It was another case of subprime driven dollar damage in Asian trade, as the U.S. dollar tumbled to fresh record lows against the euro (1.3833) and multi-decade lows against the Aussie, loonie, kiwi and sterling, after Bear Stearns’ subprime sector hedge funds were revealed to be worthless. The U.S. dollar index, as calculated by the Federal Reserve against a basket of seven currencies, fell to its lowest level since its inception in 1971, while the trade weighted index traded daily at the New York Board of Trade (Nybot) is nearing its lowest since 1995, down 6% on the year. Although the yen rose against the high yielding currencies in a bout of unwinding of carry trades, the Japanese currency rallied 0.5% against the U.S. dollar from 122.35 to 121.59.
But the dollar sell-off did abate during the early hours of European trade, with sterling accelerating its retreat after the minutes of this month’s Bank of England (BoE) rate hike showed a contentious six-to-three vote for the decision (more below).
Today’s activity will be dominated by the June reports on CPI and housing starts/building permits, and Federal Reserve Bank Chairman Ben S. Bernanke’s testimony to Congress as well as the Fed’s semi annual central tendency forecasts for the economy.
At 8.30 am is U.S. June CPI is expected up 0.1% from 0.7% in May, with the core rate up 0.2% from 0.1%. This would drag the annual headline CPI to 2.6% from 2.7% but maintain the annual core CPI at 2.6%. A higher than expected figure in the core and the headline would be negative for U.S. stocks and bonds as it would justify the Fed’s anti-inflation vigilance at a time when markets are increasingly averse to the threats of sub-prime fallout on the overall economy.
Also at 8:30 am is the June report on housing starts expected to show a decrease to 1.45 million from 1.474 million, while building permits are expected to drop to as low as 1.45 million from 1.520 million. If materialized, these forecasts would engender fresh worries on the prospects for the pace of home construction and cast fresh dollar selling.
Bernanke’s testimony will focus on inflation versus headline inflation and his latest outlook on the housing sector. Equally important, is the Federal Reserve Board’s forecasts for the economy, which could include a downward revision for 2007 real GDP growth to a range of 2.0% to 2.5% from the previous forecast of a 2.50% to 3.0% range. We may also see a lowering in the core PCE forecast while unemployment is seen unchanged.
USD/JPY drops 0.5% before stabilizing The bulk of USD/JPY losses occurred in Asian trade from 122.35 to 121.80 following the latest subprime revelations, this time from Bear Stearns. The pair extended losses to 121.59 in early European trade before stabilizing. The possibility of further dollar selling may occur in the event of a weaker than expected core CPI reading (such as unchanged core CPI m/m and 2.1% y/y). A high figure may boost the yen in the event that U.S. stocks suffer from a combination of upside inflation risks and the impending subprime developments from Bear Stearns.
USD/JPY resistance drops to 122.35, sending the pair towards the 122 figure. Interim support is seen holding at 121.80, backed by 121.65. While much focus has been placed on the CPI and Bernanke, the housing starts/building permits have the potential for triggering sharp moves in FX. Key support stands at 121.45.
Euro cools after new record at $1.3832
Euro rallied to a new high largely on the overall dollar damage following the Bear Stearns announcement. The subsequent retreat to 1.3766 is expected to stabilize at 1.3750s. The potential impact of a weak housing starts/building permits report may be a renewed run-up towards the 1.3790s. But the overall FX reaction is not expected to form until the conclusion of Mr. Bernanke’s testimony. Resistance emerging at 1.3820.
Sterling brought down by contentious rate hike Sterling peaked about one hour prior to the release of the Bank of England minutes at $2.05460. With the minutes of this month’s Bank of England rate hike showed a contentious six-to-three vote for the 25-basis point rate hike, there are expectations that UK rates may have peaked at 5.75%, which could generate a mild correction in sterling. Yet, with the bulk of sterling’s gains having taken place on the heels of dollar weakness, the retreat may be tempered. We expect interim support at 2.04550, followed by 2.0430. Upside seen capped at 2.0530.
We noted yesterday that “The risk that the Committee made another contentious vote (such as six-to-three or five-to-four), or even a three-way split - with some members demanding a 25-basis point rate hike and others no change - may be negative for sterling.” We also warn traders of China’s second quarter gross domestic product (due at 10 pm EST today), expected to grow by 11% while inflation is growing as high as 4%, surpassing the PBOC 3.0% target. In such case, nervousness of renewed rate People’s Bank of China hike hikes may upset Asian markets as well as the higher yielding currencies such as sterling, especially in the GBP/JPY.
Ashraf Laidi
Chief FX Analyst
CMC Markets US
140 Broadway, 30th Floor
New York, NY 10005 (212) 644-4220
a.laidi@cmcmarkets.com
