by Darrell Jobman, Editor-in-Chief TraderPlanet.com
The Euro found support above the 1.36 level against the dollar on Monday and strengthened to highs around 1.3700 in cautious US trading as markets assessed wider asset-price stresses.
The further increase in European credit default risk was a negative Euro factor, especially as IKB Deutsche Industriebank warned over sub-prime losses. The dollar failed to gain strong benefit given fears over the US economic outlook while the recovery on Wall Street also curbed safe-haven dollar buying. The US currency should still gain some net backing from higher risk aversion as US institutions cut back on aggressive overseas asset holdings.
The US inflation data will be watched closely on Tuesday as a benign reading for the core PCE prices index would provide greater scope for the Federal Reserve to lower interest rates if growth conditions deteriorate. The Fed will still want a series of annual inflation rates below the 2.0% level before relaxing over inflation trends and will be looking to keep policy on hold for the next few months.
The yen strengthened to near the 118.0 level against the dollar in early Asian trading on Monday, but the US currency held support and strengthened back towards 119.0 in US trading.
Risk aversion levels will continue to be a very important short-term factor and underlying stresses are liable to remain at elevated levels. There is, however, the potential for some further near-term relief and a rally in global stock markets given the sharp downward pressure seen at the end of last week.
There will be further pressure for Japanese Prime Minster Abe to resign after the heavy Upper-House election defeat on Sunday and this will dampen expectations of an August Bank of Japan interest rate increase. The industrial production data was more encouraging with a 1.2% monthly increase for June after a disappointing run of data. The short-term political impact should be limited as market expectations over a rate increase have already dipped to near 50%.
Sterling weakened to a 7-week low against the yen on Monday before finding some relief as stock markets attempted to stabilise. Sterling also found support below 2.02 against the dollar with gains back towards 2.0250.
The latest Hometrack survey reported that prices were essentially static in July with the annual increase below 6.0%.
The consumer lending data for June was firmer than expected, but mortgage approvals fell in the year to June and the evidence suggests an underlying housing-sector slowdown.
The shadow MPC, which is a group of academics, voted 5-4 for unchanged interest rates and this will reinforce market expectations that the Bank of England is likely to retain a tightening policy bias. Inflation concerns will continue to be fuelled by concerns that flood damage will inflate food prices. The Bank will be reluctant to tighten policy on a one-off increase in prices, but will need to keep inflation expectations under control and could be forced to respond if prices do not moderate. Rates should be left on hold at this week’s policy meeting.
The ABN bank takeover battle will be watched closely in the short term as ABN has dropped support for the Barclays-led bid. Success for the rival RBS-led consortium would increase the risk of capital flows out of Sterling given the much higher cash component in the offer.
The franc strengthened to highs around 1.6415 against the Euro on Monday, but weakened back towards 1.6490 in US trade as Wall Street rallied. The Swiss currency was also unable to strengthen through the 1.20 level against the dollar.
The Swiss currency gained initial support from the increased credit default risk priced into markets, especially with concerns over European bank’s exposure to sub-prime difficulties.
Franc buying will continue to ease temporarily if global stock markets stabilise, but the underlying risks will continue to build as credit conditions tighten.
The Australian dollar continued to weaken in local trading on Monday with a low around 0.8480 below a recovery back above 0.85 in US trade. The trend in carry trades will remain a very important short-term influence with the Australian dollar vulnerable if there is any further deterioration in risk tolerances.
The Australian currency will be particularly vulnerable given that stock-market falls will also undermine confidence in global growth prospects and tend to weaken commodity prices. In this context, the Chinese monetary tightening will tend to undermine the Australian currency slightly.