Once again, an injection of capital from Mideast and Far East investors is offsetting the latest array of bad news in the financial sector. In what may otherwise have been a market-destabilizing event, UBS’ announcement to write down $10 billion in U.S. subprime mortgage investments was simultaneously announced with a strategic investment worth $11.5 billion from the Singapore government and an unnamed Middle East investor. The news are helping stocks and overall risk appetite, which is weighing on the Japanese yen and favoring the EUR, AUD, GBP at the expense of the U.S. currency.
The 10 am EST release of U.S. pending home sales is expected to show a 1.0% decline, in October following a 0.2% rise.
A 25-bps cut will help dollar, hurt stocks, bonds, gold
Although Friday’s U.S. payrolls report showed the fifth of release of sub-100,000 in the last six months, the 94,000 figure was deemed higher than expectations and the unemployment rate remained steady at 4.7%. This has reduced expectations of a 50-basis point rate cut from the Fed tomorrow, and makes a 25-bp rate cut in the Fed funds rate (to 4.25%) and a 50-bp rate cut in the discount rate (4.75%) the more probable outcome.
The smaller easing alternative by the Fed is expected to help the dollar from a yield and risk appetite perspective. A 4.25% fed funds rate would be more beneficial to the U.S. currency than 4.00% interest rate, while a less generous easing will likely disappoint a shaky stock market and curtail risk appetite. Renewed selling in equities will weigh on higher-yielding currencies, particularly the Aussie and sterling, whose central banks are less inclined to pursue a hawkish stance. A resulting rally in the U.S. dollar is also likely to be fuelled by a resulting pull back in gold to as low as $780 per ounce.
Our Friday forecast for higher 10-year yields materialized after the jobs report, seeing yields rise to 4.14% from 3.99%. Last week’s rise in long yields was the first in seven weeks. Historically, an interruption in a considerably long string of falling bond yields has signaled a rebound of about four-to-five weeks, which is generally accompanied by stability in the U.S. dollar index. Reversals in bond yields (rebounds or pullbacks) in conjunction with the dollar index have especially occurred during the last five weeks of the year as market repositioning curtailed net longs/shorts in U.S. paper.
A 50-bp rate cut would be a positive surprise for risk appetite and is likely to boost U.S. equities at the expense of the dollar, which would sustain a bigger erosion in its yield foundation.
In the unlikely event that the fed funds rate is held unchanged, we expect a sharp sell-off in U.S. equities (2%-3%) and considerable gains in the dollar across the board accompanied by a $25 to $30 decline in gold.
Euro attempts to break downtrend
The euro’s rebound from 1.4640 to 1.4725 is being fuelled by renewed boost in risk appetite that may break the falling trend in the event of a breach of 1.4750. The European Central Bank’s (ECB) Likannen reiterated the seriousness of the upside risks to inflation, which is reducing expectations for a 2008 rate cut. Nonetheless, Likannen and Italy’s Smaghi did say the Euro zone’s credit strains might worsen, urging banks to clarify their credit situation. Yet, the ECB is likely to continue addressing the credit situation by further injection of liquidity rather than cutting the overnight rate, which is seen further fuelling already high inflation.
The emerging head-and-shoulder formation in EUR/USD remains intact as long as the 1.4750 is not taken out. The level also marks the 50% retracement of the decline from the 1.4966 high to the 1.4524 low. Subsequent resistance stands at 1.4770. Support starts at 1.4660, followed by 1.4635.
USD/JPY eyes 112
Yen drops across the board on the latest surge in risk appetite and broad gains in global equities. Yen losses will likely continue in the event of a 50-bp rate cut from the Fed. But the more expected outcome of a 25-bp easing is seen neutral to positive for the Japanese currency. Last week’s downward revision in Japan’s Q3 GDP added to the selling but the increasingly challenging situation facing the Fed (slowing growth, eroding banking capital and rising inflation) may dampen appetite-seeking trades trigger renewed yen gains.
USD/JPY is eyes 112.00 trend line resistance extending from the Oct 15 high thru the Nov 1 high. A breach of the figure may potentially give way to 112.30. Key resistance stands at 112.75. Support climbs to 111.40, followed by 111.00.
Sterling capped at 2.0480
Sterling joins rest of currencies in gaining versus the dollar, especially with higher than expected 1.7% increase in input prices. The 0.5% increase in PPI output prices show that producers are able to pass higher prices across the pipeline. The figure may help keep next week’s release of December CPI above 2.0%, but this may not be an obstacle to further BoE easing next year.
Press reports of a struggling UK mortgage industry and intensifying liquidity crisis in retail property raise the risk of renewed action from the central bank and fresh downside in sterling. We continue to expect $2.01 by end of month, while interim support stands at $2.0370. Upside capped at 2.0475 trend line resistance, followed by 2.0490.
Ashraf Laidi
Chief FX Analyst
CMC Markets US
a.laidi@cmcmarkets.com
