by Darrell Jobman, Editor-in-Chief TraderPlanet.com
The dollar was able to resist a further challenge on the 1.3850 level against the Euro in early Europe on Wednesday and strengthened sharply to highs around 1.37. The US currency gained support from a technical adjustment after recent sharp losses as well as Euro selling on the crosses.
The US housing data remained generally weak with existing home sales falling 3.8% in June to an annual rate of 5.75mn, the lowest annual rate since November 2002. Inventories were little changed while prices held firm over the month, but concerns over the sector will persist. The new home sales data will be watched closely on Thursday, especially as there will be an important impact on market confidence towards house-builders.
Most Fed districts reported moderate growth in the latest Beige Book despite further weakness in residential construction while there were on-going cost pressures and a firm labour market. The report, overall, will encourage the Fed to stay on hold in the short term.
Overall risk tolerances have continued to decline while credit concerns have persisted following the postponement of a US$12bn loan deal from Chrysler. Any repatriation of capital from emerging markets triggered by increased risk aversion would tend to support the dollar, especially given strong US market liquidity.
The US Sub-prime fears will continue, but there is also likely to be increased fears that financial institutions outside the US will also suffer and this will create some net dollar support with Euro confidence liable to be eroded. Sentiment will also deteriorate if the German IFO index weakens on Thursday.
The Japanese currency gained further support from an increase in risk aversion during Wednesday. The yen pushed to highs of 119.85 against the dollar before retreating to 120.40. The yen strengthened strongly against the Euro, but was unable to sustain an advance through 165.0.
Overall risk aversion increased during Wednesday with continuing fears over sub-prime difficulties. A tightening of global lending standards and reduction in credit supply will cut securities issuance and will also tend to reduce the flow of Japanese funds into bonds which will strengthen the capital account. There remains some risk of heavy capital repatriation which could result in substantial yen gains.
An increase in the trade surplus of over 50% in the year to June to JPY1.23trn illustrated the Japanese fundamental strength with robust export growth.
Sterling was unable to hold above the 2.06 level against the dollar on Wednesday and weakened to lows below 2.05 before stabilising. Sterling held firm against the Euro with gains to 0.6680.
There will be further pressure to curb aggressive Sterling positions funded through the yen and this will tend to undermine the UK currency, especially if wider risk aversion levels continue to increase. In the very short term, these pressures may be offset by optimism over merger-related capital inflows.
There is also likely to be increased speculation that the UK economy is slowing sufficiently to ease pressure for a further short-term increase in interest rates. Given that markets have priced in an increase in rates to at least 6.0%, Sterling will remain vulnerable to significant selling on any downgrading of interest rate expectations. The forthcoming UK housing data will be watched closely for further evidence.
The Swiss currency weakened to lows near 1.2160 against the dollar on Wednesday before recovering back to 1.2140. The franc also struggled to make any impression against the Euro despite a recovery from lows.
The franc gained some relief in US trading after news that Chrysler had postponed a US$12bn loan deal as this increased fears over a sustained tightening in global credit conditions.
The overall elevation in risk aversion levels should offer important protection to the Swiss currency even though the franc has not been able to make any gains over the past 24 hours.
The Australian dollar weakened to lows near 0.8790 in early Asia on Wednesday as risk aversion levels increased, but the currency regained ground after the higher than expected inflation data. Consumer prices rose 1.2% in the second quarter which was above expectations even though the year-on-year rate dipped to 2.1% from 2.4%. Core prices rose 0.9% to give an annual increase of 2.7%.
The higher inflation data will increase speculation over a further Reserve Bank monetary tightening, although the bank has suggested that it will be patient in the short term. The Australian currency will be hampered by a general increase in risk aversion and failed to hold above the 0.8850 level.