top of a government bailout of AIG, which cost a further $85 billion earlier last week. As the US already has a vast current account and budget deficit, the required capital can only be provided through the issuance of government debt and the flooding of the market with dollars. This is not good for the dollar in the long run, because ultimately the more dollars on the market, the less they are worth individually. Even short term sentiment is against the dollar, despite the fact there is a global economic slowdown and investors across the world have been running for cover. Some analysts believe the final bill for the ‘bailout’ will more likely be closer to $2 trillion, an even worse prospect for the dollar. What the dollar does have going for it is the fact that there appears to be little to justify much faith in many of the other major currencies at the moment and because of this, ongoing volatility looks likely while investors weigh up the pros and cons of holding dollars versus other major currencies. The dollar’s strong Rally through July was fuelled by the repatriation of funds back to the US, rather than currency traders laying long positions on the dollar, so if these funds now dry up, given the dollar’s poor yield and rate outlook the currency will struggle and should be sold on any significant rallies. The euro should be able to make it back to 1.50 and only a firm indication of lower interest rates from the ECB is likely to terminally damage the single currency. There is the very real danger that a new commodity price bubble could form over the next couple of months, if the dollar declines too sharply. Speculators willingness to pour back into commodities en masse was evident again late last week, when oil and gold staged massive bull rallies. While Central Banks worldwide have thrown billions at the financial markets in an attempt to calm them, the massive and sudden injection of liquidity could come back to haunt Central Banks in the form of rising inflation and a return to a stagflation environment, which will temporarily put a stop to any consideration of easing in monetary policy. The commodity currencies should outperform in the coming weeks.

EUR/USD
The market is less concerned about economic data at present while traders look more towards safe havens while risk aversion and general market uncertainty persists. The dollar has been abandoned as a safe haven as investors don’t like the thought of an additional $700 billion + being printed and circulated to protect the US banking system. The euro is trading almost 5 cents above the lows from last Friday as currency traders see the euro area financial system as much more secure than that in the US while the relatively flat current account balance in the euro area immediately looks a far more attractive bet than the ballooning one in the US. EUR/USD sold off by 21.5 cents from early July to the middle of September and there is every reason to believe that a 50% retracement of that move could now be underway. That would see the euro rise to 1.4950 and indeed a return to above 1.50 is possible, especially if the deterioration in euro area economic data does not accelerate. Currency markets are a law unto themselves at the moment and one thing we can be certain of is that uncertainty itself will continue to prevail, so big swings will make short-stop trading strategies virtually redundant. Wednesday’s German Ifo survey report is the next economic event that could potentially unhinge the euro. The sharp deterioration in that survey’s index last month caused a major euro sell-off.

GBP
Sterling has gained 5 cents against the dollar since last Friday morning, something of a remarkable feat when one takes into consideration the litany of bad economic data that continues to stream out of the UK. Last week’s surprise increase in retail sales offered some level of comfort but the accuracy and veracity of the retail sales figures have come in for much criticism over recent months and this number may simply be another blip in the series. The UK, along with the US, has a worrying current account deficit and with the British economy seemingly in freefall, there is little reason to buy the pound on fundamental grounds. The pound’s only real chance of appreciation is if risk tolerance levels rise further, thus attracting additional funds into the high-yielding currencies like sterling. Cable should struggle to make it past 1.85, but if the dollar comes under increased selling pressure because of market concerns over the US financing plans, cable could return to 1.90, before the market is forced to take stock of its value once again. If the dollar manages to stage a broader rally across all markets, then cable could quickly fall back to 1.7850 over the next week.

JPY
The yen got hammered last Friday as a surge in global stocks triggered a return to risk tolerance and a resumption of the carry trade. The Japanese currency has lost 10% against both the Aussie and New Zealand dollars in the past week, while it has also ceded major ground to the euro and the pound. The US dollar is the only currency against which it is trading higher against than at the start of last week. The yen will be undermined by the ban on short selling of financial stocks which will limit the downside for global stocks and hence prevent the sort of extreme bouts of risk aversion that were so evident all last week. However, the speed with which traders have returned to carry trades looks to be over-ambitious and with stock markets trading lower thus far on Monday, we could see a forced scaling back of these positions overnight which should help the yen claw back some ground. How markets respond to the US bailout plan for banks will be pivotal for determining direction over the next week, so the reaction of US stock markets needs to be watched very closely in the coming days. Economic data will not have any major significance this week.

