Volatile trading week likely to drag euro down

The week is likely to be more favourable to the dollar. (AP)

The first week of full-fledged trading activity of 2009 begins this week and market would encounter a gamut of economic event risks, which include the non-farm payrolls (job growth data) from the United States, interest rate decision from the Bank of England, housing sector performance in the US, Eurozone growth rate, etc.

The week is likely to be highly volatile, but more favourable to US dollar despite the extended weakness in the US economy. It is pretty much clear that the US economy is in a complete slowdown, but with scenario being the same or even worse in many other G7 nations, US dollar continues to remain the most sought-after currency. Investors generally tend to keep very less investments in exotic currency pairs amid global economic downturn and opt to park it in safe haven currencies such as US dollar.

There is a high possibility that euro would drop this month due to seasonal factors such as corporate hedging flows, asset allocations. Analysing the historical performance of euro over the past 10 years, the month of January has always been negative for the single currency.

From 1999-2009, the currency has fallen against the US dollar seven out of 10 times. This is despite the trend that the prior month, December, being equivalent number of times positive over the same time frame. This year – 2009 – is certainly different, but chances of extended weakness in euro are much pronounced this year, given its economic positioning vis-à-vis its counterparts.

The Eurozone was officially declared in recession towards the end of last year following a second quarterly contraction in economic output.

Manufacturing activity in the Eurozone is at a record low and figures for December 2008 suggest that down the line outlook remains grim as new orders also sinking to fresh new lows.

The Markit Eurozone Purchasing Managers Index (PMI) for the manufacturing sector slumped to 33.9 in December, a low not seen in the survey's 11-year history and well below the 34.5 flash estimate and 34.5 forecast by many economists. The index is considerably below the 50.0 mark that divides growth from contraction and the outlook is grim with the new orders index slumping to a new survey low of 26.4 from the flash estimate of 27.4 and 28.8 in November.

This is the seventh straight month the PMI has shown contracting activity.

With such grim positioning of the Eurozone economy, European Central Bank (ECB) will have fewer options other than to slash rates again this month to resuscitate the flagging economy. ECB's current interest rate of 2.5 per cent is the highest among the G7 nations and is burning the brunt for not having acted in tandem with the US Federal Reserve.

The next interest decision from ECB is due on January 15, 2009, and it is likely that ECB would slash rates by at least 50 to 75 basis points. It is viewed that since US was the first to enter into the global credit crunch chaos, the first to act by slashing interest rates, first to pump liquidity into the systems, first to initiate bail out packages, it would be the first to get out of the crisis.

Outlook wise, German employment change, Eurozone producer price index, EZ third quarter GDP, Eurozone retail sales, industrial production and factory orders are due this week and these data feeds are likely to give clues of the immediate trend in the currency.

In addition to this data feeds from US economy, especially the non-farm payrolls, US pending home sales figures and US service sector index are likely to add to the volatility in euro/dollar currency pair.

Technically euro/dollar is pointing to a negative bias in the weekly charts and might slide lower as the month progresses. Strong reluctance to close above the key moving averages and overbought momentum indicators hint that the currency pair is uncomfortable around the current trading zone. Though euro/dollar rallied swiftly in mid-December, 2008, it failed to scythe and hold above 61.8 per cent retracement resistance at $1.4651. It has slipped back since then auguring the view of potential weakness in the currency.

Near-term support is at $1.3785, and on break of this level euro/dollar has the potential to slip $1.32 and below.

POUND

British pound (GBP) looks quite fragile, despite dropping 26.31 per cent against the US dollar and 30.28 per cent against the euro last year. There are visible signs of cracks in the UK economy and many economists are predicting UK's sterling pound to trade on par with euro – possibly resulting in merger with the Eurozone. Latest figures show that the UK housing market remained in a dire state in November, with mortgage approvals slumping to just 27,000, their lowest since records began in 1999. Meanwhile, the purchasing managers' index for the UK manufacturing sector was at 34.9 in December, 2008, only just above November's record low of 34.5.

Though lower UK interest rates (two per cent) compared with the Eurozone (2.5 per cent) has been a prima-facie reason behind the sell off in sterling against the euro, there were other factors that added momentum to the selling pressure. UK has much larger imbalances than the Eurozone in terms of its current account deficit and also has larger dependence on the financial sector. In addition, UK's economy is largely a service sector oriented with high level of consumer indebtedness.

With these sections of the economy (service and financial) like to struggle in coming quarters, it seems that UK would have to slog for an extended period, before returning to normalcy.

Financial markets seem to have fully priced in a cut in rates to 1.5 per cent when the Bank of England (BoE) meets on January 8, 2009. BoE Governor Mervyn King is expected to indicate the possibility of a bigger reduction in the coming months. As grim news continues to flow, GBP's path to levels below $1.40 seems possible and might be achieved sooner than expected.

YEN

The Japanese yen was among the top performers in 2008, surging higher due to massive unwinding of carry trades (borrowing in the low-yielding yen to invest in higher-yielding assets elsewhere).

In 2008, yen surged 23.1 per cent against the dollar to ¥90.73 and 29.6 per cent against the euro to ¥126.01. With global interest rate likely to narrow down further, yen might surge in the coming weeks.

In addition to this there are also chances for the Bank of Japan to intervene in the currency markets by selling yen in order to keep the currency weak. Japan has a history of intervening in the markets, as they hold the second largest foreign currency reserves ater China (at the end of November 2008 Japan's Foreign Exchange Reserves stood at $1 trillion (Dh3.6trn). Dollar/yen has the potential to strengthen to ¥85.50-¥81.10, provided BoJ does not intervene substantially. With Japanese interest rates likely to remain unchanged, the performance of other economies would determine trading levels.



- The author is Senior Research Analyst at Richcomm Global Services DMCC

 

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