GBP/USD Possible to test 1.50?

EUR: Italian Election Scenarios
JPY: BoJ Governor Nomination Next Week
CAD: Hit by Sharp Decline in Retail Sales
AUD: Supported by Steven’s Optimism
NZD: Oil Up, Gold Steady

Moody’s dropped a bomb on the British pound half an hour before U.S. markets closed for trading on Friday. For the first time ever, a rating agency stripped the U.K. of its prized AAA rating. Almost immediately, the British pound fell approximately 75 pips or 0.6% and would have probably fallen further if the announcement didn’t come right before the market close and when European and Asian traders already turned in for the night. In early Asian trading on Sunday, the GBP continued to fall, breaking below 1.51 to drop to its lowest level since July 2010. When the news broke, many economists argued that the decision by Moody’s was expected and will not have a meaningful impact on the currency but based on the reaction that we have seen so far, FX traders are not acting as nonchalantly as the “experts” predicted. In the long term, these economists could be right in that the downgrade will not cause investors to abandon U.K. stocks and bonds but in the short term we could see the GBP/USD break 1.50 and maybe even test 1.45.

The surprising revelation in the March MPC minutes that 3 members voted for more easing has put further QE back on the agenda. But will the news before the next meeting be enough to change other voter’s minds? One important consideration will be any further signs that existing policy moves are working. Friday’s money numbers will provide some evidence on this. Today’s BBA mortgage approvals data will provide a preview, likely showing a further small rise.

The euro ended the week near its lows and whether it recovers or extends its losses from here will hinge on the outcome of this weekend’s Italian elections. Bersani’s center-left party is still leading in the polls but by a small a margin. A clear majority win by the center-left party would be the best-case scenario and the most positive for the euro. A Berlusconi win on the other hand would be the worst-case scenario and could send Italian stocks and the euro sharply lower. Italy’s vote for Prime Minister will reflect the country’s vote for austerity. A Bersani win will be interpreted positively for Italian fiscal finances whereas a Berlusconi win will mean a return to the dangerous free spending days of a man nicknamed “Il Cavaliere” for his lavish lifestyle. Most likely if Bersani wins he would need to form a coalition with Mario Monti’s new centrists. The outcome of the Italian elections will drive euro flows at the beginning of the week but traders will quickly shift back to economic fundamentals on Wednesday / Thursday when we have Eurozone confidence, German unemployment and retail sales numbers.

Thanks to the FOMC minutes and weaker economic data abroad, the U.S. dollar enjoyed a nice rally against most of the major currencies last week. The mere possibility that the U.S. central bank could start to taper off its monthly asset purchase program as quickly as next month sent investors rushing to adjust their positions. The unevenness of U.S. data makes it hard to believe that the economy is strong enough to withstand less stimulus but Fed President and FOMC voter Dudley made it clear that small adjustments could be made to ease the pain of stimulus withdrawal. The question is now where Bernanke, our mild mannered inflation dove stands. The head of the U.S. central bank will be delivering his semi-annual testimony on the economy to Congress next week. It is always an interesting session to watch particularly since there is a colourful question and answer session. If he agrees that changes to the monthly asset purchase could be made, the dollar could extend its gains quickly. However if he vigorously defends the central bank’s ultra easy monetary policy and downplays the need to slow or stop their asset purchases, it could kill the dollar’s rally.

The rest of the week will be dominated by speculation about the future course of monetary policy in the UK and the US and whether Friday’s US budget sequestration can be avoided. Tomorrow will see four MPC members testify to the Treasury Select Committee. Three of the four voted for unchanged policy this month and their views will be of particular interest. Later in the day Fed Chairman Bernanke testifies to Congress. He will no doubt be asked about his views on fiscal policy and whether the Fed plans to taper its APF programme. In the meantime news out of Washington will be scrutinised for any signs of a compromise on the budget.

The contents of this report are for information purposes only. It is not intended as a recommendation to trade or a solicitation for funds. The author(s) cannot be held responsible for any loss or damages arising from any action taken following consideration of this information.

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