by Darrell Jobman, Editor-in-Chief, TradingEducation.com, LLC
Daily currency analysis
for Tuesday, May 20, 2008
The dollar was unable to challenge levels below 1.55 again on Tuesday and weakened to around 1.5610 ahead of the German data.
The ZEW index improved slightly to -41.4 in May from -44.8 previously, but markets had expected a bigger improvement and the Euro initially weakened. The ZEW chief economist took a tough stance on inflation and interest rates as he stated that he expected the ECB to increase interest rates in the near term. Markets were sceptical over the potential for a move, but inflation concerns certainly remained a live issue, especially as German producer prices rose by a stronger than expected 1.1% for April.
US headline producer prices rose 0.2% compared with expectations of a 0.4% increase. The core increase was larger than expected with a 0.4% increase and the core annual increase was at a 16-year high. The Fed will still be unsettled by the increase in underlying prices and comments from Fed Governor Kohn suggested that the Fed would look to keep interest rates on hold in the short term.
Overall yield spreads still moved in the Euro’s favour during Tuesday as US yields fell and this provided renewed support for the currency with the US currency under pressure. The dollar was also unsettled by a further increase in oil prices and weakened to lows around 1.5680 before stabilising.
Any comments from Euro-zone and US officials on currencies will need to be watched very closely in the short term. There are likely to be further calls for a firmer US currency, especially as energy prices spiked higher again over the past 24 hours.
The dollar was unable to make any significant impression on the yen in Asian trading on Tuesday
As expected, the Bank of Japan left interest rates unchanged at 0.50% following the latest council meeting with rates left on hold for the 18th successive month by a unanimous vote. The yen will, therefore, remain vulnerable on yield considerations, although there will be persistent uncertainty over market trends which will limit initial yen selling.
The IMF warned over the risk of further turbulence in financial markets which provided some degree of yen support. US and European equity markets were also generally on the defensive during the day which provided underlying support to the Japanese currency.
Former Fed Chairman Greenspan stated that Asian currencies would strengthen in the longer-term and the dollar dipped to a low around 103.40 in New York, but narrower credit spreads should stem dollar selling.
Sterling found support below the 1.95 level against the US dollar on Tuesday and strengthened sharply to a high above 1.97 in New York. The UK currency benefited from the dollar weakness, but also proved resilient against the Euro during the day.
There were no significant domestic developments during the day. Markets will watch the Bank of England minutes closely on Wednesday for further evidence on the likely stance on interest rates over the next few meetings.
A very narrow majority vote in favour of unchanged rates at the May MPC meeting would increase speculation that the bank will find it difficult to resist an interest rate cut if the economic data remains weak.
The dollar hit selling pressure above 1.05 against the franc on Tuesday and dipped to lows near 1.0350 in new York. The Swiss currency also strengthened to near 1.6230 against the Euro.
Global equity markets struggled during the day and this provided a firm base to the Swiss currency even though global credit spreads were generally narrower.
Swiss producer prices rose 0.6% in April to give an annual increase of 3.6%. Although the increase in Switzerland has been more muted that in other major economies, the National Bank will remain on inflation alert in the short term which will provide some degree of franc support.
The Australian dollar quickly found support on dips during the past 24 hours and continued to advance in local trading on Tuesday with the currency challenging the 0.96 level which was a fresh 24-year high. The Reserve Bank took a tough stance in the latest minutes with a warning that inflationary pressure made the bank consider a rate increase at the latest meeting. Yield considerations will, therefore, continue to underpin the currency in the short term.
Commodity prices are also still strong which will provide important near-term support to the currency. Nevertheless, there are still clear risks of a sharp correction with volatility levels liable to increase.