The U.S. dollar trades at its session lows as commodities rally across the board, with oil fuelled by China’s oil price hikes and reports of Israeli military exercises seen as a rehearsal for a possible attack on Iran’s nuclear facilities. The situation is worsened by bellicose response from Iran stating it would answer Israeli attack with a “strong blow,” driving oil prices back above $134 per barrel. The Japanese yen is facing less resistance and rallies across the board upon the intensification of falling risk appetite.
There are no major economic figures from the United States, but volatility may escalate as it its triple-witching Friday, which is the simultaneous expiration of futures and options contracts on indices and individual stocks.
Investor confidence continues to deteriorate primarily in the United States, weighted by continued declines in the banking sector. Aside from the major U.S. investment banks, small regional banks have come under severe pressure as a result of escalating subprime related delinquencies. Due to the fact that the latest wave of falling confidence is originating largely from the United States, the dollar is being pressured across the board. This is unlike last autumn or winter when global erosion boosted the dollar against the high yielding currencies of Australia, New Zealand, Canada and UK.
The key question now is whether continuing declines on Wall Street coupled with the existing weakness in economic data will prompt the Federal Reserve to make the transition from telegraphing a no change in rates to being forced to ease later in the year. Surely, equities are at higher levels than they were in previous episodes, but the onset of the geopolitical risk is making the less tenable. The argument against renewed rate cuts is founded on the need to temper escalating inflation and to normalize interest rates, which are excessively low for the current environment in energy prices.
Next week’s Federal Open Market Committee (FOMC) decision is expected to keep rates unchanged at 2.00%, with a statement that would express deteriorating inflationary conditions and an alertness towards weakening in economic data. As long as the Fed continues to defy the economic and market conditions by focusing on increased inflation, markets will continue to respond negatively, to the extent of further eroding major equity indices and worsening the pricing of credit derivatives.
Yen crosses finally coming down
The yen rallies across the board as the combination of falling risk appetite coupled with the threat of an attack on Iran’s nuclear facilities is accelerating the flight from risk and into the yen and the franc. We mentioned in yesterday’s chart strategy the risk of renewed declines below 107.50. We stick with our target for subsequent losses at 107.30, followed by 106.75. Upside remains capped at 108.00, followed by 108.30.
Euro gains in USD woes
Euro exploits the broadening dollar losses, rallying above $1.56 for the first time in a week. We expect the gains to extend towards $1.5670 and remain near those levels as traders grow reluctant to closing any dollar shorts during the weekend, which could bring about further tough talk from Iran and Israel. Interestingly, traders will also focus on whether Sunday’s meeting between major oil producers and consumers will include any diplomatic resolutions to the Iran-Israel issue. Euro strength isn’t just a result of oil and geopolitics, but also emerging from that of dollar-centric flows amid the aforementioned market erosion. Support held at 1.5570, backed by 1.5520.
Aussie’s extends winning streak
Aussie rises for the sixth consecutive day against the greenback, posting its the longest winning streak since February, as gold prices rally and the escalating risks are perceived to be largely U.S.-centered. Nonetheless, a decline in U.S. stocks of more than 2% will likely temper the Aussie’s gains as was the case on Wednesday. We expect interim resistance at 0.9560, followed by 0.9595-00. Recall that the Aussie is 1¢ a way from its 24-year highs against the USD. Although Australian fundamentals have pointed to weakness as in retail sales and housing, employment remain robust and more importantly, price pressures continue to preoccupy the RBA. Support rises to 0.9510, backed by 0.9470.
Ashraf Laidi
Chief FX Strategist
CMC Markets US
a.laidi@cmcmarkets.com