CAD
The loonie has broken below key resistance of 103.71 on Monday, meaning the currency has now appreciated by 4 cents against the greenback in the past 3 sessions. Nothing has fundamentally changed in the Canadian economy, but a surge in oil prices over the last few sessions aligned with renewed appetite for risk has sparked a recovery in the Canadian currency. The loonie has been carried along on the wave that has seen a very sharp sell-off of the US dollar on Monday. Canada’s healthy current account balance is also attracting investors as markets look to a huge worsening of the US debt situation with the proposal of a $700 bailout package for US banks. Volatility is likely to remain and while the loonie does now have a chance to send the greenback back as far as 1.02, any sharp up-tick in risk aversion will work against it and could see USD/CAD jump back to 1.07 by the end of the week.

Bob B - Sep 22

Bob's Currency Focus

Is it the end of the world as we know it?

The Fed’s bailout of insurance giant AIG is the latest spectacular episode in what has been one of the most frightening weeks in the history of global financial markets. On Monday Lehman Brothers became the largest (by a street) bankruptcy failure in the history of Corporate America. Also on Monday, Merrill Lynch, Lehman’s closest cousin on Wall Street, was taken over by Bank of America in a rushed deal, executed just before markets opened on Monday, when Merrill was certain to be the next guillotine victim of those shorting financial stocks. Today, we learn that Lloyds TSB and HBOS (the UK’s largest mortgage lender) are on the verge of a merger, forced upon HBOS, as their share price has plummeted so much in recent days that their market capitalisation value has plunged to farcical levels. And today the Russian stock market had to be closed after its index fell 17.5% in an hour. This follows a similar closure on Tuesday, after the index lost 20%. These are scary times and the impact is resonated across currency markets as well as equity markets, with the risk aversion Japanese yen slaying all before it. It is not a market for rational trading based upon the latest economic indicator releases and technical analysis charts, but rather it is a market to best avoid, unless the trader has massive risk tolerance levels. The volatility is resulting in huge swings across most major currencies and in particular any currency pair involving the US dollar, or the Japanese yen. Logic is out the window and wide shifts in sentiment towards what is happening in wider financial markets is forcing currencies in one direction or another. A look at the latest Commitment of Traders Report essentially shows a mediocre volume of open currency trading positions against the norm, which tells us 1) liquidity levels remain dangerously low and 2) currency movements are not being influenced to any great degree by speculative currency trading, but by the repatriation of funds across exchange rate borders, primarily to Japan and the US, resulting in the yen and the dollar appreciating significantly against the other majors. The yen has now appreciated to 2-year highs against the euro and the Aussie dollar and to multi-year highs against the high-yielding pound and Kiwi dollars. The carry trade has essentially been completely liquidated in the past 2 weeks although extreme negative market sentiment could see the yen gain further, particularly against the euro.

The current market is too risky and volatile and short stops are not working. Traders are best advised to avoid the dollar and yen and to stay away from the market until it settles, or else stick to pairs like EUR/GBP, AUD/NZD and EUR/CHF. Those stuck in open positions may need to sit them out or if brave enough, to enter the market at current range extremes, and collapse the two positions at the halfway point.

Bob B

Bob's Currency Focus

EUR/USD
The dollar’s relentless rally continues unabated, sending the euro to a 2008 low on Thursday of 1.4327. This happened after the ECB’s ‘no bias’ monetary policy statement when the Governing Council voted to hold rates steady. The market did go after the euro after that event believing the ECB will be forced to cut rates sooner rather than later but the dollar gained ground against all currencies, excluding the yen, after the IS reported that the US Services Sector expanded in August, with the business PMI coming in at 50.6, moderately above the 49.0 expected. Global stocks have tanked today, but the dollar continues to benefit from an inflow of safe haven flows and today it registered its highest exchange rate of the year against many currencies. The dollar and the yen seem to be the only game in town right now with investors reluctant to load bets on European or commodity currencies. Friday will offer another litmus test for the US economy when the nonfarm payrolls report is released. The omens don’t look good however, after Thursday’s initial jobless claims numbers came in at the worst level in 5 years, while both the ISM services and manufacturing reports record contractions in employment during August. It may well be a case of damage limitation and if the figure is something better than -50,000, then the dollar should not be penalised. The euro is oversold, but with support at 1.4365 taken out on Thursday, there seems little to stop the pair quickly descending to test the 1.40 level. Momentum could take the dollar there over the next week. Caution is needed however as the dollar has now registered a 10% gain against the euro in little more than 6 weeks, while the chance of a US interest rate hike seems more distant now than it did back in July. This dollar rally is not supported by any major shift in the rate outlook, which would tend to suggest it is unjustified and over-extended. Another point worth noting is that the positive economic data seen recently out of the US is nearly exclusively down to a sizeable upturn in exports, but in the past month alone the dollar has wiped out all of its losses for the year and subsequently its competitive advantage in the export market. Be warned! This dollar run is not sustainable, even if the greenback continues to make gains in the short run.

