Multi-Currency Fundamental Analysis for 27 July 2009

 By William Doody

U.S. Dollar
We expect continued pressure against the Dollar so long as corporate earnings and economic data point towards an eventual recovery towards the end of 2009. Improved economic fortunes will lead currency traders to unwind their “safe-haven” positions in the Dollar. Meanwhile, the Federal Reserve has indicated that they expect to maintain extremely low interest rates for the foreseeable future, a position which will make Dollar investments less attractive and which may eventually lead to damaging inflationary forces.

In the short term, Dollar trade will be influenced by several economic releases due this week. On Monday, the Federal Reserve Bank of Dallas reports on manufacturing activity, while on Tuesday, consumer confidence figures will be released. Wednesday, will be a key day, as the highly followed durable goods data is announced and the Federal Reserve’s “Beige Book” of economic data is released. Friday will also be an important day, as data on personal consumption and Q2 GDP are announced. So long as there are no unexpected negative surprises in these releases, we expect the Dollar to maintain a gradually negative trajectory. Any indication of weakness in the pace of economic recovery, however, and the Dollar can be expected to rally sharply.

EU Euro
Like the Dollar, the Euro is dependent on economic releases. Continued Euro strength will require concrete data to support the belief that the Euro-zone economy is staging a recovery, especially in key drivers Germany and France. Weak data would be an obvious negative for the Euro, in particular any weakness derived from those two leading countries.

The week ahead will see several important economic releases. German consumer confidence will be announced on Monday and the German Consumer Price Index will be announced on Wednesday. On Thursday, German unemployment figures will be released along with Euro-zone consumer confidence data. Finally, on Friday, the Euro-zone Consumer Price Index will be announced. Again, should any of these results call into question the slight economic recovery that appears to be underway, we expect the Euro to sell-off sharply. Provided all of the data is in-line, we would expect the Euro to maintain an upwards bias over the next several weeks.

British Pound
Of the major economies, Great Britain is clearly in the most perilous condition and, on a fundamental level, the Pound ought to be the weakest of the major currencies. While the Pound has maintain relative stability in recent weeks, especially against the Dollar, the latest economic data suggests that this trend will not last much longer. GDP data for the 2nd quarter revealed a 0.8% contraction, more than twice the rate that economists had expected. It seems increasingly likely that the Bank of England will be forced to revisit their recent decision to keep monetary policy stable and, instead, to consider the possibility of additional quantitative easing. Such a move would be certain to have negative consequences for the Pound.

Over the next several days, there will be a number of releases providing data on the state of the housing market in Britain. Economists’ forecasts are almost universally glum, but the hope is that the data will suggest a bottoming process is at least underway. If, instead, the data indicate further deterioration in housing prices or mortgage rates, then the Pound can be expected to decline quite sharply. On Thursday, U.K. consumer confidence results will be announced and, again, expectations are quite pessimistic. Still, for the Pound to maintain its recent levels, the results cannot come in worse than the previous month.

Japanese Yen
In recent weeks, the Yen has traded almost directly inverse to the major equity markets, serving as little more than a “safe-haven” trade for currency investors. The Japanese economy remains relatively stagnant, as it has been for more than a decade. Meanwhile, diminished risk appetite has removed the “carry trade” of shorting the Yen and buying commodity currencies from most traders’ playbook. Thus, the Yen has moved in a straightforward fashion – up when equities decline and down when equities advance.

Looking ahead, we see no fundamental catalyst to change the Yen’s behavior versus major currencies. The pace of economic recovery in Japan will clearly be slower than that of the other major economies, as recent data from Japanese exporters demonstrates. More than a decade of super-low interest rates has made investing in the Yen for its own merits a thankless proposition. We see little reason to buy the Yen, unless traders feel pessimistic about the prospects for economic recovery.