The euro breaks above the $1.40 level for the first time since its inception, reaching an all time high of $1.4063, 17-month highs vs. sterling at 70 pence, five-week highs vs. the yen at 162.54 and two-month highs vs. the Swissie at 1.6558. Against the dollar, the euro has gained 19% since its inception on January 1999, and 71% from its all time low of 82.27¢ reached in October 2000.
In addition to broad euro strength, the single currency is resting on a deteriorating interest rate foundation in the U.S. dollar prompted by weakening growth U.S. growth. Apart from the yet unchallenged notion of growth decoupling in Europe from the United States, the U.S. economic slowdown is likely to drag into a long-drawn process, characterized by the slow transmission mechanism from rising long-term yields to falling home prices, mortgage delinquencies and reduced consumption. Adding to this rising unemployment and soaring oil prices, the negative impact on consumption is magnified.
Yet we do not expect the euro’s rise to be unchallenged. Emerging signs of a peak in domestic Euro zone growth coupled with an appreciating currency (especially from the falling sterling) are likely to drag periodic phases of pullbacks especially as speculators pare down their net longs and the European Central Bank.
US weekly jobless claims are due at 8:30 am, seen up by 321,000 from 319,000. Despite their rising trend, claims are well below the 370,000 to 400,000 levels prevailing during easing cycles such as in 2000 and 2001 to 2003.
The 10 am release of the August Leading Indicators Index is expected to show a drop to -0.4 from July’s +0.4 and June’s-0.3, which should support the notion of a slowing economy.
Fed Chairman Ben S. Bernanke’s 10 am Congressional testimony on mortgages and housing will explore the current regulatory environment, but should engender debate on the extent of the perceived worsening in the housing situation, its impact on those with adjustable rate mortgages and the impact on the overall economy.
The 12 pm release of the Philadelphia Fed index is expected to show a rise to 2.6 in September from 0.0 in August, but since the report is prepared by a regional Federal Reserve Bank, there’s a possibility that it came out below zero, which may have been one of the reasons prompting the Fed to cut rates by half a point this week. Although the employment component of the survey soared to 21.2 in August from July’s 4.1, the new orders component fell to 7.1 from 11.3, while the prices paid index fell to 15.4 from 28.1. Further weakness in the August components could evoke a market validation of the Fed’s decision and lead to continued dollar weakness.
Saudi Arabia’s interest rate decision also explains the dollar’s declines Aside from the aforementioned fundamental factors driving the euro to fresh highs, Saudi Arabia’s decision to not follow this week’s Fed cut with a rate cut of its own has seen the US funds rate drop below its Saudi counterpart for the first time in 17 months. Saudi Arabia has pegged its currency to the U.S. dollar since 1986 at a fixed exchange of 3.75 riyals to $1 USD since.
But with the value of the dollar losing 25% of its value in trade weighted terms only over the last 5 years, the dollar decline has fuelled inflationary soaring in the Gulf countries, prompting Kuwait to break from its dollar peg earlier this year and revalue its currency after inflation had hit an all time high of 14.8% in March. The United Arab Emirates, another country maintaining its peg with the dollar is also expected to either revalue its currency to a new peg or break off the currency system altogether after inflation reached a 19-year high of 9.3%. Both Kuwait and the UAE cut their interest rates yesterday after the Fed’s Tuesday decision.
Saudi Arabia’s insistence to maintain interest rates unchanged is not only explained by its high inflation rate which hit a seven-year record of 3.8%, but also by the negative impact on the value of its mostly dollar-denominated investments in its central bank and sovereign wealth funds, totaling over $300 billion. As the oil rich Gulf nations are paid in an increasingly falling U.S. dollar, their purchasing power diminishes while their imported inflation surges. With U.S. interest rates expected to drop by at least another 50-bps and the central banks of non-USD reserve currencies expected to maintain rates unchanged, the potential of portfolio losses from a currency value and yield perspective is significant.
The UAE and Kuwait have already discussed reducing the proportion of their dollar holdings in their currency reserves. The strong political and trade relationship between the Gulf nations and the United States is amid the reasons of maintaining the dollar-centric investments, but local pressure and economic realities are making the current arrangement increasingly untenable.
GBP/USD stabilizes on sales, BoE UK mortgage lending fell by 6% to GBP 32.2 billion in August from 34.1 billion stg in monetary amounts, but lending volumes remained robust, which is an explanation of tightened lending standards.
As BoE Governor Mervyn King explained to the Parliament the Bank’s decision for its initial reluctance to provide liquidity, the central bank announced a loosening in banks’ reserve requirement to +/-60 % from +/- 37.5%. Such form of monetary policy easing increase chances of seeing a cut in the overnight interest rate as early as next month.
On the data front, UK retail sales rose 0.6% in August from 0.7% in July (vs. expectations of 0.1%), and up 4.9% y/y from 4.4% (versus expectations of 4.1%). The report follows a series of economic data showing slowing inflation and housing prices, which have raised the odds that rates will not be increased from their 5.75% level.
GBP/USD sees interim resistance at $2.0080 followed by the trend line resistance and 50% retracement at 2.0110. Support holds at 2.0000, followed by 1.9960. Key support stands at 1.9910.
USD/JPY eyes 116.35 resistance Yen is propped by a broadening dollar weakness reflected in the rising price of oil hitting 16-month highs. While risk appetite is being modestly curtailed, the yen gains are mainly a dollar weakness story. After failing to break a key trend line resistance of 116.35, USD/JPY is now nearing 115.20, eyeing support at 114.85 – 38% retracement of the rise from the 112.58 low to the 116.39 high. Key downside target stands at 114.40, while upside is capped at 115.60.
High yielding Kiwi 74¢ to five-week highsNZD/USD surges to a five-week high at 74.14¢, prolonging the upward run of the high-yielding currency as the combination of reduced risk appetite and broad USD weakness makes for the best of both worlds for the NZD. With the NZD rate advantage relative to the USD rising to 3.50% from 3.00%, further NZD gains are in store. With the pair now exceeding our 74¢ target, there remains the 100-day moving average at 74.42¢, at which point we temper our bullishness, before a possible reassessment of the 75.50 cent level. Support stands at 73.90, followed by 73.60.
CAD: half a cent away from Parity with USD The Canadian dollar extends gains to fresh 30-year highs at 1.0040, which is less than half a cent away from the elusive parity level. Yesterday’s softer than expected CPI report temporarily weighed on CAD, but broadening USD weakness is calling the shots in the loonie. A drop in oil prices may temper the gains, so caution is urged at selling beyond 1.0038 for now. Upside capped at 1.0080, followed by 1.0120.
Ashraf Laidi Chief FX Analyst CMC Markets US a.laidi@cmcmarkets.com