GBP/USD
The nightmare continues for sterling and at one stage today the pound was down 23 cents on the price it was trading at on August 1st. The sell-off is extreme and it is not just a dollar phenomenon because sterling is also trading at a record low against the euro and a multi-year low against the yen. The Bank of England reneged on its duty today by pressing the mute button after they voted to keep interest rates unchanged. It beggars belief that the MPC did not see fit to offer some sort of statement to address the turbulence that has been unleashed in UK financial markets at a time when the Chancellor of the Exchequer states the economy is in the worst economic downturn for 60 years. We will have to wait 2 weeks to get an insight into the MPC’s thinking but given the Bank of England’s lack of foresight and indifference to the sort of creative monetary policy adopted by the Fed, much of the blame for sterling’s sudden collapse can be laid squarely at the door of the MPC. Sterling has had only one meaningful upside day since August 1st last and a depreciation of this magnitude is almost unprecedented, for the currency of a major developing economy. The technical indicators are nearly off the chart, so extreme is the sell off in the pound. One bright spark came today when the pound did at least manage to push the euro back to the 81 pence handle, but that is scant consolation for pound supporters that see GBP/USD record new lows on an almost daily basis. Cable has to rise above 1.80 before it is safe to buy. Another weak close today could se it hit 1.75 before the next shot at a recovery.

Bob B - Sep 4

Bob's Currency Focus

EUR/USD
The key question we would all like an answer to now is has the dollar rally gone too far? From 1.6035 in the middle of July to below 1.46 before the end of August is as aggressive a move as they come, but it has happened during a period when liquidity is markedly low and currency moves tend to become exaggerated. We must look for the change in interest rate differentials over this time period to determine whether or not the dollar’s rally is justified in the wider scheme of events. There is no doubting weaker euro zone data has had futures markets reassessing rate expectations for the euro area and the yield on the March forward contract has fallen to 4.11% today, from 4.61% on July 21, thus a narrowing of 0.5% in the rate differential. The yield on US treasuries has hardly moved over the past month, so therefore we can say since the euro hit its peak, rate expectations between the dollar and the euro have narrowed by 0.5%. Since the ECB started its current monetary tightening cycle way back in Dec 2005, a 1% shift in rate differentials between the US dollar and the euro has translated into an approximate 8% movement in the exchange rate. Therefore the 0.5% shift seen over the past 6 weeks should translate into roughly a 4% gain for the dollar. A 4% gain would mean EUR/USD should now be trading at around 1.5395 and not 1.4595. That suggests the current rally may be overdone by as much as 8 cents. Of course rate differentials are likely to narrow further in favour of the dollar through to the end of the year, when falling commodity costs should give the ECB greater wriggle room to consider cutting interest rates, while any pickup in economic activity in the US will bring closer the day when the Fed will be in a position to increases US rates. For now though, the market seems to have lost the run of itself and it is sheer momentum rather than economic fundamentals that is driving EUR/USD lower. It is therefore dangerous to sell the euro at the current price and while most traders would prefer to follow the trend down, one is best advised to only sell down at an attractive price (closer to 1.50), which is not currently on offer. We could witness a very sharp correction higher in the euro next week, when liquidity returns to normal after the August holiday period comes to an end. Today’s Ifo business survey for August shows sentiment amongst German business executives fell much more than expected, hitting new record lows and pointing a probable recession in the euro area’s largest economy. I previously remarked that the ECB’s rate hike in July could prove to have been a fatal error of judgement and all of the economic data we have seen since holds up that argument. Jean Claude Trichet and his colleagues have not been in touch with reality and their failure to accept the basic economic principle that slowing economic growth will always temper inflation reveals a level of naivety that is worrying. Having been largely responsible for guiding the euro’s meteoric rise over the past 2 years, the ECB may now be looking for ways of trying to cushion its fall.

