by Darrell Jobman, Editor-in-Chief TraderPlanet.com
There were no significant US data releases during Wednesday with bond yields also little changed. The Philadelphia Fed survey will be watched on Thursday for further evidence on the industrial sector and a robust reading would revive optimism over a stronger US economy.
The global trends in carry trades will remain very important and higher risk tolerance levels will tend to weaken the dollar slightly in the short term. Any renewed stresses in global stock or bond markets would provide fresh dollar support.
The early release of the Euro-zone June PMI index is due on Thursday and a weak reading would reinforce speculation over a slowdown in the economy. This would also dampen market expectations of two further ECB interest rate increases.
The yen found some support close to 166.0 against the Euro and 123.60 against the dollar, but was still unable to make any significant progress as underlying sentiment remained weak.
The latest Japanese business investment survey was weaker than expected with a drop to -0.9 for the second quarter from +6.2 previously and this survey will undermine expectations over the Tankan survey which is due for release next week. The weaker than expected data will further undermine expectations over a near-term increase in official interest rates.
The Bank of Japan minutes from the May meeting continued to state that the bank would increase interest rates gradually. Yield considerations will remain negative for the yen in the short term and carry trades will, therefore, tend to remain the dominant short-term focus. Volatility levels are liable to increase in the short term given the overall positioning bias and global stock market retreats would support the yen.
Sterling strengthened after the Bank of England minutes on Wednesday and pushed to highs around 1.9940 against the dollar while the UK currency held firm against the Euro.
The Bank of England minutes from the June meeting recorded a 5-4 vote for unchanged interest rates. The minority wanted a further immediate increase in rates to curb inflationary pressure. The overall tone of the minutes was firm and will increase expectations that rates will be increased again at the July meeting rather than waiting until August. Expectations of an increase to 5.75% will provide short-term Sterling support, especially as the money supply and consumer lending data released at the same time today was also robust.
From a longer-term perspective, the overall economic risks are continuing to increase with a growing threat of a hard landing which would weaken Sterling sharply later in 2007. Any evidence of a significant slowdown in spending over the next two weeks would also unsettle the UK currency. A key fact is that further interest rate increases are already priced in which will limit the potential for aggressive Sterling buying even if selling pressure is contained.
Carry trades will remain very important in the short term with the UK currency benefiting from the inflow of funds into high-yield currencies. There will still be the risk of a sharp reversal in carry trades which would also undermine Sterling.
The Swiss franc found further support just weaker than 1.6650 against the Euro on Wednesday and strengthened back to near 1.66. The Swiss currency also edged stronger to highs near 1.2355 against the dollar.
Producer prices rose 0.9% in May with the annual inflation rate rising to 2.8% from 2.4% which will reinforce National Bank concerns over inflation trends. The bank will also be more sensitive to franc weakness given the inflationary implications of a weak franc.
In this context, there is the potential for more aggressive warnings over currency weakness from National Bank officials which will tend to curb aggressive franc selling, especially as interest rate expectations are liable to be revised up.
The Australian dollar has continued to edge stronger over the past 24 hours, supported by a continuing flow of funds into high-yield currencies. The Australian dollar pushed higher to 0.8475 in local trading on Wednesday before edging back to 0.8450 in US trade.
The domestic data has been limited with a firm release on housing starts offering small-scale support. Confidence in the Australian currency should remain firm in the short term, especially as US yields have stabilised, but there is a high risk that volatility levels will be higher given the risk that global stock market turbulence will return.