Forex Investment and Currency Trading

Euro/dollar stretched past 1.4300 to a new 2009 high in London time on risk positives from Asian news - notably Australia’s higher than expected 1Q GDP report of +.4% growth vs -.2% expected - and on Asian equity gains.  But equities reversed course in Europe time, led by a .5% drop in the MSCI index of 23 developed countries, first drop in 5 days.  Russia’s equity index dropped 3.4% and analysts say the risk positive trade has gone too far.  Earlier, Sterling joined Euro and broke past 1.6600 after a solid upside surprise in UK May PMI services, 51.7 vs 49.5 expected, and the UK nationwide consumer confidence indicator rose 2 points to 53.  Eurozone May final services PMI was revised slightly higher to 44.8, now up for 5 straight months and signaling that 2Q EZ GDP should improve to -.4% q/q from 1Q -2.5% and the worst is over.  USD buying was triggered by individual reports from China, Japan, India, and South Korea that there’s no viable alternative to USD as a reserve currency, China noting its partnership with the US in its USTreasury holdings.  Euro/dollar dropped almost 2 cents.  FX strategists note the two phases of USD weakness:  first is driven by unwind of safe-haven USD longs in favor of currencies to benefit from global growth, a phase which is well under way; second is policy related, notably inflation worries and fiscal sustainability.  This phase seems likely to be muted since inflation indicative trades (10 year TIPS) are back to normal and the UST auction last week was successful, with CDS spreads on US government debt now back to pre-Lehman levels.  Bottom line:  USD can weaken more but not much.  Technicals suggest selling Eur at 1.4361.

USD has continued to weaken over the past few weeks, but the reason now appears to center on growing inflation concerns, rather than growth expectations. Interest rates are now rising while the USD is softening, but are not necessarily reflecting the expectation of a near-term “V-shaped” recovery. In contrast, the relationship between strengthening growth and equities with a lower dollar has petered out, with stocks changing little recently while USD dollar weakness stretches out, showing the shift in correlations in FX markets as the macroeconomic focus changes.

The upcoming week is exceptionally busy across the G10, with the heart of the US data calendar (ADP employment and payrolls) and a hat-trick of central banks on Thursday with the BOE, ECB and BOC. Economists do not expect anything major in the way of new initiatives to come out of those announcements. But one policymaking wild card some also consider is that the Fed likely does not want to see the USD falter significantly further and that foreign central banks do not want to see their currencies relentlessly strengthen. Such a move would dampen an already-weak outlook outside the US and potentially risk even more capital markets chaos if USD appeared to be heading toward a disorderly decline.