Currencies tend to over extend their gains or losses as greed and fear drive prices to far in one direction. This occurred last week in the US dollar as speculators were flushed out and the dollar mounted a strong rally. Now the rally is over the bears look likely to take control again, as the outlook still remains bearish the dollar.
The US Dollar had a strong rally last week but this is nothing more than a short covering rally in a bear market and the down trend should re assert itself this week. The Dollar remains under pressure from worries about the sub prime mortgage crisis but although there is concern, it is unlikely to lead to a financial crisis and easing of rates.
However, the Fed remains on hold interest rate wise, despite a tight labour market.
The fact that interest rates are unlikely to be cut is not supportive for the dollar as the Fed will remain on hold as other countries abroad hike rates putting pressure on the greenback.
The currency holds a premium yield over the dollar just like the euro.
Falling jobless claims low unemployment and a tight labour market are all supportive of the currency. Q2 GDP was firm at 0.8% and beat expectations which further under pins the currency.
So why the recent falls?
There is an argument that interest rates at 5.75% may not need to go any higher but the real reason for last weeks falls was simply:
Speculators had pushed it to far (indicated by the record long held by speculators reported in recent Net Traders Positions realized by the CFTC) and the pound was due a correction – which we saw last week. This is a speculative washout and when the dust settles the BP should resume its up trend for another pop At the highs.
Still remains firm and is a multi-decade highs and should remain bullish based upon 4 factors:
1. General US Dollar bearishness
2. Bank of Canada tightening of rates
3. Globally strong commodity prices
The C$ though has not been steaming ahead of the other majors and had a good correction last week so why has this occurred? Firstly, like the BP it was simply overbought and needed a correction to flush out speculative longs. Secondly, bullish oil prices have been offset by bearish natural gas prices.
The C$ though should move higher:
Strong oil and metal prices (and a probable recovery in natural gas prices), combined with a firm interest rate outlook and capital inflows, will be more than enough to support the C$ into year end and push it back to the highs.
As the Fed holds the ECB looks set to tighten again in the fall and push rates up to 4.25%.
Trichet is already becoming more hawkish and a rate rise in August looks firmly on the cards.
The data for euro zone is strong enough to keep the bank vigilant and with the banks history of striking first in terms of inflation, the rate differential will remain in the euros favour.
The yen scored some impressive gains against the US$ last week but is likely to fall despite some impressive economic numbers:
Unemployment is at 10 year lows, growth is on the rise and the weak currency gives the yen a huge advantage in the export market but the bulls may have to wait a little while longer for the yen to turn up.
Even with a possible .50 basis point rise the interest rate differential is firmly against the yen in the short term and we may have to wait a few more months for a possible bull trend in the currency.
Last weeks action looks like a correction by the dollar in a bear market.
Traders should time their entries on strength in the currencies above apart form the yen, where you look for the reverse scenario.
Pick of the currencies is the C$ followed by euro and BP – While the yen looks due to fall again, we are more wary of this trade due to its volatility.