EUR USD (1.2730) Given the almost one-way, 7.5 percent rally that the euro
underwent from mid-April to mid-May, the exceptionally narrow range that it
delivered in the last two weeks is remarkable – especially as most of it was
contained between $1.27 and $1.29. Market participants were also surprisingly
relaxed with the development. Consequently, it ticked up on each data that hinted at
slowing US growth and fell back on any release that suggested that inflation had not
been tamed. It was almost as if traders believed that one cancelled out the other:
an economic slowdown would produce the desired brake on inflation and remove
the necessity for the Fed to tighten further. Unfortunately, there is absolutely no
reason why this should be the case and it is unlikely that the Fed sees things this
way. Recently the St Louis governor, Poole, had to dispel this very misconception –
and not for the first time. It is regrettable that the Fed might be forced to tighten, in
response to an uncomfortably high core inflation rate, at a time when the economy
is already showing signs of slowing and while many of the rate hikes already
undertaken have yet to take effect. But that is all that it is: regrettable. There are
many factors that make the next rate decision difficult, but the fear of having to cut
rates again sometime down the road is probably not one of them.
None of this is particularly encouraging for the dollar. Interest rates are still
rising in both the US and the EU, but according to the respective central bank
chiefs, growth in the two areas are on opposite sides of the peak. This observation
did not seem to interest medium-term traders last month, however. They were in
possession of satisfactory explanations for the prior rally: the Bush administration
favours a weaker dollar; Bernanke is weak, Snow is a lame duck; ‘there is no
financial leadership in America’ said one despairing analyst. So comfortable were
they with the higher price for the euro that a two percent correction was enough to
get medium-term traders, who had missed the entire upswing, to consider it cheap
enough to buy, and a return to peak, reason enough to take profits. Thus, currently,
their euro-exposure is again at the lowest level in over 18-months. Nobody fears
higher prices so this remains the side that pre-occupies us the most. We hold out
little hope of seeing prices much below last months lows, whilst our bullish
expectations extend all the way up to 1.3310.
Tanagaki and Adams
play ‘G7 ping-pong’
USD JPY (114.30) With speculation rife about the proximity of a Japanese rate
hike, the arguments for holding long dollar positions were not easy to find last
month. Initially, the Japanese finance minister’s interpretation of the G7
communiqué, which he discarded as not being a call for dollar weakness sounded
plausible. But soon afterwards, when US Treasury official, Adams, interpreted it as
the US actually favouring a weakening dollar, the finance minister Tanigaki’s
subsequent retort that his US counterpart had assured him that the strong dollar
policy was still intact, sounded hollow. It was too probably late anyway. When
market participants start hoping for BOJ intervention, a capitulation is never too far
away. Within a week, the dollar had sold off to an eight-month low near ¥109 amidst
speculation that a hedge fund was in trouble. This was easily enough for the
attainment of our downside target. Another issue that traders had to grapple with
was the possibility of China being labelled a currency manipulator. Coincidentally,
the US Treasury’s decision not to ‘name and shame’ came almost to the day that
China overtook Japan as the world’s biggest holder of forex reserves. The news
itself was no market mover, but it was then that the fate of the now outgoing
Treasury Secretary, Snow, was visibly sealed; traders lumped him together with
equally unloved Fed chief, Ben Bernanke. More dollar-bearish news came
thereafter, notably the surge in Japanese 10-year yields beyond the two percent
barrier for the first time in seven years, but the dollar moved no lower. This suggests
that at least some long-term demand was present. A couple of weeks of sideways
trading sufficed, thereafter, to get the speculative crowd interested in the upside
once again. Given this configuration, it is difficult to imagine price rises beyond the
115.55/116.45 supply zone. From there, or at the latest below 111.35, one must
prepare for new lows again.
Multi-year high suits
neither traders nor
policymakers
EUR JPY (145.50) For the cross to get back on its feet, we were looking for it
to clear the 144.50 level in our last report. Having seen it top out dramatically earlier
in May, we thought it unlikely that traders would want to buy it close to the peak. We
suspect that they opted for top-picking. ECB member, Noyer, also aired what was
undoubtedly the wider G7 view that a change in the euro rate is not seen as part of
the solution to global current account imbalances. Thus the current development –
the cross at its highest level since the introduction of the euro – suits neither traders
nor policymakers. It is therefore with intrigue that we adhere to the bullish view for
an objective at 147.50. But we keep the risk-limit near at hand: 144.00.
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