Fundamental Analysis, Sept 07

Sept 07

EUR/US$

The dollar was unable to make any headway against the Euro on Friday and weakened sharply to lows near 1.38 after the US data before rallying modestly as the Euro came under pressure against the yen. The dollar's trade-weighted index also dipped to a 15-year low.

The US employment report was sharply weaker than expected with a 4,000 decline in employment, the first monthly fall for over four years. Markets were braced for a figure below 100,000 given the weak ADP report, but the outcome was still a surprise. The unemployment rate held at 4.6%, although the survey also indicated that employment fell as workers left the labour force. Within the data, there was a sharp drop in manufacturing employment and an unusual drop in government jobs.

Although, the manufacturing and government sectors may recover next month, the data will reinforce expectations that the US economy is deteriorating rapidly. There will also be additional pressure for the Federal Reserve to cut interest rates aggressively to help support the economy with markets calling for a 0.5% cut in interest rates at or before the September meeting. The Fed will still want to take a cautious approach and the data was not as weak as the headline suggested but it will be increasingly difficult to resist a reduction in rates.

ECB officials issued mixed comments on Friday as firm comments on inflation were offset by caution over the state of global financial markets. ECB member Stark, for example, stated that the bank must be continuously vigilant while Bundesbank President Weber stated that the bank should respond to the data.

Yen:

The dollar was unable to make significant headway above the 115.20 level on Friday and weakened sharply after the US employment data with lows close to 113.10 while the yen also gained on the major crosses.

There is a continuing risk that carry trades will be scaled back as credit fears continue, especially after the poor US data reinforced fears over the growth outlook. These risks will escalate if there is further sustained downward pressure on global stock markets and, especially, if there are reports of more extensive difficulties within the global banks.

Japanese institutions are still promoting investment trusts strongly with launches valued at close to US$0.8bn due on Friday and these funds will invest in overseas bonds which will tend to undermine yen demand to some extent.

Sterling

Sterling found support below the 2.02 level against the dollar on Friday and strengthened sharply to highs above 2.03 after the particularly weak US employment report. The UK currency was unable to sustain the gains and also weakened to near 0.6790 against the Euro.

Global risk tolerances deteriorated again on Friday with strong yen and Swiss franc buying. Flows into these currencies will tend to weaken Sterling as carry trades are scaled back even if dollar weakness provides an important cushion.

The UK data will be watched very closely next week for further evidence on the economic trends with the retail sales data likely to be particularly important on Thursday. Any comments from Bank of England officials will also be watched closely as the bank remains under pressure to ease money-market stresses. Speculation that interest rates have peaked will undermine Sterling support.

Swiss franc

The dollar was unable to secure any significant support above the 1.20 level against the franc on Friday and weakened sharply after the US employment data. The Swiss currency also made strong headway against the Euro with gains to near 1.6350 and the drop below 1.19 against the dollar will further undermine dollar confidence.

The US employment data has increased global risk aversion and triggered a further unwinding of carry trades which will help underpin the franc in the short term as there will be much reduced confidence in using the franc as a funding currency.

Australian dollar

The Australian dollar has tested resistance levels close to 0.83 against the US currency. The Australian currency initially secured support from cautious buying with Australian yields seen as attractive.

There were no major domestic influences on Friday and international trends will tend to remain dominant in the short term. The net risks surrounding the credit markets have increased after the sharp Wall Street losses and this will tend to reverse high-yield buying support, especially with risk aversion remaining at elevated levels. These risks undermined the currency with the Australian currency retreating to 0.8260 later in US trading despite heavy US dollar losses against the Euro.

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