FX Research : The dollar doldrums

The dollar doldrums
by Calyon Fixed Income Markets Research

For those who like to sail, being without wind is the worst place to be. Better a gale which you can run with or tack against, but the doldrums offer nothing but a listless drift along the prevailing current. Unfortunately, the currency market remains trapped in the dollar doldrums, and our suggestion that this would be a week where the USD would make small advances, simply because there was nothing to undo the mild rise in risk aversion evident after the non-farm payrolls, appears to be materialising. The current is soft, but it is still tugging the USD along.

In the absence of any notable economic releases today, FX fortunes will therefore hinge on two principal factors. First, will the US Q2 09 earnings season provide the kind of singular directional impulse that has been so lacking in the economic data of late? Bad news on US employment is countered by good news on the ISM. Concerns among policymakers over Eurozone growth (among others) are offset by upgraded global growth projections by the IMF. For those keen to see trends re-established, we have to hope that the earnings season sends an unequivocal message of either doom or delirium. More likely the interpretation of the results will be replete with ifs, buts, caveats and a suitably muddied implication for the double-dippers vs blossoming growth debate. In any event, the notable releases on the banks are not scheduled until next week, so no need to unfurl the spinnaker.
The alternative hope is that the limp FX currents are at least enough to drag us to key levels, a breach of which forces a re-think among the chartists. This is a more realistic prospect for jolting the FX market. USD/JPY finally got through support at 93.50 yesterday, triggering stops and extending the decline, and prompting a government spokesman to say that excessive currency moves are undesirable for economic stability. EUR/USD support at 1.3750 is not a million miles away and markets may also eye 1.6000 on GBP/USD though the more tangible support is at 1.5800. Still, each of these levels point to additional USD strength if breached, and there is enough gloom or boredom in the market to provide some after-the-fact rationalisation courtesy of rising risk aversion.

GBP faces the additional wrinkle of quantitative easing. The BoE is widely expected to leave interest rates unchanged, and the majority of forecasters think they will expand their QE programme by GBP25bn (or effectively an additional month's worth of purchasing on top of their existing plan). Alternative outcomes generally centre on either nothing being added or the BoE announcing that they will go beyond the GBP150bn war chest available when the programme was first announced. The market continues to equate QE with currency weakness. We dispute this logic as we believe QE is only currency negative if it fosters inflation, an outcome which requires an assumption of mistakes being made in the exit strategy. Nonetheless, widely held misconceptions are still a potent force for a market, and we think investors will be reluctant to buy GBP ahead of the statement. But given 1.6000 has held on GBP/USD, we may look towards some fresh buying once the QE uncertainty is out of the way.

We have seen a little bounce in the commodity currency / JPY crosses overnight, aided by those warnings from Japan as well as oil's ability to hold above USD60. The hope will be that the 13% drop in the CRB index so far this month has shaken out some of the unjustified speculative bullishness in the commodity market and dragged us back to levels which more accurately reflect the balanced nature of the global activity debate currently. As a consequence, the danger here is that these currencies too will settle into listless trading, joining the USD in the doldrums.

Daragh Maher Deputy Head of Global Foreign Exchange Strategy