Daily Foreign Exchange Market Overview - 20th September 2010

Currency Pair

Exchange Rate

GBP - USD

1.5638

GBP - EUR

1.1932

EUR - USD

1.3103

GBP - JPY

133.8400

GBP - CHF

1.5714

GBP - AUD

1.6514

GBP - CAD

1.6112

GBP - NZD

2.1396

GBP - SGD

2.0854

GBP - HKD

12.1443

GBP - CZK

29.3440

GBP - PLN

4.7036

GBP - SEK

10.9878

GBP - DKK

8.8837

GBP - NOK

9.4915

GBP - THB

47.7600

GBP - ZAR

11.0937

The British Pound was little changed last week, adding a meager 0.03 percent against a trade-weighted average of its major counterparts. Prices have been confined to a narrow range since the beginning of the month, with volatility readings lagging the spectrum of major currencies. The relative standstill has owed to a fairly stable monetary policy outlook, with traders seeing virtually no changes on the horizon for the foreseeable future, as well as a rapidly fading correlation with risk sentiment. Indeed, the link between the aforementioned trade-weighted average and the MSCI World Stock Index is now virtually nil while that of equities and typically risk-sensitive pairs like GBPJPY and GBPUSD has dropped below significant levels on 20-day percent change correlation studies.

Turning to scheduled event risk, the release of minutes from the last Bank of England policy meeting takes top billing. While traders will certainly pay close attention to the vote break-down on the rate-setting MPC committee as well as the rhetoric presented in the discussion leading up to the announcement, the likelihood of a material shift in the markets’ established outlook seems unlikely. The central bank has argued for some time that the upswing in prices since the beginning of 2010 owes to temporary factors, with the annualized inflation set to fall back below 2 percent by 2012. Given such a prolonged time frame, Mervyn King and company are surely going nowhere fast despite a promise to shift policy “in either direction” as needed, a comment likely directed at the domestic audience amid jitters about economic headwinds from the government’s austerity program. Indeed, a Credit Suisse gauge of rate hike expectations points to a static monetary policy for the coming year.

The remainder of the economic calendar is filled out with low-level releases, hinting that absent a re-coupling with risk appetite, range-bound conditions are likely to persist for the time being. Indeed, 1-week implied volatility readings suggest sterling price action will remain relatively quiet compared with the remainder of G10 FX space.

Fresh multi-month highs in the US S&P 500 and other financial asset classes made the risk-sensitive Euro top-performing G10 currency through the past week of trade, but a late-week reversal warns of a potential turnaround after significant gains. The EURUSD finally broke out of its tight month-long range on a surprisingly sharp US Dollar tumble. There was ostensibly little ‘reason’ for US Dollar losses, but we had earlier warned that currencies were poised for breakouts after an extended lull in volatility. The Euro’s next moves may be especially important as it has thus far shown relative inability to challenge multi-month highs against the US Dollar.

A relatively empty European economic calendar suggests that the Euro will need to take its cues from broader financial market sentiment and price swings. Traders should nonetheless watch for any especially large surprises out of upcoming German IFO business confidence results, while Euro Zone Consumer Confidence and other second-tier economic reports could also affect markets. The recent upswing in the US S&P 500 and broader financial market risk sentiment favors Euro gains against the safe-haven US Dollar. Yet examination of FX Options market sentiment suggests that the Euro may have reached an important sentiment extreme through very recent trading.

The benchmark dollar put in for a critical bearish break this past week. Though, the odd thing about this slip is that the complimentary speculative markets weren’t following the risk appetite track that would normally have catalyzed this move. In fact, it seems the greenback’s sudden drop would develop completely outside of the risk arena. Has the dollar broken free of its overbearing (negative) correlation to investor optimism? The answer to this question is the essential first step to reasonably projecting the dollar’s future. If the currency’s appeal as a liquid harbor for capital diminishes, its primary fundamental driver will be open to interpretation and therefore lacking the necessary influence to develop a meaningful trend.

There is a chance that the dollar could permanently lose its appeal as a safe haven and turn to a longer-term deterioration in its fundamental health that has to this point been ignored. In the government’s effort to encourage growth, the expansion of stimulus in turn boosts the money supply. This is a natural burden on the value of the domestic currency. However, to this point, the role of safe haven has been more important to traders. Now, in this period of respite for risk, investors can be shaken in their confidence as the Federal Reserve has the ability to abruptly increase stimulus. Last week, speculation that the central bank will increase its lending program ushered the dollar lower. The Fed will actually have this chance this week at the policy meeting. Will they increase stimulus beyond the $2 trillion floor? Unlikely. And, such an outcome would solidify the correlation and perhaps lower speculative confidence.

Aside from this big ticket event risk, it is worthwhile to keep a close eye on the factory and housing related data due through the week. The former has proven a sieve for consumer confidence and the latter is the last hope for a recovery that is quickly deflating.

DAY

TIME

CURRENCY

EVENT

MON

09:30

GBP

GBP Major Banks Mortgage Approvals (AUG)

MON

09:30

GBP

GBP M4 Money Supply (MoM) (AUG P)

MON

09:30

GBP

GBP M4 Money Supply (YoY) (AUG P)

MON

15:00

USD

USD NAHB Housing Market Index (SEP)