Favorite Play of 2008 Alive & Well

While central banks in most industrialized economies are either reducing interest rates or expected to do so thus year, the Reserve Bank of Australia is expected to further raise its rates to fresh 12-year highs. Overnight, the RBA revealed in the minutes of its policy meeting this month a debate whether to raise rates by 50-bps. The central bank ended up raising rates by 25-bps to 7.25% to counter rising wage and price inflation. Last week, the Aussie hit multi-month highs after Australia ’s unemployment rate unexpectedly fell to a 34-year low of 4.1% last month from 4.3% in Dec. Interest rate futures are now pricing an 80% probability of a 25 bps rate hike next month. Diverging interest and GDP growth rates were the backbone of our December calls for broad Aussie gains versus GBP, EUR and USD.

Specifically, we called favoring AUDGBP pair as our favorite trade of 2008 as the pair is now up 7.5% year to date. Considering the prolonged downturn in UK housing, the resulting downturn in the British economy and the need for the Bank of England to slash rates by 75-bps to 4.50% this year, we expect the Aussie to reach the 50-British pence mark later this year, which is the highest since March 1997.

AUDUSD: We continue to see a 60% chance for the Australian dollar to reach parity against the US dollar later this year, especially in the event that global risk appetite remains largely intact. Interim resistance stands at 92.70 cents, followed by 93.20. Prolonged strength in the price of wheat and copper, all of which are major Aussie exports, shall also will also bolster the currency’s standing and the nation’s trade balance.

Euro Capped at $1.4780

Euro ekes out fresh gains amid a combination of rising risk appetite and prolonged USD weakness in the aftermath of the long holiday weekend. Friday’s 1.9% annual increase in French non-farm payrolls and a 4.4% annual increase in Spanish inflation for kept the bears at bay. Although tomorrow’s release of the US housing starts and building permits figures for January may signal further deterioration, our optimism for prolonged euro/usd gains remains guarded as we expect the market to retest preliminary support at 1.4650 and 1.4620. Upside capped at 1.4780, followed by 1.48.

Our bearish EURAUD outlook signaled last Thursday is on track as the pair has dropped from 1.6300 to 1.5995.as expectations of further RBA tightening contrast with increased pressure on the ECB to cut rates before end of Q2. Nonetheless, our positive AUD outlook versus EUR remains more limited in scope than that against GBP and USD.

Yen Drags Dollar

The overnight decline in USDJPY to 107.50 from 108.25 is a reflection of overall dollar losses than JPY strength, which is reflected in a rebound in gold to $925 per ounce and the aforementioned jump in EURUSD above $1.4720. But the yen remains weak against non USD currencies as risk appetite returns to global markets. The lack of US economic releases may make way for modest gains in equities today, which maintain negative pressure on the USD, especially ahead of tomorrow’s starts/permits report. Interim support stands at 107.20, followed by 106.60. Upside capped at 107.80.

Sterling Heads South on Northern Rock Consequences

Sterling sustains broad damage as the nationalization of UK mortgage lender Northern Rock is expected to shed employment losses in the banking industry, weigh on already struggling lenders and exacerbate the government’s poor finances. While our month-end call stands at $1.9500, we see the possibility of testing 1.9420 this week. Sterling’s ability to make corrective bounces of at least 50-75 pips allows the possibility for a rebound to as high as 1.9560 (38% retracement of 1.9720-1.945), but resistance weighs at 1.9600 (50% retracement of said move), which may be challenged on tomorrow’s US housing data.

Loonie Drops on Soft CPI

Canada’s CPI rose 2.2% in the year ending in January, while core CPI rose1.4%, well below the 2.0% target, which opens the door for a 25-bp cut to 3.75% next month. Dovish comments from Bank of Canada Governor Carney support this outlook and open the door for 3.50% by year-end. The 2.9% decrease in Dec wholesale sales just released now should help boost USDCAD towards 1.0080. Pressure stands at 1.01. Support climbs to 1.0020.