by Darrell Jobman, Editor-in-Chief TraderPlanet.com
The dollar remained under pressure for much of Tuesday, but managed to secure a weak recovery to 1.3755 from lows around 1.3780.
US 10-year bond yields briefly weakened to below 5.0% on Tuesday before edging higher and the slight recovery in yields helped stem dollar selling pressure. Sub-prime mortgage unease persisted and there will be fears over US mortgage bond selling by overseas investors. Any distress selling in the sector would tend to put further downward pressure on the dollar unless confidence in the economy improves.
The dollar faces two important tests over the next 48 hours. The monthly trade report is a key structural data release and the headline deficit is liable to be inflated by high oil prices. Any increase in the underlying deficit would undermine dollar confidence, especially after a record Chinese trade surplus reported for June.
The US retail sales data will also be important given the increased fears that mortgage-related difficulties will have a wider impact in undermining consumer spending trends. A weak report would create fresh downward pressure on bond yields.
The ECB has maintained a tough stance over the past 24 hours with bank President Trichet, for example, stating that policy was still on the accommodative side. The ECB has also expressed no alarm over the Euro and there will be speculation that the tough stance is aimed at heading off any European political pressure for a pause in monetary tightening.
The yen pushed to high near 121.10 against the dollar, but was unable to hold the gains and weakened back to 122.10 in New York trade.
Risk aversion levels increased on greater fears over the US sub-prime sector and triggered a reversal in carry trades which pushed the yen stronger. There was still evidence of yen selling on rallies, especially after US stock prices recovered, but there was also evidence of increased demand for yen call options.
The Bank of Japan is likely to leave interest rates on hold at 0.5% on Thursday. The decision will also provide important evidence on the August decision. A split vote and firm comments from Bank Governor Fukui would increase expectations that the bank will increase rates in August. A unanimous vote and cautious remarks from Fukui would dampen expectations of a rate hike and tend to weaken the yen. The bank may be cautious over issuing a clear signal while markets remain in a turbulent phase.
The Japanese current account surplus increased to JPY2.13trn in May, 31% increase over the year. Although balanced by heavy capital outflows, the data llustrates the fact that any temporary reversal in capital account trends would result in strong yen gains.
Sterling continued to advance against the dollar on Tuesday with fresh 26-year peaks around 2.0360 while the UK currency also steadied against the Euro.
Bank of England member Gieve gave a generally more balanced view on interest rates than Sentance did yesterday. Gieve stated that previous rate increases wee starting to have some impact while it would be dangerous to raise rates too quickly given the delayed impact. He was also committed to a vigilant approach on inflation and, at this stage, markets will continue to price in further interest rate increases.
With markets searching for currencies with rising interest rates, Sterling will remain supported in the short term, but a sustained increase in risk aversion would still tend to undermine the currency. A reversal in rate expectations would also weaken Sterling sharply.
The Swiss currency pushed to highs around 1.20 against the dollar before a retreat to 1.2040 in US trade. The franc was also unable to hold levels close to 1.65 against the Euro.
The recovery in US stock prices tempered immediate demand for the Swiss franc after early strength. Nevertheless, the underlying credit stresses will continue to underpin the franc with robust Swiss fundamentals also providing important background support.
The Australian dollar pushed to highs near 0.8640 against the US dollar before edging lower in New York as the US currency attempted a fragile rally.
Domestic influences have remained limited with a small decline in consumer confidence not having a significant impact. The employment data will be watched closely on Thursday and a firm figure would reinforce expectations of higher interest rates late in 2007. Global flows have remained dominant and a sustained increase in risk aversion would tend to undermine the Australian dollar. Losses should be measured while confidence in the domestic economy remains intact.