GBP/USD
15 cents this month is what the dollar has gained against the pound. Gains of this magnitude in such a narrow time span are unprecedented and it must added, they are also generally unsustainable. The big problem with cable at the moment is trying to pick a bottom. It had looked last week that 1.85 might prove to be a point from which the pound would rebound, but earlier this morning the pair went as low as 1.8329 and we cannot be confident of having yet hit a bottom. A serious lack of liquidity this month has cost the pound dearly as negative sentiment against the UK currency has encouraged traders to use the rather thin trading conditions to send the currency tumbling. Cable certainly offers value to buyers at current prices, but the problem is that volatile trading could see the market move significantly lower without warning and leave positions exposed. Next week, when market liquidity will improve, we could see a greater volume of value trades come into the market and lead to a corrective bounce in the pound, possibly a sharp bounce. There is no data of any real not this week, with the exception of Nationwide house prices on Thursday, which will show a further retreat in UK house prices. With UK consumer price inflation running at 4.4%, the Bank of England, which meets next week, is not in a position to ease UK interest rates for now, thus cable’s collapse to 1.83 looks to be way overdone. A safer trade involving the pound would be to sell EUR/GBP, because with so much bad news already priced into sterling and the euro economy slowing at an equally fast pace, there is scope for a substantial pullback in EUR/GBP over the coming months.

JPY
While the dollar has steamrolled over every other major currency this month, it is only marginally higher against the yen. We have seen a major unwind in carry trades in recent weeks and this together with a rise in risk aversion on equity markets has broadly protected the Japanese currency. The euro has fallen back to the Y160 price mark and we could potentially see this pair fall to 1.45 by year end, particularly if European equity bourses remain subdued. As long as the dollar remains in vogue against other currencies, the yen will struggle to make gains against the US currency and if economic data out of the US gains more positive momentum, USD/JPY will become one of the long plays for the rest of this year, with the potential for a push towards at least 1.15 before the year end. There is the danger of a reversal in US dollar support over the next 2 weeks when liquidity levels rise and in this environment the yen could also find itself on the back foot, particularly against the euro, pound and Swiss franc, given the extent of the currency’s gains in August. Economic data out of Japan will continue to play a minor role and yen traders instead need to focus on the performance of global equity markets as well as following US economic data over the coming weeks.

CAD
The loonie has proven itself to be remarkably resilient over the past week, gaining broadly across the board against every single major currency and significantly so against the euro, pound and Australian dollar. The rollercoaster ride of commodities in the past week has failed to puncture support in the loonie, which seems to have gained a new lease of life, possibly owing to a growing appetite for North American currencies, thanks to the revival in the US dollar. Canadian economic data has printed mostly in line with expectations over the past week but the all important litmus test comes later this week, when Quarter 2 GDP is published. Following a contraction in quarter one we should see a marginal gain in growth in quarter 2 as exports grew thanks to a dramatic increase in commodity prices. If we get another contraction, Canada will officially be in a technical recession and this will hurt the loonie very badly, particularly if commodity prices continue to tumble this week. The loonie may come under pressure against the greenback and USD/CAD offers good value on any dips back towards 104.30. The key support on the downside for the greenback is 103.70 and as long as this holds the pair will remain in an uptrend. For those going long, a stop should be placed below this price level. Against the other majors, the loonie could continue to make inroads on the euro, although any break below 1.52 might be unrealistic ahead of a euro correction higher.

