U.S. dollar selling intensified across the board as the post-bailout hysteria subsided and questions remain on the details of what banks and credit institutions will be eligible for the purchase of bad debt and the ban on short selling. The dollar lost nearly one third of its two-and-a-half month rally against the euro and the pound. Euro breaches above the key $1.46 figure, oil regains the $106 per barrel and gold hits $885 per ounce.
Despite the deflationary repercussions of the sharp break in credit formation, from struggling banks and the deflationary implications of the increasingly weak macroeconomic dynamics of escalating joblessness and falling consumer demand, the required monetary policy response from the U.S. and overseas central banks will be an easing. That would prop up gold prices anew against the dollar and rest of major currencies. The rally in gold will be less pronounced, hence our long-held prediction of a rebound in the gold-oil ratio from its 5.8 lows in July to the current 8.4.
Risk appetite vs. dollar centric risks
Last week, the principal pulse of flows in currency markets swung from dollar-centric flows to risk-driven flows. Dollar-centric flows are mainly driven by overall buying/selling of U.S. dollars vs. the main currencies depending on the announcement from U.S. banks or government. Risk-driven flows are orders mainly dictated by shifts in risk appetite, i.e. buying/selling of low-yielding yen and Swiss francs vs. high yielding GBP, AUD and NZD. Often we saw a combination of both types of dynamics shaping the market activity, whereby the brunt of the moves was reflected in the USD/JPY exchange rate.
Today, these two types of order flows are overlapping as market activity is mainly shaped by USD driven flows as the U.S. currency hits two-week lows, while the yen and Swiss franc are struggling against European and antipodean currencies.
Euro eyes $1.47, IFO key
Markets may witness further euro advances this week on the release of what could be a stronger than expected IFO survey (due Wednesday) following the unanticipated rise in the August ZEW survey on investor sentiment. A weaker euro and falling oil prices shaped the optimistic responses in the survey. Tuesday’s release of the Euro zone services PMIs may not produce the same optimistic results but any signs of a bottoming in these figures could further propel the euro’s momentum, and solidify gold’s rally above the $900 mark. Technically, EUR/USD faces key resistance at $1.4705—38% retracement of $1.6030-1.3878 decline. Support has cropped up to $14540 and $1.4450.
Cable’s rally to subside at $1.85
Considering the stark negatives in UK fundamentals, the current strengthening in the GBP/USD rate is a vocal expression of deteriorating sentiment in the U.S. currency. Today’s $1.8477 high marks the 38% retracement of the decline from the July 15 high, but markets are likely to probe $1.85, which is the low during the week of Aug. 22. We reiterate that GBP remains our favorite choice for USD-bullish trades emerging from the next dose of U.S. government interventions. The next batch of negative UK data on the manufacturing, services, and employment fronts will also offer plenty of opportunities for GBP downside.
USD/JPY seeks 105 despite stabilizing conditions
Although stabilizing market conditions may have dragged yen against the European and antipodean currencies, yen strength is re-established against the USD, dragging the currency from 107 to 105.80. The lower highs formations suggest 105.50 and 105.20 to be the next key targets, whether via renewed risk aversion or overall USD-selling that is propped by gold gains. This week’s Congressional testimonies by Bernanke and Paulson may affirm the authorities’ control of struggling credit institutions but will also highlight the negative implications for private demand and rising unemployment.
Ashraf Laidi
CMC Markets UK
