Euro surging on inflation fears

The single currency has found its wings following inflationary concerns expressed by two ECB members in what may yet become a re-run of the monetary tightening fears surrounding the U.S. in the fourth quarter. The return to a focus on economic fundamentals is a boon for the euro as ECB President Trichet deflects the burning sovereign debt issue, warning implicitly that interest rate medicine might yet be on the agenda sometime in 2011. The shift in emphasis from indebtedness to inflation is a clever and well-timed ploy.

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Euro – The euro rose this week by the most in two years driven by the threat of inflation. At the same time Mr. Trichet has tossed the ball back into the court of European politicians with a message that they should speed up the reengineering process surrounding the scope of the bailout package. The euro rallied to its best level against the dollar since December 14 and reached $1.3457. Subsequently the single currency has pared gains and settled back to $1.3346 ahead of a raft of U.S. data. Mr. Trichet yesterday said that the ECB had “never pre-committed not to move interest rates,” and has caused investors to suddenly fast-forward expectations of monetary tightening into this year rather than next.

U.S. Dollar – Investors face consumer price data on Friday, which could present a challenge for the dollar given the tame nature of the series. Expectations for the December reading shot up to 0.4% today, which in light of changing expectations for what the ECB might do could challenge the dollar later. Also on the agenda is retail sales data for December where analysts are looking for an unchanged 0.8% increase on the month. The dollar index has rebounded this morning to stand at 79.27 as the dollar makes gains against commodity dollars, the euro and the yen.

Aussie dollar – Thursday might have been a better day for the Aussie unit, but two pieces of Chinese news helped wreck a two-day rally. The Aussie trades towards its session low in New York buying 98.65 U.S. cents, although above its worst point of 98.04, in ongoing response to the Queensland flooding. Overnight the Peoples Bank of China announced a further 50 basis point increase in the amount of capital banks need to hold by lifting the reserve ratio requirement across the nation’s lenders. The ongoing move should help to dampen bankers’ ability to lend. In the China Securities Journal it was suggested that the authorities are considering fresh price control measures. Right now, Australia is looking inbound at the devastation caused by its floods. Economists are struggling to estimate the impact on growth from the catastrophe but it’s safe to say that the export-reliant nation needs restriction in overseas demand from its number one market like it needs a hole in its head.

British pound – The pound is little changed but trades marginally higher buying $1.5853 to end a week in which it rallied from a low point of $1.5475. The pound remained buoyant following some fairly ugly producer price data, which fits pretty well into the increasingly bearish picture exerting itself on trading patterns. If anything the data supports the call from some corners for the central bank to lift interest rates, yet on the other hand the data series is more volatile and certainly more elevated than consumer prices, which admittedly have remained above target and stickily so for the past nine months. The pound should remain supported by losses across the short sterling strip as more investors sense that borrowing costs and therefore the reward for holding the pound stays firm. The euro lost out to the pound and buys slightly less pennies at 84.26.

Canadian dollar – The challenge to risk this morning has caused a ditching of Canadian positions sending the local dollar down from $1.0110 U.S. cents to $1.0025 ahead of U.S. data. Equity indices around the world fell following a weakening in the U.S. initial claims for unemployment series. The sudden emphasis on inflation has served to undermine risk appetite and has investors worried over monetary tightening, which could dent growth. This is one of those hazardous speed bumps that investors have to deal with is the boost to yield from rising interest rates while simultaneously having to worry about the knock-on impact on growth.

Japanese yen – The dollar is facing a hard time recapturing ¥83.00 against the yen, although it is higher on the day. Demand for the yen remains firm in an increasingly hazardous economic landscape.

Andrew Wilkinson is a Senior Market Analyst at Interactive Brokers LLC

Note: The material presented in this commentary is provided for informational purposes only and is based upon information that is considered to be reliable. However, neither Interactive Brokers LLC nor its affiliates warrant its completeness, accuracy or adequacy and it should not be relied upon as such. Neither IB nor its affiliates are responsible for any errors or omissions or for results obtained from the use of this information. Past performance is not necessarily indicative of future results.

About the Author
Andrew Wilkinson

Andrew is a seasoned trader and commentator of global financial markets. He worked for several London-based banks trading cash and derivatives before moving to the U.S. to attend graduate school. Andrew re-joins Interactive Brokers following a two-year stretch at a major Wall Street broker-dealer as their Chief Economic Strategist. His coverage of stocks, options, futures, forex and bonds regularly surfaces in global media, and over the last several years Andrew has made many TV appearances on Bloomberg, BBC, CNBC and BNN and Yahoo Finance.

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