The U.S. dollar dropped towards its session lows as Fed Chairman Ben S. Bernanke’s speech allows for further deterioration in housing labor, credit markets, thus confirming markets’ expectations that rates will be cut by 50 basis points next month to 2.50%, and we could well reach 2.00% before end of Q2. Accordingly, gold is boosted to $911 per ounce. We mentioned in today’s note that although the dollar has grown increasingly resistant to negative U.S. data recently, the currency's resilience would be challenged in the midst of Bernanke's pronouncements highlighting a broadening macroeconomic slowdown, reduced bank credit and dysfunctional money markets. The sense of immediacy of Bernanke's statements carries more weight in currency markets than economic data.
The yield curve is steepening further with the 10-/two-year yield spread rising to 1.88% as 10-year yields hit 3.80% and two-year yields test 1.92%. While a steepening yield curve has been attributed to a near-term improvement in conditions, we expect further to reach as high as 250 basis points (bp) as two-year yields are seen retreating towards 1.60% amid further Fed easing and 10-year testing the 3.95% figure. The aforementioned factors are behind our outlook for renewed dollar losses against the EUR, AUD, CAD and NZD later in Q2 following a temporary retreat in these currencies in the near term horizon. Despite hawkish Bank of England (BoE) rhetoric, GBP/USD is seen coming under renewed pressure toward the $1.95 amid expectations of another 75 bps in rate cuts this year.
We continue to favor the Aussie against GBP, EUR and USD, with interim bouts of risk reduction seen as fresh opportunities to enter a currency with 85% chance of a 25 bp rate hike next month.
The impact of struggling bond insurers is reaching towards the $300 billion auction-rate market, where underwriters of these bonds are increasingly refraining from buying them when bidding at the auctions fails. As an underwriter to these bonds, UBS would normally intervene by buying auctions that fail to obtain bidding. But considering the bank’s record losses ($11 billion loss in Q4) and the rising cost of such bonds in light of the deteriorating state of their insurers (Ambac MBIA), failed auctions mean further escalation in the cost of debt of state municipalities, schools and hospitals. Currency traders continue to view these developments largely confined to the U.S. domestic bond market, and hence, a dollar-based problem. But it is unclear to what extent holders of these bonds are outside the United States.
Euro supported by Bernanke
The euro lost ground despite better than expected Euro zone Q4 gross domestic product (GDP) growth, which slowed to 0.4% in Q4 from 0.8% in Q3, exceeding forecasts of a 0.3% increase. On an annualized basis, Q4 growth slowed to 2.3% from the prior quarter 2.7%, bringing overall 2007 growth to 2.7% from 2.8% in 2006. 2008 GDP is expected at 1.6%. We expect the pair to obtain support from Bernanke’s speech at the 1.4570s, before mounting a rebound towards 1.4560.
Yen may slip further as policy makers speak
Despite Japan’s surprising 0.9% increase in Q4 GDP from 0.3%, the yen remains under pressure amid prolonged risk-seeking flows. Annualized growth rose 3.7% from 1.3%, vs. 1.7% expected. The 2.9% rise in capex and exports offset moribund consumer spending and negative housing sectors.
We expect the pattern of continued equity gains on comforting remarks from government officials and to persist into today’s trading, which is likely to weigh on the yen across the board. Treasury Secretary Hank Paulson and Securities and Exchange Commissioner Chris Cox will also testify today. Despite the gains in USD/JPY, strong resistance stands at 108.60, also a previous support. Friday’s release of U.S. industrial production figures should also dictate sentiment into early next week, with the possibility of a negative figure maintaining cap at 108.80s.
Aussie seen adding to gains
Aussie soared by more than a full cent overnight after the Australia’s unemployment rate unexpectedly fell to a 34-year low of 4.1% last month from 4.3% in Dec. Employment rose by 26,800 from 24,800 versus forecasts of 15,000. Although the bulk of the increase was in part-time jobs, the figures maintained the participation rate unchanged at 65.2%. Interest rate futures have boosted chances of a 25 bps rate hike in March to 85% from 74% prior to the data. The recent drop from 90.60s is seen stabilizing at 90.10 and is set to rebound back towards the 90.40s in the event that Bernanke’s testimony open s the door for further rate cuts without necessarily causing market nervousness as was the case in his last two testimonies. AUD/JPY seen regaining the 98 figure and onto the 98.45. Support crops up towards 97.30.
GBP/CAD set for short-term gains
Considering the latest inflationary warnings from the Bank of England (BoE) and temporary return to risk appetite, we favor GBP/CAD, especially amid latest dovish pronouncements from the new BoC governor opening the door for a March rate cut. The slowdown in Canada’s trade surplus is also dragging CAD lower. We expect the pair to extend gains towards 1.97 onto 1.9745. Support stands at 1.9620.
Ashraf Laidi
Chief FX Strategist
CMC Markets US
a.laidi@cmcmarkets
