The currently reduced FX market volatility is partly a result of narrower trading ranges in global equities, as major economic data releases take a backseat to weaker than expected projections by the Federal Reserve and the International Monetary Fund. Forecasts by Fed staff expect a U.S. growth contraction in the first half of the year, while the IMF estimates total losses from the U.S. mortgage fallout to surpass $900 billion, well above the current $240 billion. These IMF projections pose a stark challenge to the notion that the worst has passed in mortgage-related write downs and hedge fund losses. It is worth noting that since the appointment of Dominique Strauss-Khan at its helm, the IMF has adopted an increasingly bolder than usual approach in recommending fiscally-driven stimulus packages as well as downgrading individual nation growth rates and projecting mortgage-related losses to the global economy. Strauss Khan was the finance minister under the center-left French government at the turn of the decade, a clearly opposing side of the political spectrum from his IMF predecessor Rodrigo de Rato, who was finance minister under the right-of-center government of former PM J.M. Aznar.
The relative calm in currencies is also emerging ahead of tomorrow's much anticipated interest rate decision by the Bank of England and policy press conference by ECB President JC Trichet. The BoE is widely expected to cut rates by 25 basis points to 5.00%, while Trichet is likely to maintain the policy emphasis towards inflationary pressures despite cautioning on the negative impact of the currency market turmoil.
Sterling stabilizes on output data
Sterling weakness is somewhat stabilizing after better than expected manufacturing output figures dampened any speculation of an aggressive 50 bp rate cut tomorrow. UK manufacturing output grew 0.4% in February, from 0.5%, bearing forecasts of a 0.5% rise, the fastest pace in over a year, while the annual rate rose 1.9% from 0.7%, falling short of 1.5% forecast. Industrial output rose 0.3% following a 0.1% decline, but less than the expected.
The 2.5% annual inflation rate registered in February was the highest in nine months, is deemed as a principal reason to why the Bank of England may opt for the 25 bp cut route. But as BoE Governor Mervyn King has repeatedly stated in past testimonies, inflation is expected to retreat towards the 2.9% target later this year thus validating a steady easing campaign.
We continue to refer to the weekly GBP chart below, which highlights the last three major phases in the pair since summer 2006. GBP/USD has now entered its fourth phase, which started in the week of March 4, when the cable dropped 5¢ to $1.9750. We’d have to see a rebound above the $2.0070 in order for this down channel to be broken and the bull to be revived. Interim resistance stands at $1.9760, at which point we expect the pair to retreat back ahead of tomorrow’s BoE decision at 7 a.m. EST. Support climbs to $1.9680, followed by $1.9635-40.
Euro consolidates ahead of G-7
Euro consolidates against the USD at $1.57 to $1.58 range, while hitting a new record high at 80 pence against GBP and pushing towards the 161.45 yen high. Despite media attention ahead of this weekend’s G-7 meeting, we do not expect central bankers and finance ministers to come up with a foreign exchange communiqué that is meaningfully different from the current one urging China and emerging Asia to move towards faster liberalization of their currency regimes.
Considering that the IMF estimates total losses from the U.S. mortgage fallout to surpass $900 billion, well above the current $250 billion, G-7 leaders are faced with bigger set of challenges than overshooting currencies. Market risk mitigation, shaky banking fundamentals and soaring world food prices will dominate the meetings in Washington. Having said, traders must be aware of the possibility of behind-the-scenes remarks regarding the “strong dollar policy” and impact of rising euro on Euro zone economy.
Euro’s upside faces pressure at $1.5750 coincides with trendline resistance of 61.8% retracement of the decline from 1.5900 to 1.5510 as well as trendline resistance from the said high. Subsequent upside is seen standing at 1.5780, while support climbs to 1.5650, backed by 1.5620.
USD/JPY upside slips to 102.80s
USD/JPY treads around the 102.80-102.20 range amid the absence of major economic data and tight trading ranges in U.S. equities. The Bank of Japan voted unanimously to leave rates unchanged at 0.50%. The pair withstood brief bouts of downside pressure following the release of the Federal Open Market Committee (FOMC) minutes. Any comments from the G-7 reiterating the need for currencies to pursue market-driven forces should work in the favor of the yen, while any emphasis on contained volatility is likely to weigh on the currency.
We expect yen bias to resurface, dragging the pair towards 102.45 and 102.00. Any further attempts to the upside to depend upon fresh gains in Wall Street, thus facing resistance at 102.70, backed followed by 103.00.
Ashraf Laidi
Chief FX Strategist
CMC Markets US
a.laidi@cmcmarkets.com
