NEWS / Foreign Exchange

Technical round trip in the FX market

• Technical round trip in the FX market
  
• Expected exchange rates, 30 April - 11 May 2007
  
• Central bank meetings in May

Technical round trip in the FX market

This weekly newsletter, which covers a fortnight because of the Danish national holiday on Friday next, makes a round trip of the FX market, seeing it from the technical point of view. It is no secret that exchange rates have been volatile for the past few weeks, and in spite of warnings from the last G7 meeting and from central-bank chairmen across the world, market participants still seem to be fearless of risk in their quest for return. So there is still only one major theme in the financial markets: strengthening of the commodity currencies, dollar weakening and "carry".

EUR/CHF:

At 2.25% the Swiss francs is still one of the global currencies with the lowest interest rate, and it is therefore a natural choice for carry/interest arbitrage. What counts is funding yourself as cheaply as possible, which leaves a natural selling pressure against the hard-pressed franc.

Repeated warnings from high-ranking members of the SNB, the Swiss National Bank, to the effect that the current weak level just points to more interest-rate hikes in the future because of the inflationary pressure, is completely overlooked by market participants, and obviously we need to see action on the part of central bank chairman Roth & Co. before there is a counter reaction.

The below chart shows clearly how the EUR/CHF rate is again hitting solid resistance at around 164.50, while our momentum indicators RSI and Stochastics are a whisker away from giving a proper sell signal. Moreover, the RSI shows a divergence, which is another sign that the EUR/CHF rate is losing momentum!

A number of interesting Swiss indicators will be announced in early May, among them CPI and unemployment. Unfortunately, we must keep patient in relation to the next interest-rate announcement, which will not be until 14 June. Exchange rates currently discount a quarter-point hike by SNB the next time. In addition, almost 0.25 percentage point more is expected before the end of the year.

We are still of the firm opinion that these are the last twitches before the EUR/CHF rate caves in and heads back north. The first short-term point of support is 163, and then 161.50-162. However, it should be noted that, if CHF starts moving in earnest, the said points of support will be negotiated fast, and we may be in for a much lower EUR/CHF rate (159.50-160).

EUR/USD:

The dollar is still tottering under the general trends in the FX market, and market participants' belief in interest-rate cuts on the part of the Fed and a restrictive monetary policy on the part of the ECB are still nudging the EUR/USD rate towards new record highs. Not since January 2005 has the cross rate been at this level, and decisive breach above the top at 136.67 will be very likely to pave the way for a test of the psychological level around 140.

A look at the momentum indicators, RSI and Stochastics, convinces us that also here it is not the time yet for a significant rise of the EUR/USD rate. That being said, it is important that investors determine stop loss for their short-term long dollar positions, if a day closes above the said level. Subsequently, it will be time for re-consideration, but it cannot be ruled out that we may recommend early sale of EUR/USD.

The money market still expects almost two interest-rate cuts by the Fed before the end of 2007, while they expect almost two in the euro zone. However, we stick to our expectation that the Fed may have to make another quarter point hike in the course of the summer before it puts hikes on hold. This supports our expectation of a dollar appreciation. The first short-term target comes in at 134.50, but with potential down towards 133. For the longer term we expect the dollar to strengthen.

AUD/USD:

The current search for high-yielding currencies gives the two commodity currencies AUD and NZD (and to some extent CAD) a head start. At 6.25% Australia ranks solidly in the top range, although the latest inflation numbers caused concern among participants of the financial markets.

Consumer prices for March came out much lower than expected, and while exchange rates discounted almost a 50% chance of another hike on the part of the RBA at its next meeting (2 May), expectations of a quarter point hike have evaporated completely. Expectations are now for only 0.25 percentage point in the course of the next twelvemonth.

As the chart below shows, AUD is beginning to sag under market participants' disappointment, and the AUD/USD rate has just given us a firm sell signal on a weekly basis.

The RSI showed that the momentum of the long-run uptrend is flagging, so it is proper to expect another correction of the AUD/USD rate.

If CHF strengthens, as we expect, also AUD will weaken because of the closure of interest arbitrage positions.

The first important point of support for the AUD/USD rate comes in at around 81 (the first Fibonacci point on the movement from March until now), and we recommend that investors keep their short AUD positions. Stop loss should be put at closure above 84 for AUD/USD. On the downside we recommend investors to move stop loss gradually lower in line with developments.

NZD/USD:

Like AUD, like NZD, although NZD is in a worse position, since the New Zealand interest rate is impressive at 7.75%. Therefore market participants reacted promptly when the RBNZ unexpectedly chose to raise interest rates late on Wednesday night, and the NZD/USD rate skyrocketed (the money market had discounted approx. 50% chance of a hike at the meeting. Not until June were expectations for 0.25 percentage point).

Twice has the NZD/USD rate flirted with 74.90, most lately after the surprise interest-rate hike, but the fate of the kiwi dollar changed swiftly when the central bank at the subsequent press conference stated that NZD is/was overvalued, given the current and medium-term fundamentals.

The comments were construed by market participants as a broad hint that the central bank will not hesitate to intervene if the rising trend continues. However, it is hardly likely that the bank chooses to intervene before the end of its current interest-rate hike cycle! Currently market participants expect another quarter point on the part of New Zealand before the end of October.

We still recommend selling NZD/USD at the current level in expectation of an early correction. The NZD/USD rate has so far not been able to scale new highs above 74.90-75, which means that both the RSI and Stochastics are signalling great weaknesses before the current uptrend. The first point of support comes in at around 71.90-72.00, but there is scope for much lower levels. At the time of writing, stop loss should be put at a close above 75. As the movement plays itself out, investors should also here move both stop loss and target further down.

USD/CAD:

At only 4.25%, Canadian interest rates make CAD less than obvious as a "high-yielding currency", but it is extensively affected by developments in commodity prices, particularly oil, and also gold. The latest favourable development in commodity prices together with the appetite for high interest and high risk, has generated a fairly strong demand for CAD. The USD/CAD rate is therefore flirting with low levels that we have not seen for a long time.

Under reference to the latest FX Weekly we reiterate that we still expect a correction of the gold price which - together with expectations of a correction of the oil price - points to a higher USD/CAD rate.

Also for the USD/CAD rate the monument indicators show extreme levels, but here we are in oversold territory unlike the other cross rates described in the foregoing. We thus expect that the USD/CAD rate is facing a movement back towards higher levels, so buying at the current level is recommendable.

Stop loss should be put if there is a downward breach of the old bottom at around 110, and the target at first is 114.50-115. Since the cross is looking thoroughly overbought at the moment, we recommend moving both stop loss and target higher in line with developments.

• If you want to view more on EUR/SEK, EUR/NOK, EUR/GBP, EUR/JPY, USD/JPY see the full report.