by Darrell Jobman, Editor-in-Chief TraderPlanet
The dollar was initially little changed in Asian trading on Monday, but then weakened to test levels beyond 1.49 in early Europe. The dollar weakened to a seven-week low of 1.4910 against the Euro before recovering back to 1.4865 in New York.
With no US data releases, the dollar was again undermined by interest rate expectations. Following Fed Chairman Bernanke’s comments on interest rates last week, markets are expecting interest rates to be cut by 0.50% this month. There has also been increased speculation that the Fed will move to cut rates before the planned January 30 FOMC meeting. In this environment, the dollar has remained vulnerable to selling on yield grounds.
There has also been further unease over the US financial sector with a stream of US bank earnings due this week starting with Citigroup on Tuesday. Amid expectations of further debt write-downs, there was a further shift into more defensive currencies which tended to undermine the US currency.
The Euro gained some support from a high wage settlement in the German rail sector which will reinforce ECB unease over inflation trends. The Euro will gain further support on yield grounds, although there will be the threat of a further deterioration in confidence in the Euro-zone. There is also scope for increased protests over Euro strength with ECB member Bini-Smaghi stating that the dollar trend could limit the scope for Fed action on interest rates.
The dollar was unable to secure any recovery against the yen in Asian trading on Monday. Tokyo markets were closed which dampened activity and also curbed yen selling in relation to retail investment overseas.
Overall confidence in the global economy remains fragile and this will continue to fuel short-term demand for defensive currencies such as the Japanese yen. Risk aversion increased further in Europe and the yen strengthened sharply to test November highs beyond 107.50 before a retracement to 108.25 in US trading.
Comments on exchange rates by Japanese officials will be watched closely in the short term if the yen continues to strengthen as there will be fears over a negative impact on exports.
Sterling strengthened against the dollar in early Europe on Monday, but again failed to break above the key 1.9650 resistance level and weakened back towards 1.9550 later in US trading. The UK currency also weakened to fresh all-time lows against the Euro at 0.76.
Overall sentiment towards Sterling has continued to weaken with confidence further damaged by an increase in corporate profit warnings and expectations of a further economic slowdown.
UK producer prices rose 0.5% in December with the annual rate at a new 16-year high and there was a core monthly increase of 0.4%. The producer prices data will cause some Bank of England unease over inflation trends. These fears will intensify if there is a high CPI reading on Tuesday, although the most likely outcome is that there will be a mixed report.
Only a sharp increase in the core rate would be likely to trigger a significant shift in interest rate expectations and more durable short-term Sterling support.
The franc remained strong on Monday with a test of level beyond 1.6250 against the Euro. The Swiss currency also pushed to highs beyond 1.09 against the dollar before consolidation close to 1.0925 in New York.
Financial markets were again unsettled by uncertainties over US financial-market trends and the banking sector. In this environment, there was further demand for defensive currencies which supported the franc.
Hopes for an aggressive Fed stance on interest rates should still curb short-term franc demand to some extent.
The Australian dollar held around 0.8960 in local trading on Monday before pushing higher in early Europe. Domestically, a rise in inflation expectations provided support to the local currency with renewed speculation that the Australian central bank could increase interest rates in February.
Internationally, there was further support on wider US dollar vulnerability while gold prices were strong. There will still be fears over the global economic outlook which will create unease over the Australian currency, especially if Asian economies appear vulnerable. The Australian currency was holding just below 0.90 in New York.