Brave New World

FX Update 19/05/2009

News

EUR: German ZEW, which measures investor and analyst confidence rose to 31.1 in May from 13 in April; highest in 3 years

GBP: UK Consumer Price Index was 2.3%y/y vs 2.4% consensus forecast

AUD: Minutes from the RBA meeting, “economic stimulus has been applied by supporting demand”, likely to keep rates at 3% in 2009

Commentary

Risk has made a full fledged return to the market, as positive market friendly news in the US at the end of Monday helped drive equity markets higher. The MSCI Asia Index closed up 2.75%. Given the strong inverted correlation between the USD and JPY, the currency market took its cue and by early European trading the market witnessed a sell-off, particularly against Sterling. GBPUSD reached new highs, trading above the 1.54 handle. Sterling even rallied against the USD following weaker than expected CPI figures. Despite the pair trading around its Purchasing Power Parity level the market is, according to flow data, still oversold in Sterling. More positive economic data out of the UK, crucially Retail Sales figures later this week, could see Sterling reaching new levels against the USD, perhaps aiming towards the 1.60 level. This will certainly be in play if GBPUSD breaks a key 200 SMA resistance level of 1.5586. The EUR also rallied against the USD, but has been the less favoured currency. Economic data from the Eurozone is a real cause for concern and the feeling is that EURUSD is gaining not only from a weakening USD but as a result of FX reserve diversification; the rally in commodities and pick up in activity in China is allowing emerging market economies to once again build up their economies. Although green shoots indicators are increasingly apparent around world, optimistic indicators in the Eurozone come from solely from sentiment surveys. The Germany ZEW is a perfect example. The survey measures investor and analyst sentiment; in other words not participants in the ‘real’ economy. Today it posted a sharply higher reading for May, from April. This was mostly due to renewed confidence in the banking sector. It is unlikely that this confidence will continue to keep on the same trajectory, particularly given that European banks are in a much weaker position than was previously thought and no US style stress test has been agreed on in principle, let alone implemented. Given that the Eurozone is so dependent on exports, rather than domestic demand, for governments in the region will be concerned about much more appreciation in EURUSD. Nevertheless, the pair is likely to grind, cautiously, higher as improved market sentiment and the beginnings of a momentum away from the reserve status of the Dollar will weaken the US currency more than European authorities can manage. After all, the ECB will be extremely reluctant to outdo the Fed in aggressive monetary easing.