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Dollar Deepens Post−FOMC Losses

Thu, Jun 26 2008, 14:12 GMT
by Ashraf Laidi

CMC Markets

Dollar deepens post-FOMC losses after weekly jobless claims were unchanged at 384K, above expectations of 380K, pushing the 4-week moving average to 378.25K from 376K, with the continued claims rising to 3.139 mln, highest since February 2004. Markets shrug the final Q1 GDP reading showing no revision at 1.0%. The dollar losses are clearly highlighted by gold’s jump to a 1-month high of $913 per ounce.

The current dollar decline reflects an adjustment in traders’ expectations towards US interest rates after the FOMC policy statement added a phrase describing the “downside risks to growth”, while making a clear upgrade in its inflation alert. Despite the Fed’s explicit recognition of higher inflation in the statement, we consider this language largely a rhetorical shift aimed at managing interest rate and currency market expectations rather than setting up for an actual rate hike. The main basis to our rationale is

1) Prolonged liquidity concerns among banks as signaled by the rise in 6-month LIBOR, which stands at 6.19%, a few bps away from its 6-month high attained earlier in the week.

2) Labor market indicators have shown no signs of coming off their worst levels; as weekly jobless claims continue to hover above 380K, unemployment rate is at 5.5% and payrolls remain either in negative territory across all sectors or continue to weaken.

3) Housing related measures of sales, prices and construction continue to deteriorate.

Neither these factors, nor deteriorating consumer confidence and shaky stocks markets (S&P500 and Dow are 5% and 8% below their respective levels of the April 30th FOMC meeting) are likely to stabilize with higher interest rates. On the contrary, the Fed runs the risk of exacerbating these negative these dynamics, especially via accelerating erosion in capital markets. The Fed is well aware of this fact, hence the addition of the phrase “Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased”.

The intention of such dual-risk policy statement is to prevent bond markets from dragging down yields aggressively, while adding two-way risk to the currency markets and tempering the decline of the dollar. Nonetheless, next month’s expected ECB rate hike and prolonged inflationary concerns in the UK will further support these currencies against the dollar, with the euro gaining strength relative to the pound due to superior activity indicators.

The ensuing dollar decline is in line with our Pre-FOMC analysis stating “…statement to further neutralize expectations of higher interest rates for 2008 by clarifying the ensuing macroeconomic weakness as well as the fact that “markets remain under considerable stress …which should further shed modest losses in the US dollar”

Euro Gains on Renewed ECB-Fed Policy Divergence

The strengthening in the euro to 2 week highs at $1.5725 goes well beyond the geopolitical tensions between Iran and Israel. Currency traders have been offered with fresh interest-rate driven play from a Fed policy statement suggesting prolonged status quo rather than a tightening and an ECB rhetoric suggesting prolonged tightening bias backed by a likely increase in rates.

As for the oil front, OPEC’s president has just issued a statement indicating that oil prices will likely attain $150-170- over the summer. Surely, this reflects the clear dissonance in rhetoric between most OPEC ministers and Saudi Arabia’s good-faith approach to raise output by 200K. While we refer to this as a dissonance, it may well reflect a tactic by Saudi Arabia’s dual approach to simultaneously maintain its long established relations with Washington, while preserving support for the price of oil by allowing other OPEC members to make hawkish remarks such as “there’s no real demand for the increased supply”, “world remains awash with oil” and today’s remarks on $120-150 being the likely summer target.

Having broken $1.5695, EURUSD likely to garner further gains, targeting $1.5735, which is the 61.8% retracement of the 1.6018-1.5282 move. Subsequent gains seen capped at $1.5755. Support remains underpinned at 1.5675, backed by 1.5650

USDJPY Drops as Yield Spreads Turn to 2-week Lows

The consolidation in USDJPY of the past 2 weeks between 108.50 and 107.20 shows signs of a gradual retreat as the USD part of the pair is dragged down by US-centric negative dynamics with US banks, stock market and macroeconomic data. Despite the clear interest rate advantage favoring the US over Japan, 10-year and 2-year bond yield differentials have fallen off their 6-month highs attained last week to reach their lowest level in 2 weeks today. The US-Japan 10-year spread is now at 4.21%, from 4.63% in June 13, while the US-Japan 2-year spread is at 2.20% from 3.9% on June 16. With inflationary concerns reading over to Japan and falling equities seen reigniting concerns with risk appetite and USDJPY, we expect the 107.20 support to give in to 107.00 and 106.77. We expect 105 and 103 to emerge in the next 2-weeks, with 101 likely to be broken by end of July. Upside remains capped at 107.90, followed by 108.30.

GBP Breaks $1.9850

Sterling rallies on a combination of prolonged dollar weakness and hawkish Bank of England rhetoric. In their testimony to the parliamentary Treasury Committee, the Bank of England’s Monetary Policy Committee members reiterated their vigilance with the increase in price pressures. While most members said they considered raising rates at this month’s meeting, they curbed aside any expectations of an interest rate increase. Governor King’s comments were most notable indicating the probability of 4.0% inflation but at the same time stated his opposition to putting the economy into recession just to avoid writing letters on inflation.

GBPUSD is seen facing substantial resistance at $1.9880--the 50% retracement of the decline from the $2.0396 high to the $1.9361 low. We don’t foresee sterling’s bear trend to wane until a break of 1.9950-55. Support climbs to 1.9780, backed by previous resistance of 1.9830.
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Published on  Thu, Jun 26 2008, 14:21 GMT