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GLOBAL GROWTH CONCERNS DRIVE RISK AVERSION
• Concerns over global growth weigh on markets and boost the USD.
• USDCAD continues to move higher as USD strength is ongoing.
• UK GDP growth disappoints at 0.1% q/q, but marks the end of record recession.
• Greece issues debt in market but at a premium to ensure success.
• Japan leaves monetary policy unchanged, S&P lowers country’s credit rating outlook.

FX Market Update

The USD is on firmer footing as concerns over global growth continue to have investors favouring risk averse positions. A warning on Japan’s rating, ongoing problems in Dubai, lower than expected Q4 UK GDP, risks over Portugal’s budget and confusion over China’s tightening stance have markets fairly bearish as we move into the North American open. Also giving the USD a boost is Obama’s proposal to freeze domestic spending for 3-years.
• As of yesterday the market was pricing in a 40% chance of a 25bpts Fed funds increase at the August 10 meeting and a 72% chance at the September 21st meeting. Just two weeks ago there was a 72% chance that the first hike would come at the August meeting. Accordingly, the market has pushed out the expectations for higher interest rates. However, over these same two weeks the USD has gained ground over every primary currency, with most currencies losing 3% (the one exception being Japan). We have reiterated that monetary policy and interest rates will be a significant driver of the USD this year, but over the last two weeks this has not held true. The main influences over the last few weeks have been: 1) The impact of sovereign risk on the EUR; 2) Concerns over the outlook for global growth if China continues to tighten monetary policy; 3) A changing political sphere in Washington; and 4) A shift in sentiment to a far less USD bearish position. Once these influences begin to stabilize, we think there will be a reversion to focusing on relative monetary policy. We expect tomorrow’s FOMC meeting to provide a fairly balanced statement, with the reference to ‘extended period’ in place.
• Today, we will receive an update on US housing prices through CaseShiller’s home price index, which is expected to increase +0.3% m/m. Consumer confidence is expected to rise to 53.5, but as the top chart highlights this is still historically low. C.S.

Americas

USDCAD (1.0643) • CAD is a mid performer today, having lost 0.6% against the USD, but outperforming most of the other commodity currencies. • The near-term drivers for USDCAD are mixed. As we noted above relative interest rates have not been a solid near-term driver of currencies. This is also true with USDCAD. Since the beginning of December the Canadian 2-year bond yield has been moving higher, gaining 20bpts over the last six weeks. The US 2-year bond yield has gained an advantage over the US 2-year but USDCAD has moved higher. Sentiment towards CAD had held in quite well, in light of recent price activity we suspect that this has waned somewhat. However working in favour of a higher USDCAD (weaker CAD) has been concerns over the outlook for global growth. This has been reflected through lower commodity prices, copper has held up well, however oil has dropped 11% from its December highs. Concerns over global growth and the impact of tighter Chinese monetary policy have also been evident in weakening equity prices. As the middle chart highlights, USDCAD and equities are still very much in sync. Accordingly for USDCAD to revert back to its medium term downward trend we will need to see some evidence that expectations for global growth have not been too bullish. As we look out to mid-year, we continue to expect CAD to outperform, however we are cautious in the near-term. • There is no domestic data in Canada until Friday, which will leave USDCAD trading off or risk aversion, the outlook for global growth and the broader USD move. Support lies at the 100-day moving average of 1.0565, while resistance comes in at the December high of 1.0747. C.S.

Europe

EURUSD (1.4074) • EUR is off 0.6% against the USD, though the currency is an outperformer today against a good number of the majors. EURUSD sold off through Asian trading as equities came under pressure, but stability was found above 1.4070 and EURUSD gained on the back of better than expected German IFO data which saw business confidence in Germany rise to its highest level in 18 months in January. The Greek issue that continues to plague EUR sentiment saw a bit of development today (we are hesitant to call it good news however) as Greece sold €8bn in 5-year bonds in the country's first debt issuance since being downgraded. Though such a sale looks positive on the surface, the government added a premium of 0.3% to comparable bonds already trading in the market in order to ensure a smooth issuance. The fact that this was required (the bonds initially yielded 6.2%) shows that the Greek issue is still nowhere from being resolved and thus markets will continue to require a risk premium for Greek assets. EURUSD topside resistance looks likely to be heavy at 1.42 while the downside of Friday's 1.4067 low (a level being threatened as we go to print) shows support. S.T.
GBPUSD (1.6117) • Sterling is one of the weaker performing majors today, off 0.8% against the USD though GBPUSD remains above its two week low (achieved on Friday) of 1.6078. A weaker than expected Q4 GDP print is responsible for the selling as the market looked for a gain of 0.4% q/q but received only 0.1% q/q. Services provided a drag relative to where expectations were set as the market looked for a greater than reported 0.1% expansion in that sector of the economy. This marks an end to the six quarter UK recession, though the degree to which the UK’s economy limped out the record long recession means that GBP sees no strong justification to rally out of its 1.5-month range that has been capped below 1.65. This also hits at the outlook for the Bank of England as the market has pushed short yields in the UK lower, with the two year interest rate swap having fallen past 2009 lows (see graphic). S.T.

Asia / Oceania

USDJPY (89.68) • The yen is being boosted by risk aversion and is the only currency to be recording gains against the USD with a very strong 0.7% increase. The Bank of Japan left its monetary policy unchanged, perhaps against the bias in the market that the BoJ would undertake additional policy steps to battle deflationary forces (helping support JPY today). The yen seems to have shaken off Standard and Poor’s lowering of the outlook on Japan’s sovereign credit rating on a slower than expected pace of fiscal consolidation. S&P cited the risk that the country could see its AA rating cut if economic data remained weak and measures to help support growth are not forthcoming. USDJPY has broken below 90 in the most convincing fashion since December and is now trading at a one month low. S.T.
USDCNY (6.8268) • It is being reported that Chinese banks have begun to restrict new loans on direction from financial regulators in the country. Asian equities sold off overnight with Chinese shares suffering some of the worst selling (Shanghai was down 2.4% while Shenzhen was off 3.1%). The global financial market environment continues to show concern for financial/monetary conditions in China, a factor which could continue to weigh on global bourses and commodities. S.T.

Commodities

Oil ($74.57) • Crude is down today, though still showing stability above support at $74. The market will await API crude inventory data this afternoon after last week’s 1802K decrease. Weekly inventories have on average fallen by around 1000K since the end of October. S.T.

Suggested Reading

Investors flock to Greek bond issue, Tony Barber, David Oakley, FT (January 25, 2010)
UK economy emerges from recession, Daniel Pimlott, FT (January 26, 2010)
Beijing acts to curtail bank lending binge, Jamil Anderlini, FT (January 26, 2010)
Budget Freeze is Proposed, Laura Meckler & Jonathan Weisman, WSJ (January 26, 2010)
Bernanke Gains Backing in Senate, Sudeep Reddy & Greg Hitt, WSJ (January 26, 2010)
Default-Bet Anomaly: Firms Over Countries, Gregory Zuckerman, WSJ (January 26, 2010)

Please consider voting for us in Euromoney's FX Poll 2010 between January 14 and February 26. The link can be found at http://www.euromoney.com/stub.aspx?stubid=92.
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Camilla Sutton, CFA, CMT Sacha Tihanyi
Currency Strategist Currency Strategist
Scotia Capital Scotia Capital
416-866-5470 416-862-3154
Camilla_sutton@scotiacapital.com Sacha_tihanyi@scotiacapital.com



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