Dec. 7, 2006 — Yen strength dominates across the board, while the dollar is marginally higher against European currencies. The Aussie sustains broad strength after an unexpectedly strong employment report. The Bank of England kept rates unchanged at 5.0%, while the European Central Bank (ECB) raised rates to 3.50%. There was no surprise in either central bank decision. With the Euro zone refinancing rate at 3.50%, the highest since October 2001, the rate reduces the U.S. dollar’s yield advantage over the euro to 1.75%, the lowest differential since matching it in December of last year.
We expect some downside pressure on the euro as ECB President Jean-Claude Trichet begins the press conference at 8:30 am. Trichet is expected to communicate the central bank’s macroeconomic forecasts for 2006 and 2007. With the euro near 20-month highs vs. the dollar and record highs vs. the yen, and with oil prices off their two-month lows, we do not expect Trichet to sound off an extremely inflation vigilant speech, as that would only stoke sharp gains in the currency that would be undesirable for the central bank. Thus, Mr. Trichet may stick to the usual “vigilance” mantra, without using the term “extreme.”
An upward revision in GDP growth estimates may not be sufficient in boosting the euro. Traders must watch for any comments on the euro’s strength and to what extent the bank communicates its preoccupation with further gains.
Traders should also watch the U.S. weekly jobless claims (8:30 am) for whether last week’s release showing the highest increase in 13 months (357K) was a result of seasonal factors related to Thanksgiving holiday or a slowing U.S. job market. Today’s release is expected to show 320K, which may not trigger major reaction as the release will be eclipsed by the European Central Bank press conference due at the same time. In order for weekly jobless claims to elicit any type of move in the dollar, claims may have to come in below 310K to 315K (dollar positive) or remain above 330K to 340K (dollar negative). Recall that the four-week average also stands at the highest on over a year at 325K.
Euro nervously awaits ECB conference
Our expectation for a modest euro pullback hinges largely on technical factors to prolong into early next week, but that should not take away from the euro’s long-term fundamental rally. We do not think the ECB press conference will communicate any new insights on the policy horizon in addition to signaling that interest rates remain low and the Euro zone expansion remaining robust.
As traders shift attention to Friday’s U.S. non-farm payrolls, markets will look for any sign of vindication for the Federal Reserve, whose assessment on the economy is proving more optimistic than that of the market. Interim support starts at 1.3250, followed by 1.3220. Key foundation stands at 1.3180. Upside capped at 1.3320, followed by 1.3350.
Yen sustains strength.
Yen strength escalated in Asian trade after Bank of Japan's policy board member Iwata did not comment on monetary policy, allowing traders to bid up the currency. Comments from Ministry of Finance’s Watanabe indicating recent data did not show deterioration in economic conditions helped drag the dollar towards 114.80.
The People's Bank of China report indicated the U.S. dollar faces downside risk if capital stops flowing into the United States and the trade current account imbalance grows faster than GDP growth. The report raised the risk of investors' appetite for U.S. financial assets and mentioned the possibility of portfolio adjustment from Asian countries and oil exporters to address excess liquidity problems. The report did not indicate anything about China’s own diversification moves.
Yen traders may be reluctant to sell the currency and send the dollar back towards the 116 level before this month’s tankan survey, which could boost speculation for a December rate hike.
USD/JPY sees room for further downside towards 114.80, followed by 114.50. Upside moves seen facing interim resistance at 115.20, followed by 115.45-50.
Sterling vulnerable to further declines
The Bank of England’s decision to hold rates unchanged at 5.0% is giving a modest nudge to the pound, but we detect increased signs of toppishness in cable, making 1.9550 a realistic target before end of the week. Although short sterling contracts account for the possibility of one more rate hike next year, that could well be influenced by the minutes of today’s meeting due in a fortnight. Meanwhile, tomorrow’s U.S. payrolls will contain sufficient variables that could help extend profit taking in European FX
GBP/JPY remains bearish with 225.50 as an interim target, followed by 225.00. Cable’s preliminary support stands at 1.9630, followed by 1.9580. Key foundation stands at 1.9550. Upside capped at 1.9680, followed by 1.9730.
Ashraf Laidi Chief FX Analyst CMC Markets US 140 Broadway, 30th Floor New York, NY 10005 (212) 644-4220 (212) 644-4222 a.laidi@cmcmarkets.com
