The dollar gains across the board on a combination of resurfacing risk appetite and data vacuum and early signs of a cooling in the UK ’s housing sector. Friday’s announcement from China’s rate hike announcement and band widening is seen to make no difference in reining the nation’s growth and thus unlikely to trigger a sell-off in Chinese equities. A drop in China’s equity indices would raise fears of an unwinding of carry trades from high yielding currencies, driving flows back to the low-yielding yen.
Kuwait abandons its dollar peg
After more than four years of linking its currency to the U.S. dollar, Kuwait announced it would drop its currency peg system to the U.S. dollar in favor of a basket of international currencies in a move designed to counter inflationary pressures. Increased expectations of an interest rate cut by the Fed has raised the risk of further declines in the U.S. dollar, thereby jeopardizing the price stability of the Kuwait peg. Last week, central banks of the six-nation Gulf Countries Council, which includes Kuwait, Saudi Arabia, the United Arab Emirates, Qatar, Bahrain and Oman, met to co-ordinate a response to the growing possibility of a U.S. interest rate cut, signaling their concern about growing inflation. As these nations pegged their currency to the falling dollar, their monetary policy was challenged by a rise in imported inflation resulting from a weakening in their currency peg. Kuwaiti inflation stood at 3% to 4% over the past nine months, and as high as 5% in March, compared with a historical average of less than 2%.
Markets will keep a vigilant eye on the UAE central bank's stance regarding its holdings of U.S. reserves following Kuwait’s abandonment of its USD-based peg. The UAE central bank stated last autumn that it plans to rebalance the composition of its U.S. dollar and euro reserves from 90%/10% to 80%/20% when the time is appropriate. Considering the euro's recent retreat and resurfacing expectations of a Fed easing, the UAC central bank may well begin to step in to increase its accumulation of euros as well as gold.
Preserving currency strength is an increasingly vital factor to the GCC group of nations as they plan a unified currency for 2010. Kuwait reinstated the peg to the U.S. dollar in 2003 after briefly pegging it to a basket of international currencies. Since January 2003, the greenback has lost 31% against the euro and 21% in trade-weighted terms.
Attaining a strong currency and price stability is vital prerequisite to any currency union. This was seen in the late 1970s when the currencies of the European Community were pegged to an artificial currency called the ECU “European Currency Unit” in the European Exchange Mechanism (ERM) as a precursor to the creation of the euro. But since the ERM system was largely tied to the high valued Deutsche mark, several economies--including the United Kingdom, struggled with an appreciating currency, leading to slowing growth and rising unemployment. The Bank of England struggled to sustain the falling pound in the ERM anchor by intervening to support its currency but ultimately failed to the speculative pressures of the likes of George Soros.
The central Bank of Kuwait faces the opposite problem, whereby it was forces to cut interest rates three times in less than two months to prevent its currency from appreciating as speculators bet that the central bank will end its peg to the dollar.
GBP/USD deepens selling to five-week lows
Sterling weakness nears our target of 1.9680 from Friday’s high of 1.9760 following weak UK data on money supply and home prices. Average home prices rose at their slowest rate this year when they rose 0.4% in May from April’s 3.6%. This brought down the year-on-year growth to 13.1% from 15.0%. Money supply growth slowed to 1.4% last month versus an expected 0.9%.
This week’s release of the minutes from this month’s Bank of England meeting will be vital in shedding light on the decision to vote raising rates by 25-bps. Sterling could come under further pressure in the event that no members called for a 50-bps move or if the decision was as close as five to four, or six to three.
Friday’s preliminary release of the first quarter GDP is expected to show a q/q rise of 0.7%.
Selling momentum shows no abating on technical grounds. Interim support stands at the 100-day moving average of 1.9660, followed by the 1.9605 low. Upside capped at 1.9720.
Yen on sale again
Yen weakness surges across the board as EUR/JPY hits an all time high of 163.90 and USD/JPY hits a three-month high at 121.60 as markets deemed Friday’s China rate hike and band widening to make little difference in impacting growth and thus unlikely to trigger a sell-off in Chinese equities. A drop in China’s equity indices would raise fears of an unwinding of carry trades from high yielding currencies, driving flows back to the low-yielding yen. This week’s Strategic Economic Development talks between the United States and China will be watched for their impact on FX markets. Any interpretation that Washington is satisfied with China’s latest FX and interest rate moves is expected to prolong yen weakness while resurfacing pressure on China to revalue its currency is likely to trigger fears of protectionism, weighing on U.S. equities and boosting the yen.
Interim resistance stands at 121.80, followed by the 122.10 high. Support stands at 121.40 followed by 121.10.
We expect the Japanese currency to begin rebounding against the pound, with interim support seen at 238.20 followed by 237.70.
Euro weakness near stabilization point
Euro selling nears the 1.3430 support as the lack of Euro zone and U.S. data makes way for further scaling down of euro longs following last week’s bounce in speculative longs.
The initial data vacuum from the United States this week will make way for the German ZEW and IFO surveys on Tuesday and Thursday. The IFO survey on business sentiment has beaten expectations over the past two months and was instrumental in boosting the euro. The United States reports on new and existing home sales on Thursday and Friday could also potentially fuel a new dose of buying in the single currency on fears of prolonged slowdown in U.S. housing.
A breach of the 1.3430 support is expected to be followed by stability at 1.3405-10, which is the previous point of resistance. Markets will await any remarks from the UAE central bank on its stance regarding its holdings of U.S. reserves following Kuwait’s abandonment of its USD-based peg. Initial resistance at 1.3460, followed by 1.3490.
Ashraf Laidi Chief FX Analyst CMC Markets US 140 Broadway, 30th Floor New York, NY 10005
(212) 644-4220
a.laidi@cmcmarkets.com
