Renewed selling in the U.S. dollar intensifies due to prolonged bad news on the housing sector, including this week’s existing home sales, Case/Schiller home price index and last week’s housing starts and building permits. In addition, there was the unexpected rebound in German confidence and further inflationary figures in the UK, all of which are factors seen extending the dollar’s yield disadvantage on the premise of further Fed easing in contrast to steady central bank hawkishness abroad. Although we predicted broad dollar strength into mid Q1 2008, we’re not yet abandoning renewed selling in GBP and CAD, along with more temporary retreat in EUR.
Improved risk appetite is having a key role in resurrecting dollar selling in favor of the higher yielding currencies, especially as the Federal Reserve, U.S. Treasury and NY Insurance superintendent have articulated their readiness to maintain confidence in the economy and the financial system. The S&P 500 has risen 4.6% since its Feb. 7 low, while the U.S. dollar index fell 2.6% over the same period.
Risk appetite was further boosted after Fed Board Governor Donald Kohn virtually downgraded the risks of rising inflation, indicating today that he does “not expect the recent elevated inflation rates to persist,” and adding that the “adverse dynamics of the financial markets and the economy have presented the greater threat to economic welfare.” Kohn’s remarks may imply that Chairman Bernanke will stick to his gloomy assessment on the economy in tomorrow’s testimony, vowing to cut interest rates by at least 25 basis points (bp) next month, rather than raise the ire of the markets, and Congress, by paying lip service to inflation.
USD/JPY to test 107The aforementioned dynamics are should are yen negative as carry trades favor the higher yielding AUD, NZD, GBP, EUR at the expense of the yen. But as the chart below shows, USD/JPY stands to be the exception on the heels of another expectedly gloomy testimony by Fed Chairman Bernanke, which is casting broader negative pressure on the U.S. currency. Normally, under such risk environment, one would expect USD/JPY to push towards higher levels, but the current dynamics are a combination of rising risk appetite and eroding dollar confidence.
We expect USD/JPY to prolong its retreat towards the 107.20 support, followed by 106.80 which is the 50% retracement of the 104.96 to 108.62 rally.
EUR/CAD set for rebound The latest retreat in EUR/CAD is largely a result of soaring oil prices rather than any improvement in CAD-specific fundamentals. The sell-off clearly disregards today’s IFO surprise, which has proven to be no aberration considering the prior month’s increase in the survey and back to back improvement in ZEW survey. Expectations of at least 25 bps cut from the Bank of Canada week coupled with expected improvement in EUR sentiment should help the pair recover past the 1.4700 figure and onto 1.4740. The only downside risk to this assessment will be Thursday’s German unemployment figures, expected to show a 50,000 decline this month following -80,000 in Jan and a decline in the unemployment rate to 8.0% from 8.1%.
Ashraf LaidiChief FX StrategistCMC Markets USa.laidi@cmcmarkets.com
