IB FX View
Currency direction up in the air

Wednesday May 6, 2009

The outcome to the stress testing process was an early factor in governing the direction of the dollar as a media story circulated stating that Bank of America might need to raise $34 billion in capital. The fear subsided shortly after, however, as the ADP employment report predicted a smaller than anticipated number of private U.S. job losses for April. The euro is trading either side of unchanged and currently stands at $1.3310 as stocks continue to rally on hopes that Friday’s official non-farm payroll report will come in lower than forecast and hasten the economic healing process.

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The ADP report arrives two days prior to the government report and covers only private sector job movements. It doesn’t have a particularly good track record of predicting the official out turn and doesn’t include changes in government job hiring, which also picked up in April. Today’s 491,000 job less reading records an improved tone to the labor market and provokes discussion as to whether the current 8.9% unemployment rate will reach a double-digit pace sometime in 2009. The BLS will report a 610,000 job loss on Friday according to current predictions.

Traders brushed off the earlier BoA story in which the bank is said to require a further $34 billion in capital beyond the stress testing report. The early morning story hurt commodity currencies, which again staged a later rebound. Today the IMF noted a reduction in Asian growth to include Japan, Australia and New Zealand. Following a 5.1% growth rate in 2008, the IMF dragged down its 2009 forecast for the region to 1.3% while calling for a 4.3% rate next year.

The local dollar is currently unchanged against the U.S. dollar at 74.25 cents after Australian retail sales grew unexpectedly sharply in the month through March at a 2.2% rate. Economists had predicted growth of just 0.5%. The trade surplus also widened to A$2.5 billion thanks to slowing imports but a pick up in the pace of Australian farm exports. Investors remain nervous about extending the recent break higher in the Aussie ahead of the official stress test results due Thursday.

The People’s Bank of China made ripples overnight with its latest quarterly monetary report. It warned against the longer term potential inflationary effects of quantitative easing in the aftermath of the financial meltdown. It said that “a policy mistake by some major central bank may bring inflation risk to the whole world.” It added that quantitative easing may lead to a high risk of a major currency being devalued. We guess the caged reference here is to the dollar and this logically follows March comments from Wen Jibao, the Chinese premier in reference to fears for the rather large hoard of some $744 billion, which the Chinese hold in U.S. treasury bonds and notes.

One has to wonder what the impact would be if the Chinese decided to side with a currency that didn’t adopt quantitative easing such as the euro. Imagine the ripple effect if China sold its dollar-denominated debt and piled into Eurozone government bonds. There would be all-round dollar weakness at the expense of a euro heading towards an all-time high. But the problem with that scenario is that, like Japan, Europe doesn’t need currency strength to heal what will be an anemic recovery if it can ever stop shrinking.

On Thursday the views of the 22-member ECB will be aired on the prospects for priming the Eurozone with printed money. The scope of opinions ranges from “do” to “don’t” and what we already know is that the ECB will not take that path until we have been told that monetary policy has been eased to the hilt. Yet discussions on where that low point will be remains clouded.

The British pound remained above $1.50 despite the ebb and flow of risk aversion stories. The CIPS/Markit survey showed a rise in the services index to 48.7 in April from 45.5 in March. That’s still contracting, but we guess that investors expect a resumption of service sector growth as soon as next month. Meanwhile the Nationwide Building Society revealed a strong rise in consumer confidence in its latest reading.

Andrew Wilkinson
Senior Market Analyst ibanalyst@interactivebrokers.com

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