Daily FX Strategy
NY Fed’s Empire Index plunges to -22.2 in March from -11.72 in February, versus expectations of -7.0.
The 9.15 am release of the US industrial production figures expected at -0.1% from 0.1% will steer short-term interest in the pair, especially if a decline of more than 0.2% is in the works.
Q4 current account deficit drops to $173 billion from $177.4 billion in Q3 as the decline of the dollar boosted the trade part of the imbalance. Yet our concern going forward, is with falling US equities, which have proven an increasingly important component in financing the widening trade gap.
Sunday evening’s announcements from JP Morgan to purchase Bear Stearns for $2 per share (compared to Friday’s close of $30.85) and the Fed’s 25-bp cut in the discount rate to 3.25% had caused a brief rally in the US dollar, which was followed by continued erosion across the board. The Fed’s announcement to triple the maximum maturity of discount window loans to 90 days and its $30 billion in funding of Bear Stearns less liquid assets not only indicated the grave situation posed to the counter party risk involved, but also highlights the increased ineffectiveness of the Fed’s historic liquidity injections yet to date.
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Despite these historic liquidity injections and the Fed’s historic weekend decision to cut interest rates, our expectations lean towards a 100-bp cut in the Fed funds rate to 2.00%, brining the short-term rate well below the level of inflation. As the Fed has stated, these massive injections of liquidity are aimed at maintaining the market fed funds rate from falling below the 3.00% benchmark target. This will leave the Fed no choice but to come up with a shock rate by as much 100 bps in its benchmark target tomorrow so as to ease the cost of loans among commercial banks and keep it at those low levels.
Lack of Coordinated Cenbank Intervention Highlights Negative USD Fundamentals
Despite jawboning from Japanese government officials addressing the sharp rise in the yen, The only meaningful interventionist remarks serving to slow the strengthening yen were those by Japan’s LDP policy chief Tanigaki indicating the need for international cooperation. Indeed, currency traders are unlikely to temper the yen buying unless there are signs, or intentions of coordinate central bank intervention to support the dollar and cap the yen against the major currencies. Continued statements by officials pointing out the undesirability of excess currency moves will therefore prove of no effect, unless the central banks demonstrate some type of joint effort. Nonetheless, considering the rapid loss of the dollar’s interest rate differential and the ensuing deterioration in US economic fundamentals, central banks are unlikely to commit billions of reserves in intervention that would only to be eroded by counter speculative pressures due to the fundamentally-driven nature of the current moves in foreign exchange markets.
In the event that the Fed cuts by 100-bps tomorrow, the US-Eurozone interest rate differential will drop to 2.00%, the biggest US interest rate deficit since November 2002. The interest rate differential story is not the only theme haunting the US dollar onwards. Fears of continued prolonged financial market erosion and debt writedowns extending the macroeconomic weakness to business and consumers will lead to a prolonged recession and further punishing the dollar’s fundamentals.
Gold’s Prolonged Strength Despite Crises Sends Message
Unlike in the market meltdowns of May 2006, February/March 2007, July/August 2007 and November 2007 when gold prices dropped significantly, gold strength remains at record highs. Aside from weakening fundamentals, the broadening liquidity injections from global central banks are contributing to gold’s push to new record high against the US dollar at $1,032 per ounce as well as record highs against all major currencies. There is, however, the possibility that significant declines in US equities will prompt funds to realize their gold gains to meet margin calls in their credit and equity books. In this case we’d expect sharp dollar gains versus GBP, AUD and NZD.
Canadian Dollar to Remain Broad Loser
In our Sunday evening note we mentioned the CAD to be the broad loser in the current market turmoil partly due to the resulting decline in oil from $111.76 high to $110.14 as the global economy comes under threat. The close relationship between the Canadian and US economies is also contributing economy to CAD’s losses. USDCAD seen regaining 0.9950 targetting 0.9980, with support standing at 0.9890 and 0.9850. CADJPY dropped beyond our 96.80 target to 96.40 before rebounding to 97.70. We expect renewed losses towards 97.20 and 96.50.
Sub-100 Yen is Here to Stay
Remarks from Japanese officials referring to the need for coordinated measures were the only source of temporary yen retreat. Barring any temporary corrective measures to as 97.30 and 97.60 yen, we expect USDJPY to find renewed losses towards 96.30 and 95.80. Our month-end forecast is now at 97, followed by 94 before end of Q2. Looking at a 13-year monthly chart of USDJPY, we note that the lows of 2005, 2000 and 1995 were all preceded by a rebound due to Fed rate hikes. Since rate hikes are currently out of the question, we should see further declines to as low as 90 by year end.
EURUSD Supported By ECB’s Silence
The lack of any meaningful interventionist remarks from the ECB underlines the euro’s strength. After hitting an all time high of $1.5904, EURUSD stands at 1.5775, finding support at 1.5720. We expect subsequent foundation at 1.5660. Resistance starts at 1.5840, but upside capped at 1.5880. The 9.15 am release of the US industrial production figures expected at -0.1% from 0.1% will steer short-term interest in the pair, especially if a decline of more than 0.2% is in the works.
EURCAD settles at 1.5645 after surpassing our 1.5715 target to 1.5805. We see renewed gains towards 1.5680, followed by 1.5730.
Sterling’s High Yield Catches Down with it
Sterling drops across the board as the high yielding currency is increasingly expected to lose its yield luster from the current crisis, which will hit an already weakening UK economy. GBP drops from $2.0228 to $1.9995, exceeding our Sunday evening target of $2.0070. The Bank of England’s decision to inject a special loan facility of GBP 3 billion was also responsible for the currency’s damage. GBPUSD faces renewed losses back to $2.0030, followed by key double bottom at $1.9980. We expect the foundation to be broken, calling up the $1.9955. Upside capped at 2.0080.
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Ashraf Laidi
CMC Markets Plc
http://www.cmcmarkets.com/usfx
Legal disclaimer and risk disclosure
Although obtained from sources believed by us to be reliable, CMC Markets and its affiliates cannot guarantee the accuracy or completeness of the information upon which this commentary is based. This commentary does not purport to disclose the risks or benefits or entering into particular transactions and should not be construed as advice in any specific instance.The views in this report constitute our judgement as of this date and are subject to change without notice.