A profit warning from Citigroup indicating that its earnings would drop 60% in Q3 due to a $1.3 billion loss in subprime mortgages is accelerating the exits from high yielding currencies as traders reduce risk appetite. An announcement from UBS of a $690 million loss in Q3 is also adding to increased risk aversion. Euro accelerates losses after comments from ECB President Trichet indicating his reference to “extreme attention that U.S. Treasury Secretary and U.S. Fed Governor have said strong dollar in U.S. interest”, which is a veiled attempt to stabilize the rapid gains in the euro. Both the euro and sterling were already coming off their highs against the dollar after manufacturing surveys in the Euro zone and the UK showed signs of cooling in August, prompting traders to cut back from their short USD positions against the two currencies. Neither the European Central Bank nor the Bank of England (BoE) have expressed any concern about the strength in their currencies, but markets are beginning to price chances of a BoE rate cut before year-end, which is likely to accelerate sterling’s losses against the non-USD currencies and bring it off highs against the greenback.
Markets await the 10 am release on U.S. USM manufacturing expected to have eased to 52.5 in September from August’s 52.9. Also under scrutiny will be the employment and new orders indices, both of which eased in August to 51.3 and 55.3 respectively. An upside surprise would be especially positive for the greenback against the pound sterling due to the deteriorating fundamentals and market sentiment in the currency.
More sterling losses ahead Surging volatility in the GBP/USD has been the highest among the major FX pairs as sterling’s swings are driven by Northern Rock news/weak UK data on one hand, and negative dollar sentiment on the other. Last week, sterling fell to 34-month lows against the euro, 24-month lows against the Aussie, 17-month lows against the Canadian dollar and six-month lows against the Swiss franc. But against the dollar, it only fell to one-month low last week.
The avalanche of sterling negative news started a month ago with reports showing a monthly decline in home prices, followed by U-turn in inflation from 3.0% less than six-months ago to 1.9% last month in August. The Northern Rock debacle accelerated losses in the currency while reports of eroding reserves at British banks depositors’ insurance have increased the risks of a banking route, raising chances of BoE easing. The news indicate that not only the high yielding sterling will begin to lose some of its luster—from current rates of 5.75%- but the rate cuts could begin as early as this year. Since currency markets allocate significant weight on anticipating central bank moves, and since the pound’s run-up of the last year had been founded on the highest interest rate in the G7 world, a reassessment of the BoE rate outlook explains the sharp sell-off in the currency.
Surprise rate cut from the Bank of England?
While most analysis expect the BoE to hold rates unchanged this Thursday, we see chances of a rate cut as high as 40%. The aforementioned negative developments have not only pointed to a clear slowdown in fundamentals but also an increase in systemic risk. Inflation fell to 1.9% in July and 1.8% in August, a marked slowing from the 2.0% inflation target that the central bank is mandated to meet.
The latest survey from the Confederation of British Industry/PricewaterhouseCoopers LLP found that a net 11% of firms expect overall business volumes to fall, which would end the period of robust growth of the past year. The survey marks the first negative expectation figure in more than three years, and the weakest since June 1991. Ongoing liquidity problems show that measures of business volumes, income and profitability are all expected to fall over the coming three months.
Today’s release of the Chartered Institute of Purchasing and Supply's index on manufacturing showed a decline to 55.7 in September from August's downwardly revised reading of 56.1. The new orders index fell to 55.5, reaching its lowest since January while export orders slipped to 52.9, its lowest since December.
Today’s data from the BoE showed a decline in the growth rate of mortgage lending and home loan approvals in August, with net mortgage lending rising GBP 8.5 billion, down from GBP 8.9 billion in July and below the previous six-month average of 9.3 billion. The growth rate of mortgage lending slowed to its lowest rate in three years at 0.7%. Mortgage approvals registered a monthly rise of 109,000 in August from July’s 115,000, well below the 114,000 average of the last six-months.
While a rate cut may not materialize this week, the currency is expected to remain under pressure ahead of the Thursday decision. In the event of no rate cut, we still expect the currency to register considerable declines in the case of a better than expected U.S. non-farm payrolls report in Friday. Cable drops from $2.0492 high in Asian trade to $2.0398 and is expected to extend losses to $2.0350. A breach below this is seen calling up $2.032.
Sterling shorts remain attractive against AUD (0.44), NZD (0.380) and CHF (2.036).
Record drops after PMI, Trichet Euro accelerates losses after comments from ECB President Trichet indicating his reference to “extreme attention that U.S. Treasury Secretary and U.S. Fed Governor have said strong dollar in U.S. interest”, which is a veiled attempt to stabilize the rapid gains in the euro.
Euro drops half a cent from its 1.4280 highs Euro zone PMI manufacturing sector purchasing managers' index was left unrevised at 53.2 last month, which is the lowest level since November 2005 and a sharp drop from the 54.3 reading in August. The new orders index fell to two-year low of 52.2, while the input and output prices fell to 12-month and seven-month lows. There were also broad declines on the national level, with Germany’s PMI falling to 54.9 from August’s 56.0, France’s PMI down to 50.5 from 52.5 and Italy is at 52.4 from 53.6. Meanwhile, the Euro zone economic sentiment index fell to 107.1 from August’s 110.0, marking the fourth-consecutive decline after the 112.1 peak in May.
But unlike in the case of sterling, the euro remains propped by the European Central Bank’s persistently hawkish rhetoric, which was justified last week a 2.1% inflation release in September, which is the highest since August 2006.
EUR/USD sees support at 1.4180, followed by 1.4120. There is a risk that a weaker than expected ISM survey may not necessarily be euro positive if U.S. stocks extend their losses. Rising risk aversion may weigh on the single currency, prompting a reduction in euro longs, which have accumulated to fresh record highs. Upside capped at 1.4250.
USD/JPY drops on carry trade unwinding Losses in US equities following the announcements of Q3 losses from Citigroup and UBS are likely to speed up the unwinding of recent yen carry trades and drag the pair towards 115.20.
Japan’s business sentiment among large manufacturers remained resilient in Q3 as the tankan survey rose to 23, exceeding forecasts of 22. Capex rose 8.7% from the 7.7% projected in Q2 and exceeded expectations of 7.5%. Having once again failed to break its five-week trendline resistance at 115.75-80, the pair now eyes the 115.20 ahead of the U.S. releases. Subsequent support stands at 114.70 – the 61.8% retracement of the 114-115.86, followed by 114.50. Upside capped at 115.70.
Ashraf Laidi Chief FX Analyst CMC Markets US
a.laidi@cmcmarkets.com
