Forex Investment and Currency Trading

The dollar performed strongly again as further equity market weakness in the European session set the trend for FX markets once more. JPY also performed well, both at the expense of GBP and AUD. Note that the correlation between EUR/USD and the S&P is currently running at -88%, suggesting further downside is in store as US equity futures print sharply in negative territory. Today’s most important earnings reports will come from Ford and GE. So far 20% of the S&P 500 has reported, with EPS down some 30% versus a year ago. Roughly half of corporates are beating expectations, but given the dismal guidance and dividend cuts many are announcing in tandem, it is clear why equities are down and the funding currencies up. Next week may give a brief respite to risky markets since most key US financials will have reported.

Euro was weaker overnight as the equity markets continued to perform poorly. Euro area PMI was stronger than expected with manufacturing confidence rising to 34.5 and service sector PMI rising to 42.5. German Finance Minister Steinbrueck stated that a “bad bank” cannot be justified but the government is exploring ways around the issue. ECB’s Bini Smaghi said it would be risky and unjustified at present for the ECB to take interest rates close to zero. The reporting season for European financials is concentrated in the weeks of February 2 and 9, so should sustain weakness in the stock market and EUR/USD.

GBP was one of the main underperformers overnight as the concerns over the economy continued to drag the economy down. UK data was mixed, but confirmation that the UK is officially in recession has not helped sentiment towards GBP. Retail sales were stronger than expected, largely as a result of heavy discounting we continue to treat the numbers with caution as other indicators of high street activity remain very weak.

JPY continued to perform strongly as global equity markets continued their sell-off. November all sector activity index was broadly in line with consensus at -2.3%. Finance Minister Nakagawa said they will closely monitor FX and stock markets and take appropriate steps as needed, signaling that he has growing concern over the strength of the currency. However, if Japan were to interfere, it would rather do it in tandem with other central banks, which at this point makes it less likely.

AUD and NZD continued to sell-off along with the equity markets. With a series of weak figures from Asian economies, Australia’s dominant export partners, analysts now expect a 100bp cut to 3.25% next month. Former Governor Bernie Fraser says RBA may cut rates below 2%. The weakness in Asia as well as the policy outlook will not help the AUD and NZD. Continued weakness is likely today as the equities point to negative territory.

CAD fell overnight as its counterpart USD gained versus most of the major currencies on the back of increased risk aversion and equity market sell-offs. Although up from the recent $30 levels, oil and other commodities are also showing weakness, which is a drag on CAD.

The Brazilian real opened weaker against the dollar this morning as the international financial climate darkened and traders sought safe havens. Traders pulled back from positions in Brazil and other riskier investment amid the steady stream of negative news on the global economy. The tone was set from news that Microsoft Corp was unexpectedly badly hurt by the slowdown, posting an 11% drop in fourth quarter profits, and the UK officially fell into recession in the fourth quarter. Meanwhile, the Brazilian Central Bank’s surprise decision to cut the benchmark Selic rate by 1.00% to 12.75% earlier this week signaled a series of more aggressive than expected rate cuts in 2009. Deeper rate cuts will make the Brazilian real less attractive as a carry trade option. Mexico’s peso also weakened sharply as worries about the impact of the global downturn on companies drove equity markets down worldwide, knocking down emerging market currencies.