NEWS / Foreign Exchange

To a hostage crisis?

• US Treasuries sentiment weakens
• Unexpected rise in IFO justifies recent rise in yields
• To a hostage crisis?
• Oil resurfaces as an item for the markets

On Tuesday, EUR/USD moved higher from the 1.3330 area to the 1.3360 zone.

The German IFO indicator was the benchmark to look at for the markets in the morning. A small pullback (from 107 to 106.5) had been expected and this would have not been caused a euro negative reaction we believe. It however was even better than expected. The IFO index ticked up 107.7.

This sort of indicators continue to make the hawkish case of some ECB members and show the ECB may not yet be done with a hike to 4.00%. That is of course regarded as euro positive versus the dollar, as the view is over there that the Fed is closing in on its first rate cut of the cycle. Yesterday??™s S&P/case-Schiller housing index highlighted that the housing market woes are ongoing, as it showed price declines. (see news part for details). Yesterday, also the Italian business confidence was released, showing a slight decline, but this was ignored, being overshadowed by the IFO.

Today, we take a look at the German CPI number for some guidance, but probably the afternoon??™s US durable goods orders and the testimony of Fed??™s Bernanke before the Joint Economic committee will draw the most attention, as it is potentially more influential.

The EUR/USD upside could still be favoured in a buy-euro-on-dip scenario. This is kept in place as long as the pair can manage to stay above recent lows at the 1.3260 zone.

USD/JPY fell back over the past 24 hours from the 118 zone to the 117.20 zone, with most of this move this morning.

The call by the Asian Development bank on Asian countries to diversify is still a much talked about item in the markets (FT front page this morning), although we didn??™t notice any impact at the time of the release of its comments early yesterday morning. Only during the day, the market started to focus on this and it may have inspired some to buy back JPY.

We believe though, because of the large time lag between the comments itself and the market reaction, that it is now used rather as an excuse to sell the USD at this stage. It was obvious that the 118.50 zone would be a very tough resistance to break (top of recent sideways pattern), so it was safer to take profits at this stage, as the upside showed signs of stalling.

A better explanation is the escalation of the conflict with Iran. Iran??™s capture of UK military is seen as a challenge and ups the risks of a deeper conflict between Iran and UK/US. (details see EUR/GBP part below). That may give more risk aversionand implies a return to the yen. This risks aversion may also be seen in the decline of the Nikkei.

Whatever the exact reason, or its interplay, this sort of price action again confirms the sideways stance for the USD/JPY pair, as we see more action between this high at the 118.50 zone and the recent lows at the 1115.16 area. It will be just as difficult to break the downside, as signals coming from Japan show no appetite for any yen strengthening.

The EUR/GBP pair ticked up yesterday, as the euro was inspired by the better than expected German IFO business sentiment indicator.

A role may also be played by the rising tension between Iran and the UK over the capture of UK military by Iranian marines. The UK claims its military were in Iraqi territorial waters, while Iran claims they had entered Iranian waters. It doesn??™t want to release them for now as its investigation into the matter is ongoing. UK PM Blair threatened to escalate the matter. There were rumours of an attempt to liberate the prisoners. All in all though, EUR/GBP was rather calm on this story.

Today, developments on this front will be followed. A solution would be welcomed by the sterling, which is now scared a bit by this direct involvement all of a sudden. This morning, the UK Nationwide housing prices rose by 0.4% M/M, which was slightly less than the 0.7% expected. It had no impact though.

Looking at a more longer term fundamental view, we still hold on to the belief that the market has been too negative on the UK economy and the sterling. If this Iran story can cool down, we see a comeback story for the sterling (buy-on-dips) versus the single currency, but this Iran issue clearly is a problem in the very short-term.