NEWS / Foreign Exchange

Focus Shifts from Carry Unwinding to Dollar Focus

We asserted last week that the unwinding of the carry trade was not yet specifically a dollar story but an exiting from high yielding currencies such as the Aussie, US Dollar, Kiwi and Sterling into lower yielding Swiss franc and yen. Nonetheless, the combination of sub-prime worries and continued weakness in US data are rendering the FX focus to be on the dollar , hence, the jump in EURUSD past the key 1.3300 resistance and gold??™s recovery above $650 per ounce

Dollar drops 3-month lows against the euro, 2 ?? month lows against the Aussie as the US currency makes a delayed reaction to Thursday??™s dismal manufacturing data (Philly Fed and Empire Fed surveys fell near zero) as well as emerging concerns that the ensuing fallout of sub-prime lenders will spread to the broader mortgage market and the overall economy. A Wall Street Journal survey found that subprime woes will weigh on the economy but not necessarily cause a recession. A separate WSJ article postulated that that subprime layoffs will especially affect office space market as companies in industries related to mortgages layoff workers. We already have seen a 65K loss of construction jobs in a February payrolls report that was widely cheered by the market for not being as poor as feared.

The 8:30 am EST release of the February CPI is expected to show a 0.3% rise in the headline figure from January??™s 0.2% and a 0.2% rise in the core figure from 0.3%. Consensus estimates for the headline CPI were lifted from 0.2% after yesterday??™s stronger than expected 1.3% increase in the PPI. Yesterday??™s aggressively high PPI was the main reason the dollar escaped renewed selling from the dismal Empire Fed and Philly Fed readings on grounds that the Fed??™s inflation preoccupation will prevent it from moving into an easing directive.

Traders must also watch the 9:15 am release of the February industrial production seen rebounding 0.3% after January??™s 0.5% decline, which was the fourth monthly decline over the last five months (Sep-Jan). Capacity utilization is expected to edge up to 81.3% from 81.2%, which was the lowest since February.

The 10 am preliminary release of the March University of Michigan sentiment survey is expected to have dropped to 89 from 91.3, but the deterioration in equities and payrolls of the past month may drive the figure to as low as 85, in which case should provoke more aggressive dollar selling.

USDJPY vulnerable to 116

USDJPY??™s declines test 116.50 support, which is the 61.8% retracement of the 115.72-117.78 rise. Technicals indicate a break of this level should prolong further declines towards 116.20 and 116.  While upside bias with US CPI could support the dollar, any figure below 0.2% in industrial production could take out those gains, especially on the extent of the disappointment seen from the Univ of Michigan survey. A weak trifecta from the US data releases could help drag the pair towards the 115.70??”trend line support extending from March 5. Upside capped at 116.80, followed by 117.30.

Euro??™s break of 1.33 sets up for 1.3360

The decisive break of the 1.3275 resistance and the 1.3297 2007 high reflects general deteriorating sentiment in the US dollar from subprime woes and overall economic weakness. It would take a strong core CPI (above 0.2%) for the Fed to maintain its inflation vigilance, but a figure below 0.2% could be especially dollar negative. A sub 0.2% rise in Indus production should call up 1.3360 and 1.34 in the event of sub 0.3% core CPI. The extent of EURUSD retreat seen limited to 1.3280 and 1.3260.

Sterling capped at 1.9550

Cable??™s rise is mainly a result of fresh buying in EURUSD, thereby limiting gains to 1.9520 and 1.9550??”the 50% retracement of the 1.9914-1.9179 decline as well as downward trend resistance from Jan 23. Risk of renewed pullback remains intact with 1.9430 and 1.94.