Brave New World

FX Review 01/05/2009

With most Asian markets and continental European exchanges closed today market activity has been subdued this morning. In the foreign exchange market most currency pairs have traded in narrow ranges, following a volatile couple of days that has seen real changes to the dynamic of the role of the dollar as a gauge of risk appetite. EURJPY- a typical gauge of risk appetite, rallied 100 pips overnight in Asia.

In the UK a better than expected Manufacturing Index data and figures showing a rise in net dwellings helped Sterling rally almost 100 pips against the USD to the 1.49 handle. EURGBP fell below the 200 hour SMA of 89.50 to trade as low of 0.8894. The mood for the UK economy has certainly lightened over the last week. Bank stocks have risen higher, helping the FTSE post its largest monthly rally (8.1%) since April 2003. A more complicated economic picture with enough “green shoots” in earnings and economic data to pounce on has helped sentiment. However, this is unlikely to last.  There is still very little chance of any substantial recovery in the housing market, financial services industry or consumer growth. These factors make any talk of 3.5% growth in 2o11 sound ridiculous. The government is relying on that target and needs credibility for successful gilt auctions.

On a global level, there is renewed confidence among the investment community that China’s economic stimulus may allow it to reach the official projected 8% growth rate this year. This confidence has been borne out by the signficant rallies this week in currencies of countries who export a lot to China- the Korean Won, Australian Dollar and the Peruvian Nuevo Sol.

The EURUSD and GBPUSD relationships with risk appetite have been complicated by the fact that the USD is losing its strong negative correlation with risk appetite- ie it has shown bouts of strength at the same time as confidence has returned in other markets. A clear pattern has yet to emerge. Next Thursday’s Stress Test results will be the make or break for the latest bull run and could see the USD regaining its safe haven status vis-a-vis other G10 currencies.