Forex Investment and Currency Trading

Euro/dollar took out 1.5850 option barriers in early Europe when Trichet warned that inflation would explode without decisive ECB action, but sellers knocked it back to 1.5830, recent upside resistance and now support.  Eurozone PPI posted a record 7.1% y/y gain in May, justifying Trichet hawkishness and solidifying expectations for a 25 bp ECB hike tomorrow, though Holger notes softening data suggest market expectation of more aggressive ECB tightening is overdone and too much tightening could exacerbate recession risk.  Still, US data continues to re-focus markets on US economic weakness and financial stress, underscored by yesterday’s disastrous vehicle sales report, a15 year low, and this morning’s weaker than expected ADP private sector hiring report(-79k), somewhat a predictor of non-farm payrolls; expectations for tomorrow’s NFP are -20k.  Hence Euro/dollar took a run higher here, posting a new 10 week high near 1.5870.  But with the Dow opening slightly higher (financial stocks steadying), Euro/dollar is back down  near what looks to be new equilibrium around 1.5850.  Also, DXY USD index is holding above support at 72.10-15 and with neither RSI nor Momentum making new lows there is scope for a bounce toward 73.00.  Other G10 currencies are steady to weaker, including yen (BoJ said to be ready to downgrade economic outlook) and GBP (data show consumption to slow sharply in 2H 2008 and savings rate lowest since 1959) .  Traders don’t seem ready to sell USD with abandon just yet. 
 
EM are mixed again - in Asia, USD/KRW and USD/INR both busting above recent central bank intervention levels but then settling back, while CNY continuing strong (market forecast USD/CNY year/end to 6.45); Latam - BRL stronger after another decent IP, continuing good trade, and new oil fields to be on-stream in late 2009, but the BRL data improvements should wane later this year. 
 
Forex Focus Synopsis:
As the US economy and Fed policy normalization gain momentum in 2009 the USD recovery is likely to develop in earnest, pushing EUR/USD below 1.40 into early 2010. Accordingly, some view EUR strength as in its final stages, setting up the potential to establish core short EUR positions on a likely final surge during the weeks ahead.

Emerging financial markets frequently track swings in advanced economy stocks. However, the close relationship between Emerging Market (EM) currencies and the S&P 500 broke in October 2007 with virtually no sign of repair since. In the second half of 2008, Emerging Market currency strategies will likely benefit from adhering to two main tenets: 1) pursuit of relative value and 2) timing the Fed’s need to normalize its monetary stance.

The latest JPY rebound probably does not represent a start of a new medium-term upward trend. The June BoJ Tankan signaled continued deterioration of the Japanese economy, supporting the expectation of no BoJ rate hike during 2008. Stable BoJ rate expectations should leave USD/JPY vulnerable to US factors and risk developments.

One more RBA rate hike from August to November is not likely to happen even if the July 23 2Q CPI data were to exceed expectations. However, the call is not entirely eliminated at this stage; nor has the AUD curve, which is still pricing in about a 50-50 chance of another hike this year.

The IMF reported on Monday its quarterly data on official foreign exchange reserves. The central banks that report the composition of FX reserves do not seem to have been shying away from USD-denominated assets over the last year. In fact, after adjusting for the changes in exchange rates, the USD actually enjoys a slightly higher share of all foreign official FX reserves when compared to 1Q 2000.

There is a significant risk that the Riksbank will hike by 25 bps to 4.50% on Thursday in order to combat the ever rising levels of inflationary pressure. A hike, combined with a hawkish statement underscoring the Riksbank’s worry about higher inflationary pressures, would support SEK, but gains would likely be concentrated vs. USD instead of EUR, as EUR/SEK continues to be supported by the declines in the Swedish stock market.

While market sees limited risk of a snap election in India, higher global oil prices and a weaker-than-expected current account print will likely continue to unsettle the market in the near term.  Notwithstanding RBI’s recent inter-meeting policy moves that signaled its resolve to cap a further rise in USD/INR, the rupee will likely come under increasing pressure following the breach of the psychologically and technically important 43.00 level.

The forint used to be the whipping boy among the CE4 currencies but the HUF is a whipping boy no more, as fundamentals have much improved. Its recent strength is well-deserved, and while fiscal adjustment needs to continue and political risks remain, the constructive outlook is retained.

Fundamental factors in Mexico such as uncertain prospects for the US economy (Mexico’s major export destination), continued inflationary pressures, and deteriorating energy reform prospects would argue for a higher USD/MXN. However, markets’ growing perception that Banxico will have to tighten monetary policy again and therefore contribute to a wider MX-US interest rate differential could keep MXN on an appreciating trend.