Bob B - Aug 26

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

Bob's Currency Focus

EUR/USD
Euro zone data keeps disappointing and this morning’s German Ifo business survey reported the sharpest fall in business sentiment since 2001. Also, preliminary readings for the manufacturing and services sectors of the euro area see another month of contraction in July, with the slowdown accelerating. The Ifo business climate reading fell to 97.5 in July, down from 101.3 in June. The composite PMI for the euro area (measuring both manufacturing and services economic activity) is seen as falling to 47.8 in July, from 49.3 in June. French and Italian business sentiment also fell more than expected in July and all told, economic woes for the single currency zone are mounting. It is difficult to fathom that the ECB has just hiked rates against this background and only time will tell if that policy decision was a big mistake, especially if oil prices continue to ease. The dollar has made significant gains overt the past 2 days but it is essentially only back to the levels it was trading at prior to the breakout of the Fanny Mae/Freddy Mac crisis 2 weeks ago. The real test for the dollar will be if it can break below 1.5610 against the euro and hold below this level. If we can achieve that, it may be time to look for a possible retreat all the way back to 1.5283. The euro picked itself up impressively from a low of 1.5637 to reach 1.5697 in the hour following the Ifo Business survey release and after a brief stint above 1.57 after US existing home sales numbers disappointed the pair is back around 1.5670. Oil prices will continue to play an important role in the greenback’s fortunes. There is a sense that sentiment is beginning to shift against the euro and although weak US economic data will curtail dollar gains, traders need to be on their guard for any comments from ECB and Fed officials. Any softening in tone from ECB Council members will hurt the euro. If the dollar holds below 1.5720, it is worth selling down from close to 1.57, as the pair may have another run at that key 1.5610 price level either today or tomorrow. Any break below that should see us return to 1.55, possibly by Monday. Today is a very important day for direction, because the dollar has not managed a 3 day rally against the euro for 2 months.

GBP
Sterling has had a weird couple of days. On Wednesday it rose sharply against every other major currency, although its gains against the dollar were more modest, while today it has plunged after European currencies came under pressure early this morning and after it was announced monthly UK retail sales plunged by their heaviest amount since the series began. The Bank of England minutes on Wednesday reveal Tim Besley voted for a rate hike at the MPC meeting earlier this month. It is the first time a member has voted for a rate increase since July of last year. The hawkish bias to the minutes sent sterling rising rapidly as investors began to price in the possibility of a future rate hike from the Bank of England. In fact the minutes even stated that August would be a more appropriate time to increase rates, if a rate hike was warranted. One has to wonder if the MPC is seeing the same data as the rest of us. The dollar has finally managed to break below the 1.99 support point that held firm for 10 days and if it can push sterling below 1.98, then we should have a trend reversal and the pair could go considerably lower over the next week. 1.99 is a key price barrier and if the dollar does not hold it, the pound could make another run towards the 2 dollar mark and 2.01. Tomorrow’s GDP release in the UK is crucial and if it shows a contraction, which is unlikely, then sterling will sell off very sharply. If selling down, traders should place a stop around 1.9910. The pair is still being bought on dips and remains dangerous for bears, until 1.98 is broken. Sterling could find itself pegged back towards 79.50 against the euro by early next week.

JPY
The yen has been hammered this week by the dollar, the euro and the pound. The euro registered a new lifetime high on Monday at 169.95, while the dollar hit a 7 week high against the yen yesterday just below 108. The Japanese currency has stabilised somewhat today as falling stocks and a rate cut in New Zealand has temporarily stalled the carry trade. If the current stock rally comes to an abrupt end, then the yen could gain significantly against the US dollar, given the pair currently trades 4% above the worst levels from last week. However any resumption of the stock rally will continue to see the yen out of favour and the dollar could potentially try to rally all the way to 110 over the next week. There is no value on selling the yen against any currency at current prices, given the risk, while any euro moves towards Y170 offer very good medium term value for a sell down on what is the most over-stretched of the yen crosses.

CAD
There was no economic data out of Canada on Thursday and the currency continues to trade within a tight range against the greenback, moving between 1.00 and 1.0115. While headline inflation rose to over 3% in June, the core rate was contained at 1.5% and this affirms the view the Bank of Canada will keep rates on hold for the foreseeable future. Commodity prices have come off considerable in the past week, with oil prices shedding $20, yet the loonie has managed to hold its own across the board, indeed making gains against the euro and the yen, while holding tight against the US dollar. A sustained slump in commodity prices will eventually hurt the loonie against the US currency and it is difficult to see the pair not returning to 1.02 over the next week, unless there is some renewed scare in financial markets. The loonie has also been helped by a rise in risk appetite, but that too is under threat with the recent stock rally looking shaky by Thursday. The euro has fallen to 1.58 this morning, as I projected a few days ago and there is the potential for a decline to 1.56 for EUR/CAD over the next week, if the euro continues its decline against the US dollar.

Bob B - July 24