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Weekly Fx Strategy

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Current Stability is only Temporary

Thu, Aug 23 2007, 14:15 GMT
by Ashraf Laidi

CMC Markets

The Bank of Japan left interest and its economic outlook unchanged, prompting further return to carry trades at the expense of the yen. A sense of normality is resettling gradually in the market, triggering the pattern seen before the culmination of the credit crisis and weighing on the dollar against all major currencies with the exception of the yen. Banc of America’s $2billion investment in ailing mortgage lender Countrywide Financial is helping to stabilize market volatility and trigger broad gains in global equities.

A prolonged stability in the market and a lack of negative revelations related to the credit crunch may reduce the onus on the Fed to cut interest rates next month, but the concentration of key economic figures due in the next 2 weeks hold the potential to sway the Fed into an easing, especially if new revelations hit the market after Labor Day Holiday. Reports on consumer employment payrolls, consumer spending, PCE price index, Q2 GDP, housing and ISM manufacturing/services are all due prior to the September 18 meeting.

A dissipating market contagion may reduce the need for a cut in the Fed funds rate, but an expected deterioration in consumer spending, decline in inflation and rising unemployment will present the Fed with a fundamental argument to ease. At which point, the dollar’s decline is expected to resume on a broader fashion even if the ECB and BoE scale down their tightening campaign. Traders may also consider the possibility that weak US macro data imply an incoming Fed cut, which would be positive for stocks and negative for the dollar.

USDJPY eyes 117.75

USDJPY rallied beyond our projected target of 115.80, extending to a 1-week high of 117.11 amid reduction in risk aversion and the Bank of Japan’s decision to keep rates unchanged. The 8-1 vote to hold rates at 0.50% signaled the possibility for a rate hike in Q4 after BoJ governor Fukui echoed the risks of prolonged low interest rates. Technically, we see USDJPY extending gains towards the 117.75 resistance, at which point the concentration of US data will keep yen bears at bay. Subsequent pressure stands at the 188 trend line resistance. Support climbs to 116.20 and 115.60.

EURUSD targets 1.3620

EURUSD extends gains beyond its 100-day moving average of 1.3550 eyeing the 1.3620 target. But the 1.36 resistance presents the 55 day MA as well as the 50% retracement of the decline from the 1.3840 high. The currency was also aided by a confirmation of German Q2 GDP coming in at 2.5% and a statement from Fitch indicating that most German banks are well positioned to absorb any shock of limited size. The potential of seeing 1.3650 next week remains high amid a combination of weak US data releases and reduced market turmoil. Traders may also consider the possibility that weak US macro data imply an incoming Fed cut, which would be positive for stocks and negative for the dollar.

Sterling regains $2.0, capped at $2.0130

The extended market calm is seen especially positive for high yielding currencies such as sterling, allowing the Bank of England to complete its anti-inflation campaign by considering one more rate hike. The Bank of England’s reluctance to inject liquidity underscores its anti-inflation stance. We expect further gains to encounter pressure at 2.01, followed by 2.0150. Support stands at 2.003, followed by 1.9970.

USDCAD drops below 1.0550 amid reduced volatility

USDCAD fell towards our projected 1.0550 target, now extending towards the 1.05 figure after hitting 1.0477 earlier. Our rationale was explained by the fact that “a positive showing in US equities boosted by further reduction in volatility is likely to drag USDCAD”, while adding that “weekly candle chart suggests 1.05 remains within reach before week’s end”. Continued gains in equities are likely to drag the pair towards the 1.0460, with support standing at 1.0420. Upside capped at 1.0550, followed by 1.0570.

Published on  Fri, Aug 24 2007, 14:21 GMT