BBH Weekly FXView: The Luck of the Irish

The dollar rally continued with gains against most currencies in the G10 except the Swiss France, Swedish Krona and Canadian Dollar; although euro downtrend is testing support around the 200-day moving average after retracing nearly all of the QEII “sell the rumor” trade. Meanwhile, the dollar has benefited from geopolitical tensions, China tightening fears and, most importantly, the concerns over the euro-zone sovereign debt issues as investors have flocked to the safe haven, though US economic data have begun to show marked improvement, suggesting the dollar strength may, in fact, be more than just euro weakness.

Outside of the trade balance on Friday the economic calendar in the US is light. And along with only a few important prints from the euro-zone, such as industrial production, the main driver will likely continue to be events. Indeed, over the past few weeks events have been the key driver in the G10 as data has been largely ignored. That said, the key event of the week that may pose the most risk for investors is the Irish budget meeting on Tuesday (12/7). After the by-election on 11/25 the majority’s Fianna Fail party maintains just a two seat majority. More important, though, is that the budget is contested by the minority Fine Gail party and it is highly uncertain if Fianna Fail will have the votes to pass. A failure to pass the budget would be catastrophic for the Irish government and may even call in to question the recent IMF/EU loan of €85bln. Elsewhere, the Portugal’s government publishes a report on the health of the banks on Monday (12/6).

Next week we have four central bank rate announcements in the G10 with the Reserve Bank of Australia announcement on Monday (12/6), Bank of Canada (BoC) announcement on Tuesday (12/7), the Reserve Bank of New Zealand announcement on Wednesday (12/8) and the Bank of England announcement on Thursday (12/9). According to the consensus survey, all four central banks are expected to remain on hold with OIS swaps pricing in the highest probability of a surprise hike (20%) by the BoC.

Short-term trading recommendations:

Considering taking profit from AUD/JPY at current levels with a stop of 80.76
The Australian economy is clearly slowing after its economic data surprises was one of the worst performers over the past week. With the uncertainty over the Irish budget it would be a good time to pare back on risky trades ahead of the meeting.

Stay Long USD/JPY at current levels with a stop of JPY82.46
With US yields on the rise and Japanese yields most likely stuck, this attempts to exploit the interest rate differential between the US and Japan as the US economy recovers faster than Japan and as inflation expectations moderate on QEII. We expect an above consensus jobs report tomorrow and would like to be long dollar but considering taking profit ahead of the Irish budget meeting. Overall, we target of JPY85.

Enter short AUD/CAD at current levels with a stop of 0.9659
The US economy is showing signs of improvement while China grapples with inflation and further interest rate hikes loom. That said, with Canada’s strong ties to the US economy and Australia’s strong ties to the Chinese economy this trade attempts to exploit the difference between the immediate growth outlooks between the US and Chinese economy with the S&P outperforming the Shanghai.

Enter short EUR/NOK at 8.10 with a stop of 8.15
Despite the recent rally the issues in peripheral Europe are far from resolved. Ireland needs to pass its budget, for one, along with the concerns over Portugal and Spain. Combined Portugal and Spain have heavy redemption schedules in January, February and March, totaling nearly €42bln. In addition, any weakness in the Spanish housing or labor market could weigh the private sector banking system. We have a medium-term target of 7.88.