IB FX View

Euro starts to lose its friends

Monday August 10, 2009

We’ve noted for some time that the wall of money being thrown at the U.S. economy in a heroic effort to revive a critical patient towers above the efforts of any other central bank or government. In that vein the dollar has been the ultimate safety net and had remained strong, which means that onset of economic recovery would cast the spotlight on the mess left behind in terms of massive deficit. This would work in favor of the euro where its management team has cast derision on global recovery efforts. The euro’s decline following Friday’s non-farm payroll report, marking very positive news for the U.S. economy, was partially caused by the abandonment of a bullish call on the euro by Goldman Sachs. Such loss of friends for the euro could spell a move down to $1.33 before the summer is over.


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The big mover to commence this week’s trading was the Japanese yen, which gained plenty of ground. It rose against the euro to ¥137.80 off ¥138.75 on Friday while it also pushed back against a strengthening dollar at ¥97.30.

The Japanese current account doubled last month while machinery orders rose at a 9.7% pace in July signaling a first gain in four months and is consistent with the global manufacturing rebound. It feels less reasonable to report a rally in the value of the yen these days predicated on risk aversion, yet we find that traders continue to play the currency markets with that attitude at present. The yen’s rise accompanies a decline for the Dow Jones Euro Stoxx 600 index, which last week achieved its highest valuation relative to earnings for six years. That’s tempting for some investors to take profits while for other asset classes such a reversal of fortunes creates room for carry-trade reversal positioning.

U.S. interest rate futures fell sharply in price last week following the 247,000 job losses announced in Friday’s employment report for July. Yields rose and market sentiment is clearly shifting back towards thoughts of when the Federal Reserve might start to raise policy. The monetary futures market currently implies a 59% chance that the FOMC might nudge interest rates higher by one quarter of one percent at its January meeting. As  this move has played out recently, the yield advantage on holding German bunds has reversed in favor of U.S. treasuries. This in part supports the dollar rather than the euro and is another clear sign that investors increasingly view the dollar economy as being at the vanguard of recovery.

Elsewhere the British pound also continued to tumble against the dollar to $1.6571 and we note it’s almost six pennies cheaper than just one week ago. The turn in sentiment follows a weekend during which investors have dissected the actions of the Bank of England, which on Thursday voted to extend and expand its asset purchase program to continue resuscitating the economy. Analysts are now scratching their heads as to what the Bank knows that they don’t. Most signs show a turning economy and as such the expectation was that the Bank would stand pat and simply watch its efforts. Some are now thinking that the economy isn’t as healthy as was first thought.

With equity markets just a little lower at the opening the easier trade is to push on the commodity pairs. The Aussie continues to rally this morning, although not by much. Currently it stands at 83.75 U.S. cents while the Canadian is weaker at 91.62 pennies.

Investors are rethinking the prospects for the Mexican peso after Friday’s employment report. Since Mexico exports 80% of its output to the United States, good news in the U.S. is good news for Mexico. Its peso rose to a three month high against the dollar and was compounded by a positive affirmation from Moody’s on its country rating standing.

Andrew Wilkinson                                                                    

Senior Market Analyst                                                               ibanalyst@interactivebrokers.com       

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