The combination of prolonged risk-seeking carry trades and the overall deterioration of U.S. dollar sentiment are behind the broad damage in the U.S. currency. Just when currency traders were drawing conclusions that the recent FX market activity was driven by risk appetite, and not as a result of dollar-driven trading, the U.S. greenback sustained blows across the board on a debilitating combination of emerging concerns about U.S. housing weighing on consumers and overall U.S. earnings growth and improved European data strengthening the interest rate differential landscape against the U.S. currency.
The dollar hit all time lows against the Aussie, 25-year lows against the New Zealand dollar, fresh 26-year lows against sterling, fresh two-month lows against the euro (and half a cent away from its all time low) and nearing its 30-year lows against the Canadian dollar.
On the U.S. housing front, growth in U.S. consumer bankruptcies in Q2 2007, marked the fifth consecutive quarterly increase. This comes two days after reports estimating Moody’s and S&P may have failed to downgrade securities backed by faulty home loans, amounting to as much as $200 billion.
Fears that the latest terror-related developments in the UK and the Mideast might spillover against U.S. interests are also contributing to the fundamental pressure against the U.S. currency.
The U.S. dollar shrugged a better than expected manufacturing ISM report, showing a 14-month high in June at 56 from May’s 55, along with a five-point gain in the new orders index. But it was the second monthly decline in the employment and prices paid indexes that drew FX traders’ attention, presenting a double-negative development for the U.S. currency from the monetary policy drivers of inflation and employment.
One aspect explicitly manifesting the dollar’s weakness is the sharp drop in USD/JPY to two-week lows at 122.16, where the rise in the Japanese currency occurred despite renewed sell-off in the yen against the higher yielding euro, Aussie and sterling.
Gold targets key resistance $666
The other conspicuous sign reflecting dollar weakness is the three-day rally in gold prices attaining one-and-a-half-week highs at $659 per ounce, a 3% rise in three days. With the risks for further dollar weakness emerging from ongoing upbeat assessment in Europe and Asia, and an expected weakness in this week’s U.S. data releases; factory orders (due today), services ISM (Thursday) and payrolls (Friday), the fundamental underpinning for sustained gold gains are in place. This, along with a bullish MACD convergence on a daily and weekly basis, we expect the metal to target the key resistance level of $666 per ounce, which is not only the 100-day moving average (which remained tested but unbroken since May 17), but also the 50% retracement of the decline from $694 to $640.
Although the trading week is being impacted by thinning trading volumes ahead of U.S. Independence Day on July 4, the following day bears vital data and events in store, including the anticipated 25-basis point rate hike from the Bank of England, closely watched ECB press conference, U.S. June services ISM and U.S. June non-farm payrolls.
Both of the U.S. data releases are due at 10 am EST, with the May factory orders seen declining 1.2% after a 0.3% rise, and the May pending home sales index showing a 0.5% rise following a 3.2% decline. A decline in the index would mark the third monthly drop.
EUR/USD may limit gains ahead of U.S. data combo
EUR/USD Euro consolidates at the 1.3620s, boosted by Monday’s release of better than expected Euro zone manufacturing PMI (55.6 versus expectations of 55.4). Considering how the euro was damaged by reduced risk appetite in recent weeks, the return of risk-seeking traders as well as with overall negative dollar sentiment fuelled by rallying gold is aiding the rally in the single currency.
With the euro expected to remain supported at the newly found trend line support of 1.3500s, we expect any retreat towards 1.3550 to find prolonged buying that would make the path to new time highs sustainable. Interim support at 1.3590, with preliminary resistance at 1.3670, followed by the target just below the all time high of 1.3683. Subsequent target at 1.3720.
USD/JPY recovery seen capped at 122.85
The divergence between the yen’s recovery against the U.S. dollar and the yen’s weakness against most currencies (even against the Swiss franc) highlights the combination of prolonged risk-seeking trades and overall deteriorating dollar sentiment. After briefly selling off following an unchanged Tankan business sentiment survey, the yen regained ground versus the dollar while extending the sell-off against the major currencies. Better than expected plans for capital spending by large Japanese companies for fiscal year 2007-08 (7.7% from previous 2.9%) have especially boosted the yen against the dollar. Although the survey maintains the unchanged interest rate outlook into August, it may broaden the yen’s gains considering pressure on Japanese officials to quell excessive currency weakness.
We expect the current push higher in USD/JPY to breach 122.65, but remain limited at the 122.85 resistance at which point, the U.S. data element will dictate the dynamics. A breach above 122.90 is seen capped at 123.10-15. Renewed losses seen facing support at 122.40, followed by 122.00. A breach below 121.85 is seen limited at the four-month trend line support of 121.65.
BoE expectations may temper sterling’s gains
The return of risk appetite combined with negative dollar fundamentals are proving a powerful boost for all sterling pairs, pushing cable to fresh 26-year highs at $2.0195. Last week’s strong UK housing figures are giving rise to whispers of a 50-basis point rate hike by the Bank of England this week. We expect the Bank to raise by 25-bps to 5.75%, a decision that may see only limited pullback in sterling as traders sit tight ahead of Friday’s NFP report from the United States.
Due at 4.30 am EST is the UK construction PMI expected down at 57.7 in June from 58.0. A figure of at least 57.5 is likely to maintain the pair at 2.0145. We see support at 2.0130, which could only be breached by fresh selling in U.S. equities that may arise from a disappointing pending home sales report. Upside capped at 2.0170, followed by 2.0210.
Ashraf Laidi
Chief FX Analyst
CMC Markets US
140 Broadway, 30th Floor
New York, NY 10005
(212) 644-4220
a.laidi@cmcmarkets.com
