U.S. dollar selling intensifies as the currency drops to fresh all-time lows against the euro (1.4370), record lows against oil ($91 per barrel), fresh 28-year lows against gold ($778.55 per ounce), new 33-year lows against the Canadian dollar (95.95 cents) and new 23-year lows against the Aussie (91.47 cents). Increased certainty that the Federal Reserve funds rate will fall by at least 50-basis points this year to 4.25% means that the dollar will be treated as a low yielding currency, specifically, due to the onset of further rate cuts in 2008. Thus, even if U.S. rates at 4.25% remain higher than those in the Euro zone (4.00%), Switzerland (2.75%), Japan (0.50%), it is the anticipation of further rate cuts that reinforces the depreciation of the greenback, especially as the deepening housing recession is expected to continue into 2008, translating into repercussions for employment, homeowner’s equity and consumer spending.
With the Fed largely expected to reduce the Fed fund rates by 25-bps next week, the outcome will be double negative for U.S. stocks and the dollar, with the latter demanding a more aggressive easing and the latter losing its yield foundation.
We dismiss the fact that the latest dollar damage is a result of stringent U.S. political sanctions on Iran. One important (and overlooked) aspect of yesterday’s announcement from U.S. State Secretary Rice was her willingness for direct diplomatic talks, instead of low-level talks, with her Iranian counterpart, an offer never previously stated. Whether the remark was a result of pre-presidential election posturing (Democrat presidential candidates have stated their willingness to talk with Iran as do former advisors to former Presidents Reagan and Bush Senior), the situation is unlikely to trigger a direct U.S. military strike against Iran. But recent security reports that Israel is readying itself for a confrontation with Iran will likely draw the United States to the fray. Thus, it is just as important to watch any developments between the two Middle Eastern nations.
Regardless, the capitulation in the dollar is founded largely on economic factors. This reality is specifically palpable due to the implication for global central bank diversification into non-USD currencies. Both China and Japan, the largest holders of U.S. treasuries have reduced their holdings, with Japan’s holdings down 15% to a three-year low at $586 billion, and China’s holdings down 5% to a six-month low at $400 billion.
Finally, the only catalysts for dollar gains over the past two weeks have been unwinding of carry trades, as portfolio managers unload some of their dollar shorts to meet losses in equities. In other words, the only developments causing the dollar to rise have been renewed equity declines, rather than an improvement in U.S. fundamentals.
EUR/USD eyes $1.4420 high Capitulation amid dollar selling is likely to drive euro the euro above the $1.44 mark despite the decline in Euro zone M3 growth to 11.3% last month from 11.6%. Recall that the ECB’s original M3 target was 4.5% as part of its two-pillar monetary policy at its inception in 1999. But the central bank gradually gave up the M3 pillar after 2002. Thursday’s release of Germany’s IFO business sentiment survey was not enough to justify fears of a slowing economy resulting from the rising euro and falling U.S. demand. The only viable obstacle against accelerated euro buying is a change of rhetorical tack from the ECB that goes beyond reinforcing the upside risks to inflation. EUR/USD faces resistance at 1.4420, followed by 1.4450. Support climbs to 1.4350 and 1.4310.
USD/JPY afloat on risk appetite USD/JPY continues to act as the sole anchor of support for the U.S. currency amid the absence of risk aversion in global equities. Thursday’s late session rebound in U.S. stocks did help reinstate confidence in Asian bourses, while China’s announcement to raise rates for the sixth time has not impeded activity. Remarks from Japanese Vice-Finance Minister Shinohara indicating that the “Yen carry trade has virtually disappeared” and dispelling talk of a change in FX reserve portfolio in the face of FX movements are an evident sign of Tokyo’s preoccupation with rapid gains in the currency. Upside ground is capped at the 114.60 trendline resistance extending from the 117.93 high through 117.45, with subsequent resistance at 115 – 38% retracement of the 117.45-113.22 move. Support stands at 114.20, followed by 113.70.
Sterling gains vs. USD offset by losses vs. EUR Sterling’ gains past the $2.0550 level at three-month highs has been largely a dollar weakness play as the British currency was dragged to the 70 centime level against the euro. An announcement by the National Institute of Economic and Social Research, expecting a slowdown in 2008 GDP growth to 2.2% from 3.1% in 2007 has weighed on the sterling. Falling expectations of a BoE 2007 cut are also shoring up the pair, but we have to wait for next month’s Bank of England’s quarterly inflation report for the latest view on policy. Upside capped at 2.0580, followed by 2.06. Foundation vulnerable for breach of $2.0460 support, followed by $2.04.
Ashraf Laidi
Chief FX Analyst CMC Markets US a.laidi@cmcmarkets.com
