Talking Points
• Japanese Yen: back above 107.00 on better EURJOY flows
• Euro: Holds it gain in early Europe
• British Pound: Stalled at 1.9800
• Canadian Dollar: employment on tap
• US Dollar: Trade Balance on tap
A very quiet night of trade for the final session of the week as EURUSD held its gains in the wake of further problems in the US financial sector as investors questioned the solvency of Fannie Mae and Freddie Mac. The unit has now recovered almost all of its loses from last week after President Trichet uttered his famous four words of “I have no bias” and sent the currency tumbling on disappointing yield expectations.
This week however, euro strength came from a completely different source. The single currency is now being viewed as a safe haven refuge in contrast to the greenback which continues to suffer from the problems in the financial sector of the US economy. These problems raise serious doubts about the Fed’s ability to increase rates for the rest of the year, especially if the freefall in housing finds no bottom. With US rates therefore set at a paltry 2%, European short term instruments with their 4.25% rate of return look far more attractive even if the ECB decides not to tighten further in 2008.
In the meantime on the economic front, more news of elevated inflation readings from the EZ as German Wholesale Index rose to its highest annualized rate on record. Prices jumped 8.9% on higher energy costs. Energy continues to be the key macro economic driver of price in the FX market. After a small sell-off, crude is once again above the $140/bbl level and appears to be ready to vault past $150/bbl as tensions in the Middle East are reaching a boiling point.
Over the past several years euro and oil have had one of strongest positive correlations in the financial markets and while correlation does not necessarily mean causation, in this case there are good reasons why the two assets have mirrored each other. Higher crude prices have been the primary driver of headline inflation in the world. In fact on a core basis inflation has been relatively tame in the G-3 universe. Therefore with oil the primary culprit behind higher prices in the industrialized world, the currency market has made a direct connection between rising crude prices and escalating inflation. Thus, as long as ECB remains much more aggressive in battling inflation than the Fed, the EURUSD will continue to rise lock step with the price of crude.
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