Currency markets witness a partial return of carry trades after a brief bout of unwinding took place following today’s Chinese rate hike. The decision to revalue China’s daily currency band against the dollar to 0.5% from 0.3% is widely seen by currency markets to make little difference, as China does not revalue its currency and instead, sticks to its policy of allowing yuan appreciation of no more than 2.0% per year.
As long as financial markets deem China’s rate hikes and currency action to have little or no impact in cooling its economy and affecting demand for commodities, currency traders will maintain their risk appetite trades of long positions in the Aussie, sterling and New Zealand dollar. Now, the path will be open for renewed euro gains across the board, leaving the dollar the opportunity to strengthen against the Japanese yen. The renewed decline in the yen less than an hour ago is partly caused by remarks from Japan’s Finance Minister indicating that his German counterpart did not appear to be concerned with the yen’s decline vs. the euro.
Although today’s FX and interest rate announcements from China may ease the G-8’s insistence on Beijing to increase its currency flexibility, it is unclear whether they will be deemed sufficient by U.S. Congress. Any resurfacing pressure from Congress towards China will likely limit renewed carry trades, while signs of satisfaction from Congress and the U.S. Treasury are likely to trigger fresh gains in EUR/USD, USD/JPY and GBP/USD.
Next week’s U.S. trading calendar will be data-light, but the April release of new home sales and existing home sales on Thursday and Friday could be a source of liquidity to a thinly trade market as U.S. traders may end the week early ahead of Memorial Day holiday on Monday May 28.
The four-week retreat in the EUR/USD rate is expected to find further support at the 1.3470s, which we deem to be an attractive entry point by global central banks planning to increase their accumulation of euros to their reserves. Although the MACD seems to indicate a bearish crossover in the weekly chart, the divergence is expected to dissipate and bullishness takes over at the 1.3440s. Upside seen extending towards 1.3520, followed by 1.3580.
Canadian dollar's 30-year highs vs. greenback
The prolonged increase in Canadian dollar vs. the U.S. dollar reflects a combination of inflationary pressures and strong retail sales in Canada, and continued downside risks in the U.S. housing market. Increased chances of a summer rate cut from the U.S. as well as renewed upside pressure in energy prices is a extending the CAD rally to 30-year highs. The notion of a Canadian downdraft from a U.S. hard landing remains challenged, which supports our expectations for further gains towards the 1.0750 level or (93 U.S. cents) from the current 1.089.
Although we have seen a net loss in jobs from the April employment report, the contrasting growth picture between the two economies and the prospects for further oil gains ahead of the summer driving season should is expected to cap any periodic corrective declines in CAD.
GBP/CAD
Despite the 8% decline in sterling versus the loonie to 2.1530, we expect further declines to reach 2.122, which is the 61.8% retracement of the major move from the 1.9765 low to the 2.349 high. The deepening bearishness as seen by the MACD suggests that the 2.12 territory will serve as a decent support for the pair.
GBP/JPY
Our expectations for further declines in GBP/JPY embody the unwinding of carry trades, whereby high yielding currencies drop against their lower yielding counterparts. The double top seen in the chart below coupled with the MACD’s failure to show any convincing gains suggests 235 to be a viable target by next week. An eventual pullback in global equities would reduce risk appetite traders and drag the pair towards 234 from the current 238.70.
Ashraf Laidi Chief FX Analyst CMC Markets US 140 Broadway, 30th Floor New York, NY (212) 644-4220a.laidi@cmcmarkets.com
