U.S. housing starts fell by 0.6% to 1.065 million in January, above the expected 1.000 million, but building permits fell 7.8% to 978,000, well below the 1,023 million expected and the lowest level since September 1991. Permits for construction are the more forward looking indicator than the actual starts; therefore, the figures suggest further weakness to come in residential construction.
February PPI rose 0.3% (exp 1.0%), and core PPI rose 0.5% (exp 0.2%). Markets continue to price a full probability of a 100 bp rate cut in the fed funds rate. Regardless of whether the Fed cuts the Fed funds rate by 75 basis points (bp) or 100 bps this afternoon, the dollar is bound for deeper losses against the euro and the yen into the rest of the week and the month. Either outcome will take the dollar’s rate disadvantage with the euro at the worst level since November 2002. Stronger than expected earnings from Goldman Sachs and Lehman Bros. as well as aggressive Fed easing will likely provide a short-term boost for carry trades and lift GBP, AUD and NZD higher against the USD and JPY.
Yen to step aside for Fed’s move
We expect the yen to continue its temporary retreat in the midst of expectations for an aggressive 100 bp cut by the Fed, which should reenergize risk appetite trades for the short term. Readers should be aware of the “bear market” rally phenomenon in equities, which is characterized by fierce one-day rallies of as much as 3.00% that are often reversed in a matter of one or two days. This was common during the beginning of the 2001-2002 bear market as these rallies proved detrimental to short-term traders anticipating persistent declines.
A 100 bp rate cut has the potential to carry USD/JPY to as high as 98.70 and 99.00 amid sharp rallies in equities, but the interest rate differential handicap of the U.S. dollar is expected to prevail and trigger further USD selling. A 75 bp cut may not trigger the same degree of gains in equities and could drag the pair to as low as 97 and 96.30.
CAD capped by slowing inflation
The loonie was hit across the board after CPI rose 1.8% y/y in February, following a 2.2% increase in January, while the core CPI rose 1.5% following a 1.4%, beating expectations of a 1.2% increase. The core rate remains well below the Bank of Canada’s preferred 2.0% level, thus, supporting expectations for at least 25 bps cut next month. Stepping back from the short-term fluctuations of USD/CAD, we note an upward consolidation with rising support at 0.9820 and 0.9860, with the upside capped at 0.9980 and 1.0020. Current CAD strength is triggered by improved sentiment for risk appetite and equities, which may drag USD/CAD back towards 0.9820 and 0.9780 at which point we should expect strong foundation to take hold.
CAD/JPY: Improving market sentiment to prop the pair towards 98.70 and 99.00. Since we do not rule out a rally of more than 2.50% in U.S. stocks, we may see the pair extending to as high as 99.70. But renewed yen strength should reemerge and the bear is expected to dominate anew for 99.30 and 98.00.
Euro remains supported
Persistently hawkish remarks from the ECB stressing the importance of combating rising inflation confirm to the markets that any intervention from the central bank aimed at stabilizing the euro’s strength will be limited to a mere restatement of the importance of a strong dollar and dismissing the excessive moves. That said, the euro remains vulnerable to periodic pullbacks from such remarks. Support is seen emerging at 1.5740, backed by 1.5700.
A 100 bp rate cut is widely expected to boost the euro above the 1.58 figure and onto 1.5830. A smaller cut of 75 bp may not have the same effect but will prove euro positive into the medium term.
EUR/CAD: After pulling back from its 1.5770 high, the pair stabilizes around the 1.5680s amid CAD-friendly improvement in global equities and oil. Support stands at 1.5630. Buying to revisit 1.5730, followed by 1.5790.
Sterling boosted by inflation
Sterling boosted by a combination of 2.5% rebound in inflation from 2.2% as well as improved market conditions. Despite the inflation figures, we expect the Bank of England to cut rates next month as it is unlikely to prevent an overshoot in the UK/U.S. rate differential. Although sterling has rallied from its 1.9950 low, the fundamentals remain predominantly bearish. Further gains may emerge largely on the back of today’s Fed cut. Upside seen extending to $2.0220 and 2.0280. Support rises to 2.0120 and 2.0080.
Ashraf Laidi
Chief FX Strategist
CMC Markets US
a.laidi@cmcmarkets.com
