Monday, May 19, 2008 Analysis

5/19/2008

Euro Awaits Crucial Surveys by A. Laidi

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It will be a crucial week for the euro as traders obtain two key reports on German business and investor sentiment surveys, which may prove instrumental in determining the next turning point in the currency. Tuesday’s release of the ZEW economic sentiment (5 am EST) is expected to show a retreat in the current situation index to 32 in May from 33.2 in April, and improvement in the economic sentiment index to -37 from -40.7. As the chart shows below, the current situation index has the stronger positive correlation with the ECB’s interest rate cycle. The April improvement in the index was the first since June 2007.

Wednesday’s release of the more influential IFO survey (4 am EST) will draw more attention due to the survey’s track record in triggering notable moves in the euro. Major moves in the index have served as catalysts in triggering the euro past big figures ($1.30, $1.40 and $1.50). After having posted an unexpected string of three consecutive monthly increases between January and March, the IFO’s climate index finally retreated in April to 102.4 from 104.8, the largest point drop since September 2001-- was instrumental in dragging the currency from its $1.60 high to $1.5650 in a matter of days. With the euro having consolidated mostly between $1.5650 and $1.5350 over the past 4 weeks, the currency requires fresh direction from the Eurozone for the latest signals in sentiment and growth expectations.

The chart below illustrates the close relationship between the IFO’s climate index and ECB interest rates. In the event that April’s 2.3 point drop (largest since Sep 2001) is followed by a May decline, then participants may argue that the April slump was more than a payback of the prior three increases, thus potentially portending for a new wave of economic slowdown in Germany. Consensus forecasts expect the climate index to drop to 102.0 from 102.4, the current situation index to drop to 108.0 from 108.4 and the expectations index at 96.4 from 96.8.

EURUSD has hit fresh 3-week highs on the second consecutive record high in oil at $127.64 per barrel after OPEC’s president said the world has enough oil and that the cartel will not call an early meeting prior to its scheduled September meeting. We’re unlikely to see EURUSD surpass the $1.5650-55 resistance prior to Tuesday’s data out of cautiousness ahead of the aforementioned releases from Germany. Although further weakness is expected from these reports, one should carefully weigh the role of persistent oil gains as a possible offset to euro weakness. Preliminary support stands at $1.5520, backed by 1.5450.

Sterling Awaits Retail Sales, BoE

Sterling’s latest strength is mainly a result of oil-driven oil weakness, which is fertile ground for sterling bears to function in this week on the Bank of England minutes (Wed), retail sales (Thur), CBI survey (Thur) and Q1 GDP (Fri). UK data have shown a remarkable consistency of undershooting forecast, leading to rapid and broad selling in the currency. Tune in to our Daily Video Commentary from CMC +for a detailed preview of these reports. Although upside may revisit the $1.9630s, we view this level as highly untenable for the ailing currency. Subsequent pressure stands at $1.9650. Sterling weakness to resurface, with preliminary support emerging at $1.9480, followed by 1.9430.

Aussie Extends to 24-Year High

The combination of dollar weakness, prolonged gold gains above $900 and renewed inflation worries in Australia has boosted the Aussie across the board, triggering fresh 24-highs against the dollar. Although the Reserve Bank of Australia has revised down its GDP forecast, it is expected to reiterate its inflation hawkishness, which may lend further support for the rallying currency. We have lifted our expectations for parity in AUDUSD to 80% from 50%. We expect the pair to test a new all time high at 0.9580 at which point we may see interim pullback to as low as 0.9450.

Analyst Bio

Ashraf Laidi, Chief FX Analyst at CMC Markets, oversees the analysis and forecasting functions of key currency pairs as well as decisions and trends of the major global central banks. Mr. Laidi is also responsible for education and informing clients on the essential dynamics underpinning FX markets.

Prior to joining CMC, Mr. Laidi has worked for such varied organizations as the United Nations, the World Bank, and Reuters. Mr. Laidi regularly provides expert opinion to various electronic, print and the broadcast media outlets.

Mr. Laidi has appeared regularly on CNBC-TV, Bloomberg TV, the BBC and PBS’ Nightly Business Report. His insights also appear in the Financial Times, The Wall Street Journal, Barron’s, The New York Times, CBS Marketwatch, TheStreet.com, Futures Magazine and a host of other international publications.