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Pound continues to struggle for support

Mon, Dec 29 2008, 08:33 GMT
by John Hardy

Saxo Bank

Another week of thin trading likely with the mid-week holiday. Short term moves may be poor predictor of the action coming in the New Year.

HEADLINES

• (Friday) Japan Nov. Labor Cash Earnings fell -1.9% vs. -0.2% expected

• (Friday) Japan Dec. Small Business Confidence fell to a new record low of 29.4 vs. 35.1 in Nov.

THEMES TO WATCH – UPCOMING SESSION

Events Today:

• Germany Dec. CPI - Saxony (0900)

• Switzerland Dec. KOF Swiss Leading Indicator (1030)

Market Comment:

After last week's extended bout of holiday trading, the Euro jumped into a rallying position quickly today on the events in Israel and the Palestinian territories over the weekend. Spot gold also continued rallying well above its 200-day moving average. The Euro is now trading at an all time high on a trade weighted basis and is even above the peak of the EUR-equivalent in 1992. The strong Euro and Japanese Yen are ugly developments for those two economies. It is tough medicine - only intensified by their rapidly weakening economies - for these two to stand by and watch the UK and US launch with full speed ahead into competitive devaluation to avoid deflation and ease the hard landing. The point of unbearable pain is rapidly approaching here for the EuroZone and Japan. The question in the New Year is how will these two respond? Japan is already grumbling about the strength of the Yen and feeling the full force of its effects and will undoubtedly begin to intervene soon - mostly in USDJPY, one imagines, so any progress lower in USDJPY will be very tough going from here on out. Also, US short rates can simply go no lower, so the knee-jerk trade of USDJPY tracking the rate differentials is finished in USDJPY. As for the Euro, the faith the market seems to be placing in the EUR as a safe haven may prove misplaced in the New Year - with the question one of timing - eventually the EuroZone will be torn apart if something is not done soon to address its overly strong currency.

With end-of-year effects coming into play this week, it would seem a fool's errand to try to sort through the meaning of the short-term moves in the market. One interesting note, however, about the furious rally in EURUSD and EURGBP in the week preceding the Christmas week: It emerged last week that Fortis Bank lost in the neighborhood of $400 million on long USD and GBP positions it had put on earlier in the month in preparation for a deal to sell some of its assets to BNP Paribas, but which were then liquidated on a EU decision to stop the deal due to shareholder protests. Considering the market conditions into which such a large position was forced to be liquidated and the near panic touched off by the dramatic FOMC statement, this undoubtedly aggravated the severity of the rally. We will need to see the calendar year turning before we can believe that this rally is sustainable in the short term. Until then, all bets are off on where this market can trade over the next three days.

On the interest rate differential side of things, as we have pointed out recently, the EURUSD has failed to respond to the collapsing rate differentials, a development that should give pause to those looking for EURUSD to rush immediately to 1.5000. Elsewhere, the pound continues to get pounded almost across the board with no real catalyst and seems to be the flipside of the Euro's strength. The events in the Middle East have given crude oil prices some support and CAD and NOK have perked up slightly on this development. The latter of these two looks overly weak as we head into the New Year. The situation bears close watching as any strength in commodities could add further woes to the weak greenback.

Looking at the economic data calendar for the coming week, there is very little to anticipate. For the US this week, the highlights include the US CaseShiller Home Price Index out tomorrow, together with Dec. Consumer Confidence and the final regional US manufacturing survey for the month, the Chicago PMI. Friday sees the release of the Dec. ISM Manufacturing survey. Elsewhere this week, we have the German CPI out tomorrow and the final EuroZone Manufacturing PMI's for December.

Beware the potential for more volatility this week than we saw last week with more market participants in front of their screens even if the market is likely to remain thin, and with the end of month and end of year effects coming into play over the next couple of days.

Published on  Mon, Dec 29 2008, 08:35 GMT