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Monday July 2, 2007 - 21:48:17 GMT -

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Forex - British Pound Hits 26 Year High

DailyFX Fundamentals 07-02-07

By Kathy Lien, Chief Strategist of

• Dollar Tracking Bond Yields Lower: Looks Like Market May Be Expecting Weak Data
• Euro Heading Towards All-Time Highs
• British Pound Hits 26 Year High

Dollar Tracking Bond Yields Lower: Looks Like Market May Be Expecting Weak Data

Traders were out to sell the US dollar today and nothing could stand in their way. Stronger than expected manufacturing sector growth only helped the dollar rally a mere 15 pips against the Japanese Yen, and even those gains were lost shortly afterwards. The move in the US dollar indicates that the foreign exchange market is focusing almost exclusively on bond yields today. Ten year yields are back below five percent, which is the lowest that yields have fallen to in three weeks. The drop in yields is indicative of risk aversion, profit taking ahead of the US Independence holiday and concern that the remainder of the US data due for release this week will be dollar negative. The heightened threat of terrorism in the UK and the US has caused a rise in risk aversion that can not only be seen in currency prices, but also gold prices. This week, there is a decent chance that we will begin to see softer US data. Even though manufacturing ISM increased from 55 to 56, the prices paid and employment components of the report both deteriorated in the month of June. Factory orders and pending home sales are due for release tomorrow. Having seen durable goods, new and existing home sales, chances are definitely in favor of weaker numbers. Although the dollar could fall further on the disappointments, don’t expect a full fledged collapse (120 will most likely hold in USD/JPY while 1.37 should still be resistance in the EUR/USD) because the strong rally in US stocks and continual rise in oil prices will keep inflationary pressures a problem for the Federal Reserve even if the US economic outlook worsens.

Euro Heading Towards All-Time Highs

After breaking out to the upside on Friday, the Euro ended the US trading session approximately 50 pips away from its all-time high. Of the many countries or regions that released manufacturing PMI reports on Monday, the Eurozone and Switzerland were the only ones to report stronger rather than softer growth. The acceleration in activity came predominately from Germany where growth has benefited from the drop in the Euro. Between the beginning of May and the middle of June, the EUR/USD fell from 1.3685 down to 1.3264. The breakout in the EUR/USD is also reflective of the market’s expectations for Thursday’s interest rate decision. Stronger growth and inflationary pressures suggest that the ECB could be more hawkish this week but at the same time they may want to wait until after the summer holiday season in Europe to change the degree of their bias. Contrary to popular belief, the interest rate curve is only pricing in a slim chance for a 25bp rate hike by the end of the year. Meanwhile the Swiss Franc has also performed extremely well over the past 24 hours. The combination of rising risk aversion as well as a sharp jump in the Swiss PMI index sent the Swiss franc to a 16 year high against the Japanese Yen. Consumer prices are due for release tomorrow. Should inflation also accelerate more than expected, then Switzerland would be a shoe-in for rate hike come September.

British Pound Hits 26 Year High

In contrast to the US dollar, traders were committed to buying the British pound today and nothing could stand in their way. Despite news that a burning car hit an airport terminal in Glasgow London this weekend and manufacturing conditions deteriorated in the UK, the British pound hit a 26 year high today. Part of that strength is certainly a result of dollar weakness since the British pound is down against the Swiss franc, Japanese Yen and Euro, but the pound would not be able to hit the highs that it did today without some optimism about the future outlook for the British pound. Of all of the central banks meeting this week, the Bank of England is the only one that is expected to raise interest rates. With oil hovering near $70 a barrel, the world’s concern for inflationary pressures will not be going away anytime soon. The interest rate curve is already pricing in 6 percent interest rates by the end of the year. For more on the outlook for the British pound, see our Special Report British Pound Hits 26 Year High: How Much Further Can it Rise?

Commodity Currencies Skyrocket: Fresh 18 Year High in Australian Dollar

The commodity currencies skyrocketed today with the Australian dollar hitting a fresh 18 year high, the New Zealand dollar reaching a new 25 year high and the Canadian dollar on its way back to testing its 30 year high. Both gold and oil prices are up strongly as well. A refinery shutdown in the US caused a sharp intraday reversal in crude and the move was exacerbated by the lack of market liquidity because Canadian markets were closed today. Demand for high yielding currencies continue to be voracious and we do not expect it to be curbed anytime soon. However, be especially careful of intervention by the Reserve Bank of New Zealand around current levels. In fact, they may even take the opportunity to intervene when US markets are closed on July 4th, so they can get the best bang for their buck. Australia reported softer manufacturing PMI, but that was offset by stronger inflation data. Retail sales are due for release tonight. Low employment should boost spending in the month of May.

Tankan Proves to Be Non-Even for Japanese Yen

Even though the Japanese Yen strengthened against the US dollar and British pound, the carry trade is still alive and kicking. USD/JPY has not always been the market’s preferred carry trade currency and we are seeing that same dynamic now. AUD/JPY and NZD/JPY, the poster child of carry trades continue to rise and that alone is telling us that we are only seeing carry trade profit taking in USD/JPY and not full-fledged liquidation. The much awaited Japanese Tankan survey proved to be a non-event as the data came out right in line with expectations. However labor cash earnings fell 0.6 percent in the month of May, which was a sharp disappointment considering the market was looking for earnings to rise by 0.2 percent. This will keep the BoJ on hold since weak earnings translate into weak spending.


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