by Darrell Jobman, Editor-in-Chief TraderPlanet.com
The dollar again challenged 1.37 against the Euro on Thursday, but was unable to sustain a brief break through this level and weakened sharply back to lows around 1.3770 in US trading before settling around 1.3740 in choppy trading.
The sharp increase in global risk aversion during Thursday had an important market impact. Sharp losses in US stock markets were compounded by increased emerging-market concerns after heavy losses in Argentina’s markets. The increase in risk aversion provided some dollar support on a shift into the liquid US markets, but the impact was offset by persistent concerns over the US sub-prime difficulties.
US new home sales data was weaker than expected with a drop to 834,000 in June from 893,000 the previous month. Inventories and prices held broadly stable over the month, but the sales drop will reinforce concerns over a prolonged downturn in the housing sector.
The durable goods data was disappointing with the June monthly increase held to 1.4% while there was a 0.5% underlying decline. The labour-market data was firmer, however, with jobless claims remaining at a low level of 301,000 in the latest week.
The German IFO index weakened to 106.4 in July from 107.0 in June with evidence of a slowdown in the retail sector and this will reinforce expectations of a gradual slowdown in the German economy.
The dollar was unable to hold above the 120.0 level against the yen on Thursday and the Japanese currency subsequently gained strongly to 118.50 with sharp gains against the Euro.
Fears over sub-prime difficulties spread outside the US on Thursday and this triggered a sharp reduction in carry trade positions with the move amplified by stop-loss selling. 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.
The latest weekly capital account recorded a net drop in funds invested overseas by Japanese investors and illustrates the fact that increased investor caution is strengthening the short-term capital account position.There remains some risk of heavy capital repatriation which could result in substantial yen gains.
Bank of Japan member Noda stated that the bank needs to be convinced over economic and pricing conditions before considering a rise in interest rates and there be uncertainty over an August rate increase if there is a weak consumer prices report.
Sterling weakened to lows around 2.0425 against the dollar on Thursday and was unable to sustain a renewed push above the 2.05 level in choppy trading. Sterling was undermined by a reduction in carry trades funded through the yen, although the UK currency proved more resilient that the Australian and New Zealand dollars.
The Nationwide Bank reported that house prices rose 0.1% in July, the slowest increase for 2007, with the annual increase slowing to 9.9% from 10.6% previously. There was also a slowdown in mortgage approvals for June with an annual drop of over 10%. Overall lending was still firm, but this primarily reflected increase re-mortgaging activity.
The forthcoming UK housing data will continue to be watched closely for further evidence with Sterling vulnerable if there is evidence of a sustained slowdown.
After failing to secure much benefit from rising risk aversion on Wednesday, the Swiss franc gained strongly on Thursday. The Swiss currency strengthened to 1.2020 against the dollar and 1.6530 against the Euro.
Global stock markets fell sharply which helped trigger safe-haven flows into the Swiss currency, especially as underlying risk aversion levels also increased.
The Swiss currency will gain further support if there is a sustained reduction in global credit supply and liquidity.
The KOF leading index will be watched closely on Friday and a figure above the 2.10 level would reinforce confidence in the domestic economy. Global risk tolerances and credit considerations are still liable to be the dominant short-term factors.
The Australian dollar held close to the 0.8850 level in local trading on Thursday and in early Europe, but then dipped sharply to lows around 0.8710 in US trading. The Australian currency was undermined by a global drop in equity prices and rising risk aversion levels which prompted a sharp reduction in carry trades.
Reports of losses at two Australian hedge funds, coupled with a drop in bond issuance, also undermined the Australian currency on fears over lower capital inflows, especially from Japan. Overall volatility levels are liable to remain higher in the short term.