by Darrell Jobman, Editor-in-Chief TraderPlanet.com
The dollar found support weaker than the 1.4650 level in Asian trading on Wednesday and strengthened to highs near 1.4510. The correlation with stock markets remained strong and the dollar gained ground when equity prices came under pressure. As Wall Street rallied, defensive demand for the US currency eased with losses back to near 1.4630 against the Euro.
There were no significant data releases which allowed markets to speculate over the economic risks. Pessimism remained the dominant force with futures markets pricing in at least a further 0.50% cut in interest rates by the Fed next week. In this environment of fear, there has again been some reward for currencies where central banks are being seen as proactive in supporting growth. The dollar will still be at risk on yield grounds and the housing data will be monitored closely on Thursday.
The January Euro-zone PMI data was mixed as there was a small improvement in the manufacturing index while the services-sector index fell to 52.0 from 53.1 previously. The net impact will be to maintain expectations of a sharp slowdown in the economy which will increase pressure for the ECB to take action.
ECB President Trichet also stated that the bank must be prepared to deal with a crisis situation which will reinforce market expectations of a shift in the central bank’s policies within the next few weeks.
The dollar pushed to highs above 107.0 against the yen in Asian trading on Wednesday, but then weakened sharply. The dollar tested fresh 30-month lows at 105.0 against the yen as stock markets came under pressure.
Despite Tuesday’s Federal Reserve interest rate cut, markets are increasingly uneasy over the global growth outlook and there is still major caution over carry trades. This combination will continue to provide some important yen protection in the short term.
This will become even more significant if equity markets start to deteriorate again as this would increase the persistent threat of capital repatriation back to Japan. Volatility levels will remain high in the short term and the comments from Japanese officials will continue to be monitored very closely. A firm rally on Wall Street pushed the yen down to 106.45 later in US trade.
Sterling was unable to make any significant headway against the Euro on Wednesday and dipped to lows around 1.9465 against the dollar. Sterling moves are still being influenced strongly by carry trades and a Wall Street rally pushed the UK currency back above 1.9550.
The MPC minutes from January’s meeting recorded an 8-1 vote for interest rates to be left on hold at 5.50% with Blanchflower voting for a cut. The minutes stated that the inflation outlook had deteriorated while the markets had already effectively eased policy. The bank was looking to the February inflation report to offer further guidance on inflation trends.
Despite the inflation warnings, there is a strong probability that the bank will cut rates in February, but markets will be concerned that the bank will not be able to cut fast enough to prevent a serious deterioration in the economy.
Elsewhere, there was a 0.6% increase in fourth-quarter GDP compared with expectations of a 0.5% increase. Sterling drew some immediate support from the data, but overall confidence is likely to remain very fragile.
The franc remained strong on Wednesday with sharp gains to 15-month highs near 1.5830 against the Euro while the Swiss currency also tested levels beyond 1.09 against the dollar.
Franc moves remained dominated by levels of risk aversion and the currency advanced strongly as stock markets were subjected to further selling pressure. As Wall Street attempted to rally, the franc eased from its strongest levels, but retained a generally firm tone which suggests that underlying demand for the currency is still strong.
The Australian currency was unable to sustain a move above the 0.87 level in local trading on Wednesday . Domestically, the headline inflation rate was slightly below expectations at 0.9%, but the underlying increase of 1.0% pushed the annual increase to 3.4% which was a 16-year high. There will be further speculation that the Reserve Bank will consider an increase in interest rates, although they will have major reservations given the current global environment.
The underlying tone of risk aversion will also tend to unsettle the local currency and renewed downward pressure on global stock markets pushed the currency to lows near 0.86 before a recovery to 0.8720. Trading conditions will remain choppy in the short term.