EURO BREACHES $1.50 – WHAT NEXT?

Today’s FX View from IB:

Savvy investors could tell something was up earlier this morning as equity index futures pointed lower, while an earlier rally in the dollar index petered out. In typical knee-jerk reaction lower stocks should be followed by a stronger dollar as investors react to lower risk appetite. However, that argument is fast becoming untenable as earnings smash through expectations and equity market volatility slumps towards a reading of 20. The Vix has not traded below that value since August 2008. A wrong footing from the futures market today has created a perfect backdraft to hoist the euro above $1.50 as the dollar takes an all around shellacking making yesterday’s rally look like fool’s gold.

The euro reached $1.5003 according to in-house data at around 10amET on Wednesday. The S&P 500 index, bolstered by earnings-relief at Morgan Stanley, Wells Fargo and Yahoo!, rose towards 1100 despite seeing red before the market opened.

The rally in the euro stopped short of triggering more explosive buying, but traders should expect fresh longs in the event that this morning’s high-water mark is breached in coming sessions.

The British pound also rose sharply this morning following an opinion piece in a Scottish paper by the Bank of England governor, Mervyn King. He opened up a possible schism with the government by stating his opinion that investment banks should be made separate from payment processing banks to prevent a future bank failure and systemic collapse. Mr. King also stated that it would be wise to take into account the prospects for future increases in interest rates. Meanwhile freshly released MPC minutes revealed no schism in the opinions of voting member who agreed to maintain both the level of interest rates and the amount of the asset purchase program intact.

All of today’s sterling news was positive and has lifted the pound to $1.6621 while against the euro the pound gained a penny to 90.24 pence.

The dollar seems to be faced increasingly with a longer stay in the waiting room according to those investors favoring the euro amongst alternatives at present. Many other officials are already discussing raising rates, if not now, then at some point in the future. San Francisco Fed president, Janet Yellen yesterday affirmed that low rates at the Fed were here to stat for some time and that voting members were not yet at the point of determining how to withdraw stimulus just yet.

The changing interest rate environment is creating curious currency movements. Yesterday the Canadian dollar fell as though toppled by a local lumberjack after the Bank of Canada made close reference to overall monetary conditions. Interest rates and forex rates make up overall policy conditions and as we’ve known for some time, the rising Canadian dollar has the potential to suffocate recovery. Yesterday the BoC basically warned that a higher dollar would tighten conditions and delay monetary tightening.

However, down in New Zealand where the same situation has resulted in speculators piling into the local kiwi dollar, RBNZ head Allan Bollard basically sated the opposite when he noted that a stronger dollar wouldn’t push out the onset of monetary tightening.

At the end of the day something will crack – either the BoC will have it proved to them that the strength of the dollar didn’t matter, or speculators will realize that the BoC is right and they’ll abandon their chase. Today the Canadian dollar is once again surging against the dollar to stand at 95.81 U.S. cents.

As the euro hovers around $1.50 the big question is ‘where next?’ It appears to us that the move is not yet over and we’ll likely see a couple of cents more on top before the dollar can gather its thoughts. There are increasing statements from European aficionados who are openly calling the impact from a strong euro as dangerous. Until euro bulls recant, the dollar will stay under pressure.

Source: IB