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Friday June 16, 2006 - 10:01:21 GMT
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Forex Market Update

Published: Jun. 16 2006, 06:19 GMT

USD goes weak as markets change sentiment - rate differentials fading out in importance

USD continues to see broad-based weakness with limited upside potential. With FED funds at 5.50% in August getting more and more priced in, the trajectory for rate support in USD is fading out.


MAJOR HEADLINES – PREVIOUS SESSION
• Norway Trade Balance (May) 30.6% vs. 33.5% exp.
• UK Retail Sales MoM (May) 0.5% vs. 0.5% exp.
• UK Retail Sales YoY (May) higher at 4.0% vs. 3.6% exp.
• EU Euro-Zone CPI MoM (May) 0.3% vs. 0.3% exp. and YoY 2.5% vs. 2.5% exp.
• EU Euro-Zone CPI Core YoY (May) lower at 1.3% vs. 1.5% exp.
• US Initial Jobless Claims lower at 295k vs. 320k exp
• US Empire Manufacturing (Jun) 29.0 vs. 11.0 exp
• US Net Foreign Security Purchases (Apr) $46.7b vs. $60.0b exp.
• US Industrial Production (May) -0.1% vs. 0.2% exp.
• US Capacity Utilization (May) 81.7% vs. 81.9% exp.
• UK Leading Indicators MoM (Apr) 0.6% prior 0.6%
• US Philadelphia Fed. (Jun) 13.1% vs. 11.0 exp
• NZ Manufacturing Activity (1Q) 1.0% prior 0.3%
• Swiss National Bank (SNB) raise rates 25bp
• Hungary’s Long-Term credit cut to BBB+ from A- by S&P
• US signal that it would not bloc efforts to create an Asian Currency Unit (ACU)
• BOJ Fukui repeats that the BoJ will hold down rate even after ending ZIRP

For the second straight session the USD saw broad-based weakness as the importance of FED rates hikes over structural imbalances lose its ability to support. The US Treasury reported total inflows into the US fell to one-year lows to just $46.7b. This lagging indicator was well below the consensus forecast of $60.0b and March inflows $70.4b. In addition, flows were insufficient to cover April’s $63.4b trade deficit. While these numbers were hardly a surprise given recent asset movement and data, it does highlight the change market sentiment away from supporting currencies in a tightening cycle. The inability for USD to find strength in the crosses is a telling sign to us that the trajectory of potential FED hikes over ECB, BoE and BoJ has reached its peak in supporting the USD.


THEMES TO WATCH – UPCOMING SESSION
• 07:00 Euro – Zone Industrial Production (Apr) MoM 0.4% exp. and YoY 3.2% exp.
• 12:30 US Current Account Balance (1Q) -$222.0b
• 13:45 U. of Michigan Confidence (Jun P) 79.0 exp.

REVERSAL OF FORTUNE
Normally, today’s economic releases in Euro-Zone and US would not warrant too much attention. However they might prove to be critical in defining Europe and US Friday's trading session and next few week's trading strategy. Last week the Euro-Zone showed mixed data in French factory production going lower, while German industrial production increased. Today’s release will be inline with expectations and provide the market with a sense of steady growth in the EU. In the US Current Account Balance will highlight the US’s unsustainable structural imbalances. Even while the deficit contracts as percentage of GDP to roughly 6.8% from record highs of 7.1%, recent risk aversion and instability in the USD will outweigh this minor positive. After seeing yesterday's Philly FED and the Empire Manufacturing it will be interesting to see what Michigan Confidence will bring to the table.
WEAK USD

The FX markets took a global step-back in yesterday’s session, in order to re-evaluate our current pricing environment. As we noted yesterday a rising theme has begun to re-emerge based on the underlying structural imbalances over interest rate differentials. With continued Fed hikes on the horizon, market sentiment has turned to discounting additional increases, fearing the FED is over shooting and sending the US and the global economy into recession. Anecdotal evidence comes from the lack of USD support as FED future’s implied probability increased from 40% to 54% for a move to 5.50%. This shift in market sentiment will place considerable pressure on USD strength. Traders should be looking for selling opportunities as the greenback weakeens.

