Assessing Currency’s True Performance In order to capture a currency’s true performance it is helpful to measure it against the value of gold, especially as the metal flirts with all-time highs. Sterling for instance, whose spectacular gains versus the U.S. dollar have contrasted with losses against EUR, CAD and AUD, has lost 22% year to date versus gold (charts below shows Gold +22% YTD versus GBP). The charts show gold to have soared by 33% in USD terms year to date, 18% EUR, versus 25% versus JPY and a miserly 3% versus CAD. The loonie’s relative strength measured by gold reflects the currency’s broad rally, which confirms the solid fundamental backdrop to its strength (positive budget/ current account balance, strong GDP growth, robust yield foundation and favorable oil receipts flow). Our calls favoring CAD versus GBP, and NZD in past Charts Strategies remain intact.
Why we continue favoring the AussieSiding with the Fussier – the next best performer against gold – does not come without its risks given the increasingly tenuous equity market picture. Yet the Aussie’s ability to rebound rapidly from intermittent assaults on risk appetite justifies the currency’s upward potential against GBP, NZD and USD.
Wednesday’s rate hike from the Reserve Bank of Australia underlines the robust fundamentals of the Australian dollar, even during the current credit uncertainty. The 25-basis point rate hike to an 11-year high of 6.75% was accompanied with a hawkish statement indicating inflation was likely to rise above the 2-3% target by Q1 2008. Markets are pricing a 60% chance of a rate hike in December but a greater chance of a similar move in Q1. Today’s release of the latest employment report showed the jobless rate edging up to 4.3% in October from the 33-year low of 4.2%. Payrolls rose by 12,900 from 13,000.
Considering the Aussie’s lofty interest rate structure and ongoing expectations for further rate hikes, the currency remains our favorite, even during intermittent bouts of risk aversion. Looking at a daily AUD/USD chart for instance, you will notice that each down day is immediately followed by a rebound in the following. Over the past trading days, there were only three phases of two consecutive daily declines. This may also be true in the case of the EUR/USD, whereby it had not had two consecutive daily declines since Oct 3. But the fact that AUD/USD faces higher upside ground due to the onset of further rate hikes permits the resumption of the bull in a broad basis.
Aussie soared to a fresh 23-year high at 93.98, facing 94.30¢ later today barring any protracted selling in equities. Recent trends, however, have shown the Aussie’s ability to rebound speedily after bouts of risk aversion. With further RBA tightening ahead and USD pressure on the mount, support stands at 93.20 and 92.80.
AUD/USDGBP/AUD: More Downside
Rather than waiting for sterling to retrace against the U.S. dollar, we continue to anticipate further GBP losses against the euro following last week’s predictions in the pair. Considering that gold has rallied twice as much against GBP as it had against AUD, prospects for further GBP losses remain, especially given the fundamentally weak signs in the UK economy (broader retreat in UK home prices, emerging signs of cooling retail sales and manufacturing production) and ongoing expectations for at least one more Aussie 25-bp rate hike after this Wednesday’s move. As rapid as the Aussie’s declines have proven to be during the bouts of equity selling, its rebound has been equally striking, which makes these equity corrections an viable entry opportunity in AUD. The cross pair may be boosted by further selling in equities on Thursday, but Aussie’s strong macro outlook contrasts with sterling’s deteriorating fundamentals. Not only Aussie rates are at a heftier 6.75% versus 5.75%, but they are expected to widen on Aussie rate hike and/or Bank of England (BoE) rate cut in Q1. We still see a 50% chance of a BoE rate cut before year-end.
GBP/CAD: Downtrend IntactThe case for CAD against GBP is highlighted by an already slowing UK inflation (1.9% versus 2.0% target), a broader retreat in UK home prices and emerging signs of cooling retail sales and manufacturing production. There are also lingering losses at various UK banks, where liquidity strains continue to drive banks towards the central bank’s emergency lending facility. With UK rates at 5.75% versus Canada’s 4.50%, there is ample downside room for UK rates to head lower drop as well as for the British currency to follow suit. Although GBP/CAD has already hit a three-year high at 1.9400, we expect further retreat towards 1.90 by year-end and 1.88 once the BoE begins its easing cycle.
No Currency Tips from Trichet, Bernanke A $3.7 billion markdown by Morgan Stanley, losses warnings from Capital One and American Insurance Group, and subpoenas investigating New York lending institutions are some of the explanations for the Wednesday sell-off in U.S. equities and turnaround in high-yielding currencies in favor of the U.S. dollar. Gold had dropped nearly $15 from its $840 high. Will these events serve as the eventual catalyst to the pullback in gold and trigger further losses in equities? It is possible. But in order for a gold correction to take place, the Euro zone or British equivalent of Citigroup/Merrill Lynch/Bank of America has to occur in order for risk appetite to be curtailed in a more global fashion.
Given that the central bank chiefs of the world’s two strongest economies will speak on Thursday, at a time when their currencies are racing in diametrically opposing directions, will their comments make any difference in FX markets? Will U.S. Federal Reserve Bank Chairman Ben S. Bernanke make another U-turn at Wednesday’s Congressional appearance (10 am EST), spilling more ink on the downside risks of the U.S. economy eight days after the FOMC issued a statement with a more balanced outlook? The Fed has already made a turnaround on August 17 when it Fed voted for a 50-bps cut in the discount rate, 10 days after indicating the economy to be “supported by solid growth in employment and incomes.” Considering the underlying dollar damage and renewed deterioration in equities, Bernanke may play up the strengths of the U.S. economy such as the recent resilience in the ISM services index and the relatively lackluster readings in weekly jobless claims. We expect the Chairman to be interrogated about the falling dollar, but also expect his replies to offer little value to a market gripped by a cyclically and structurally robust anti-dollar trend.
ECB president J.C. Trichet due to hold a post-meeting press conference at 7.45 am EST will be expected to continue echoing the inflationary risks especially after the preliminary October CPI figures showed a 2.6% rise, well above the 2.0% level preferred by the ECB. But we also expect Trichet to repeat last month’s acknowledgment of the ongoing strains in euro zone credit markets and the evident signs of a cooling euro zone economy. Yet that would only be effective in causing a disruption to the euro rally in the event that Trichet steps up his worries on the downside risks to the Euro zone and global economy and eases his hawkish take on inflation. Since that is unlikely, Trichet’s only FX is seen via any references to the euro’s strength, dollar weakness.
Ashraf LaidiChief FX AnalystCMC Markets USa.laidi@cmcmarkets.com
