Forex Investment and Currency Trading

Investor confidence in economic recovery has been buttressed as global PMI data thus far surprise to the upside in both EM and developed markets. Consequently currencies perceived to have a high sensitivity to the global cycle have outperformed. The high beta group includes EM and commodity linked currencies plus GBP. Sterling joins this group due to the large financial services sector and also the concentration of commodity plays in the FTSE. With capital being drawn out of defensive US markets and into EM and commodity plays the USD is under pressure. The change in environment is also leading to a higher level of concern with regard to the risks US policymakers have taken with longterm inflation and fiscal solvency to deal with the crisis. Reserve manager selling is another notable USD negative influence. Strong capital inflows into emerging markets are now being met with intervention to stem the rate of appreciation in local currency. The fresh reserves accumulated as a result are largely USD denominated, necessitating rebalancing sales of USD for other G10 currencies as part of the portfolio management process.

EUR-USD has now broken above the 50% retracement of the move down from the all-time high at $1.6038 reached in July 2008 to the $1.2330 low recorded in October 2008. Reflecting this, the DXY USD index remains on course to test the lows reached late last year – currently around 1.5% away. With oil prices breaking higher in anticipation of strengthening Chinese demand the CAD is the second best performing G10 currency over the last week, behind the NZD and just ahead of the AUD. Technically the upward trend in USD-CAD extending from the November 2007 all-time low of C$0.9058 has given way, exposing a test of the C$1.04 area. Such an eventuality is contingent on a continuation of the recent rise in risk appetite. The principal risk to short USD-CAD positions is the possibility of a negative surprise from the BOC this week. Some find it hard to believe that the BoC will want to see CAD continue to appreciate at its current pace, given the importance of trade in the overall economy and the particular importance of the US in the outlook. There is therefore a risk that policymakers try to at least temper CAD strength through rhetoric later this week

This afternoon’s US ISM survey will be important but it is difficult to envisage USD positive outcome. A strong print would further boost risk appetite, drawing capital away from US markets. A weak number would probably be viewed as evidence the US economy is being left behind in the China led upswing. Weak growth in the US could also fan fiscal sustainability concerns.