STRONG EUR & GBP
The two biggest benefactors of USD weakness will be the GBP and EUR. Both countries have much healthier balance sheets, controlled positive growth and willingness & room to fight inflation without over tightening. Traders will be looking for any reason to buy, such as positive economic data or inflation fighting rhetoric from central bankers. In the short and medium term these currencies have the greatest upside potential against the USD.

CHINA
In response to the growing money supply that’s threatens China’s economic stability, it will 'fine tune liquidity' says Governor Zhou Xiaochuan. China posted an overall trade surplus in May of $13b (outpacing expectation by $1b) and a massive $201.6b trade surplus with the US for the first half of 2006. In addition, foreign direct investment rose 2.8% representing $23b in the first five months of 2006. At the root these inflows is China’s managed currency and robust exports. As a first step in controlling MS and soak up extra liquidity, the Chinese Central bank announced it would allow the official rate to move higher. The Yuan traded to 7.9960, the strongest rate since revaluation, before closing back above 8.0. China's PM also now drawing up stricter guidelines for the banking system to curb the massive credit growth in order to slow the fast economic expansion.

While a stronger Yuan has massive global implications, in the short term the JPY will see the most benefit.


Note: the support/resistance levels used in the matrix’s of this document are levels derived from yesterday high, low and close. Reference in the text to other support/resistance levels will occur.


Euro/US Dollar
EURUSD (1.2651 @ 06:19 GMT)
EURUSD continued its three day rally in Asian trading but failed to break initial resistance at 1.2660. Changing market sentiment will test 1.2700 and any breaks on the upside will see little resistance up to 1.2800. Strong support around 1.2530 level (38.2 % retracement from 2006 highs) will provide adequate support for any Friday summer rally.

Trading stance: Look for buying opportunities above the break of 1.2660 for a move towards 1.2750, stop kept below 1.2520

Resist.
1.2780
1.2703
1.2669
1.2651
1.2592
1.2548
1.2471
Support

Quoted:
16 Jun 06
06:19 GMT


British Pound/US Dollar
GBPUSD (1.8535 @ 06:19 GMT)
GBP/USD after a three day +1.19 gain we continue to see traders adding to long positions. After challenging the 1.8320 support levels (a significant 38.2% Fib lvl) early in the week In NY and Asia session the cable found strength and broke the 1.8500 resistance and hover around the 1.8520 level. With little resistance until the 1.8590 the only question is follow through.

Trading stance: Buy on pull back to the 1.8500 support. Tight stop at 1.8470
Resist.
1.8749
1.8618
1.8557
1.8535
1.8426
1.8356
1.8225
Support

Quoted:
16 Jun 06
06:19 GMT


US Dollar/Japanese Yen
USDJPY (114.63 @ 06:19 GMT)
USDJPY on dollar selling and Yuan appreciation more than changes in Japans economic condition. We should see a test of the 114.50 (50% fib level) in today’s trading, however as Asia closes and markets get thin a real challenge is unlikely.

Trading stance: Sell on break of 114.50 with stops above 115.20 and target in the 113.30 area.

Resist.
116.05
115.46
115.10
114.63
114.51
114.28
113.69
Support

Quoted:
16 Jun 06
06:19 GMT

Risk warning
Saxo Bank A/S shall not be responsible for any loss arising from any investment based on any recommendation, forecast or other information herein contained. The contents of this publication should not be construed as an express or implied promise, guarantee or implication by Saxo Bank that clients will profit from the strategies herein or that losses in connection therewith can or will be limited. Trades in accordance with the recommendations in an analysis, especially leveraged investments such as foreign exchange trading and investment in derivatives, can be very speculative and may result in losses as well as profits, in particular if the conditions mentioned in the analysis do not occur as anticipated.

Please read our full Analysis Disclosure & Disclaimer at www.saxobank.com/analysis/disclaimer.

Saxo Bank
Saxo Bank

 

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