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Sunrise Market Commentary: Currencies

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Pound fails to gain on higher than expected inflation

Wed, May 14 2008, 08:10 GMT
by KBC Market Research Desk

KBC Bank

On Tuesday, EUR/USD opened the session in the 1.5550 area but drifted lower throughout the morning session in Europe. It is a bit strange, but yesterday morning after the publication of the UK CPI figures it even looked as if the decline in cable drove EUR/USD lower at the time (usually, the arrow points in the opposite direction). Some rather hawkish comments from ECB’s Noyer this time were also of no support for the single currency and EUR/USD lost some more ground after the stronger than expected US retail sales and US import prices. In a speech/text Mr. Bernanke elaborated on the measures to improve the liquidity situation on the markets. He saw some improvement but concluded that conditions in financial markets are still far from normal. So, he remains rather cautious in the debate whether the worst of the credit crisis is already behind us. Other Fed members addressed the difficult situation central banks/the Fed are facing as higher oil and commodity prices continue to fuel inflationary pressures while faltering growth calls for a more pro-cyclical policy stance. However, the Fed speeches only had a limited impact on EUR/USD trading. The pair closed the day at 1.5475 compared to 1.5554 on Monday evening.

Today’s, calendar contains the US CPI and EU industrial production data. The first one will get ample market attention. However, the impact on currency markets is not that easy to predict. A higher than expected figure would suggest that the Fed has also not much room of maneuver anymore to cut rates even if this would be necessary to support the US economy. Question is whether this kind of ‘interest rate support’ should be seen as a positive factor for any currency in general and for the US dollar in particular. The central bankers running out of policy options hardly can be seen as a positive factor for the currency over time. To make the situation even more complicated, this policy problem not only arises for the Fed but for most other central bankers from industrialized countries. However, at this stage, we still assume that higher inflation and higher (short-term) interest rates still are moderately positive for the dollar.

Last week, EUR/USD gave a strong warning signal as the pair temporary dropped below the key 1.5340 area as markets grew more attentive to the recent deterioration in European eco data. However, this attack was rejected after the ECB press conference and EUR/USD currently trades again above the previous range bottom at 1.5340. This suggests, that at least for now the consolidation hypothesis can be maintained. The euro obviously has lost some of its shine recently, but the question is whether the US data are already strong enough for the dollar to stage a more powerful rebound. Yesterday the dollar got some support from the data, but it is not sure that this will continue to be the case. For now we hold on to our view that there is no dominant market theme to guide trading in this pair and we expect some more sideways, probably often even erratic trading, as the picture on both side of the Atlantic probably is not strong enough to trigger a clear directional move. The break above the short-term flag top was not additional help for EUR/USD. It also looks as if the 1.56 area won’t be that easy to break short-term. So we expect more sideways trading in the 1.5285/1.5600 area. In a day-to-day perspective we put the risk for EUR/USD to drift somewhat lower in this range.

YYesterday, there was only one intraday move of importance in USD/JPY. The pair spiked higher on the back of the better/higher than expected US data (retail sales and import prices). The pair jumped form the 103.80 area to 104.50 area and easily preserved these gains later in the session. There still was some intra-day correlation between stocks and USD/JPY but this time the link was far from one to one. In this context we tend to think that yesterday’s move should be considered as dollar strength rather than yen weakness.

This morning, Asian stocks trade mixed and as such are no powerful drive for yen trading at this stage. Japanese corporate goods prices were marginally higher than expected and this was also the case for the trade surplus and the current account surplus.

Since mid March, USD/JPY became better protected as improving stock market sentiment caused a gradually unwinding of yen long positions. However, this pattern of gradual USD/JPY gains showed some cracks last week as global stock market indices (e.g. the S&P) did run into resistance. Stocks remain the key driver for this pair (even if this was less the case yesterday) but the picture on the stock markets is still far from clear with the S&P still struggling to regain the key 1406 area in a sustainable way. Last week, we turned more neutral on USD/JPY and indicated that a break above the range top in the 105.62/69 area wouldn’t be that easy short-term. We hold on to this approach even if the downside already looks much better protected. We expect more range trading in the 102.60/105.70 trading range. A break above 105.70 would suggest that another up-leg in this pair could be in the making.

Yesterday, UK markets were shocked by a sharp rise in UK inflation as the figure jumped from 2.5% to 3.0%, much higher than expected. Immediately after the release sterling tried to gain some ground as markets saw less room for the BOE to cut interest rates soon. However, as already indicated above, a central bank being paralyzed and unable to take the necessary actions to support the economy in a longer term perspective at least is a very ambiguous sign for the currency. So, soon after the publication of the inflation data, especially cable took the way south. Sterling initially gained some ground against the euro but this was mostly EUR/USD inspired and those intraday gains also evaporated later in the session. EUR/GBP closed the day at 0.7955, again rather close to the 0.7943 close on Monday.

Today, the UK labour market data and the BOE inflation report are on the calendar. Especially the latter will get ample market attention. However, even if the Bank indicates less room for rate cuts due to higher inflation, this only raises the risk for a hard landing of the economy further out. So, in line with the market reaction yesterday, one can have serious doubts whether such a scenario should be a lasting help for the sterling.

Mid April we picked up the technical signal of EUR/GBP dropping below a medium term uptrend line and saw this as a window of opportunity for sterling to enter calmer waters and even for a correction. However, the sterling rebound did run into resistance on poor UK data recently. From a fundamental point of view, we remain skeptical on the long-term rebound potential of the sterling as we expect UK economic data to remain weak in the foreseeable future. So, any further downside in this pair should come from global euro weakness, rather than from sterling strength, but also the downside in EUR/USD gradually looks better protected now. We continue to see the downside in this pair well protected. The break above the short-term flag top last week is confirmed and puts the risk for some additional upside in this pair short term.

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Published on  Wed, May 14 2008, 08:13 GMT