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Monday July 21, 2008 - 15:07:55 GMT
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CMC Markets' FX Strategy - July 21, 2008

Yen weakness dominates in another day of stabilizing risk appetite as smaller than expected losses from Bank of America and lack of negative news on the corporate/banking front pave the way for broad yen selling against the majors. EURJPY has surged to new record high of 169.89, mainly reflecting overall yen selling rather than absolute euro strength. Euro trades near its session lows against USD and GBP at $1.5834 and 0.7940. Considering our expectations for looming yen strength and the likelihood for another disappointing IFO survey on German business sentiment this Thursday, the prospects for sharp pullbacks in EURJPY remains elevated. A preferred yen cross would be AUDJPY, which has surged to 104.50, but is well below the 107.86 record highs attained in November.

The bulk of the trading week will be dominated by US corporate earnings before new and existing home sales are released on Thursday and Friday. The impact of earnings on the dollar has manifested itself through short-term but notable market moves, especially during the lack of a important economic data. With US stock indices down more than 20% off their highs, further downside in US equities could weigh on foreign inflows of US securities. The importance of equities is underlined by the fact that they were the only asset class to have consistently drawn increasing net flows from abroad between 2005 and 2007, providing 25% of total net flows. Foreign purchases of bonds of US agencies such as Fannie and Freddie fell from 44% of total net flows in 2006 to 35% in 2007. Foreigners are expected to further scale down their purchases of Agency securities given the troubles with Fannie and Feddie but will they continue to move into equities given the current erosion.

At 10 am EST is the US Leading Indicators Index expected to have fallen 0.1% in June after a 0.1% increase in May. 7 of the 10 indicators making comprising the index are already known, with the other being estimates.

USDJPY Capped at 107.30

The aforementioned yen weakness and smaller than expected loss by Bank of America are boosting USDJPY. The possibility of stronger than expected earnings from Apple later today may further weigh on the Japanese currency. We maintain our alert for later in the week and remainder of the month pertaining to the yen pairs as we see prolonged economic risks and financial market dislocation further dragging global equities. On the upside, USDJPY is likely to eke out gains to no more than 107.30. A print above 107.60 could pave the way for 108.30. 106.60 and 106.20 are seen as interim levels of support.

Euro to Remain Weak Ahead of IFO

Less than 3 days after those remarks from ECB president Trichet affirming his forecast for a growth contraction in Q2 and Q3, EURUSD remains hesitant well below $1.59, drifting at 1.5844. The lack of any convincing rebound in oil prices in light of low level diplomatic talks between the US and Iran is also helping to cap the euro. Further euro weakness is seen ahead of Thursday’s much anticipated IFO survey on German business sentiment. The medium term price action remains in consolidation, with interim support standing at the trend line support of $1.5820 trend, followed by $1.5780. Key foundation stands at $1.5740. Fading resistance starts at 1.5920 and onto 1.5870.

Sterling Dragged by More from Blanchflower

Sterling is down against most currencies by renewed warnings from Bank of England Monetary Policy Committee member David Blanchflower calling for a recession in the UK. In an interview with the Guardian newspaper, Mr. Blanchflower said the U.K. economy is probably already in a recession and is likely to contract for 3 to 4 quarters. Mr. Blanchflower, known for being the most dovish MPC member, has consistently called for a rate cut this year, and voted for 50-bp cuts in the April and February meetings. Blanchflower also reminded that the UK has not had a stimulus package as in the US, despite interest rates standing at 5.00%, more than twice those in the US. On Friday, the UK Treasury hinted it would relax its fiscal financing. Despite inflation being at 3.3%, we expect the BoE along with the Fed to be forced to resume easing monetary policy, as the downside risks to the economy begin i) impose the bigger risks and ii) cap inflation. Cable’s downside stands at 1.9870, followed by 1.9820. Renewed losses seen against AUD and JPY.


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