While the credit and sub-prime storm continues to hit the bond and the stock markets quite hard, the major FX cross rates seem to have entered some calmer waters. There were only few eco data with market moving potential yesterday and, except for a brief down-tick (EUR/JPY inspired?) during the morning session, EUR/USD basically held a sideways trading pattern in the mid 1.46 area and the pair is only marginally higher at the start of trading this morning. The tension within OPEC regarding the consequences of the weak dollar still generated news headlines, but its impact on trading was very limited.
The dollar continues to lose interest rate support. However, yesterday also European yields finally broke some important levels to the downside. These moves still call for confirmation. Nevertheless, this development could become important for the sentiment on the single currency. Recently, the market perception was that especially the Fed would be forced to cut rates in an aggressive way, while the ECB was seen on hold for a prolonged period of time. In case the market would join our view that also the ECB could come in a similar position in the first half of 2008 (our basis scenario expects two rate cuts during that period) this could over time have its consequence for EUR/USD. On top of that, US markets currently are already very aggressive priced in Fed interest rate cuts. Of course, as illustrated over the previous sessions, interest rate differentials are not the only driver for currencies, but as the relative swings in these markets now become very violent, we keep following them closely. In this respect, today’s Fed minutes could be quite important. Will the Fed continue to warn that further (aggressive?) rate cuts are not on the agenda yet?
For now, longer-term, we think that more bad US news might be in store and that the dollar is not out of the woods yet. To herald a trend reversal we also wait for a clear technical sign and this isn’t available yet. So the longstanding up-trend in EUR/USD is not questioned. However, we gradually take a closer look the swings in the interest rate differentials between Europe and the US.
In a short-term, day-to-day perspective, the EUR/USD pair last week entered a consolidation pattern with the 1.4750 area (topside) and the 1.4525 area (downside) the most obvious barriers. We expect these barriers to hold in the short-term. Today’s Fed Minutes of the previous meeting are somewhat of a wild card. If hawkish they might be slightly dollar supportive, at least short term. So, short-term players can try to play this range from the topside with stop-loss in case of a break to new highs.
Yesterday, the yen gained ground throughout the whole day both against the dollar and signal currency. USD/JPY lost one big figure and briefly fell below the 110 barrier this morning and EUR/JPY made a similar move. However, despite the tensions in a lot of other markets (stocks, credit markets), the yen failed to break some important support levels and both cross rates even show a decent rebound in Asian trade this morning.
In a longer term perspective, we hold on to our yen positive bias and continue to advocate a buy the yen on dips strategy as the uncertainty and continued fall-out from the sub-prime sector will come back to haunt the markets.
In a day-to-day perspective, this morning’s price action is slightly disappointing from yen perspective. So, in this respect, there is maybe no hurry to add to yen long positions at this stage. For this we look to the 111.50 area in USD/JPY and 163.50 area in EUR/JPY.
Yesterday, EUR/GBP showed some intraday swings, but basically held a sideways trading pattern. Stressed conditions in the UK money market are of course no help to the sterling. EUR/GBP spiked higher at the end of the session, but the recent highs in the pair were not really challenged.
Today, the UK calendar contains the Money Supply data and the CBI Industrial trends survey. Especially the latter deserves some attention. In this respect it will be interesting to see the market reaction in case of another poor report. Is enough bad news priced in at least short term?
From a fundamental point of view, we think that already a lot of sterling negative news is priced in (both in the money market and in the currency market). On top of that, our economic scenario also envisages rate cuts in the Euro-zone area in the first half of 2008. So, in this respect, the interest rate differential between the UK and the Euro-zone will continue to stay at decent levels for a while and at some point this should give the sterling some support. However, in the current credit (and housing) storm, this obviously is not the markets’ focus/view at this stage.
Short-term we wait for a technical sign that the sterling-storm is cooling down before reconsidering to buy back into sterling for a corrective move lower in EUR/GBP. EUR/GBP holding below the 0.7170 new highs for one or two days, could be a first sign that the sentiment is turning less sterling negative and that a correction might be in store.
