USD: Sentiment remains mixed (18th July 2008)

The dollar traded in tight ranges overnight, holding a 1.5822-1.5866 range against the EUR and a 106.10-106.46 range against the JPY. A late selloff in equities on Wall Street forced the dollar to concede the bulk of the day’s gain achieved by some early strong results from the banking sector. Crude prices fell sharply to below $130/bbl and looks on course for one of its most significant weekly declines seen this year. Nevertheless, we believe sentiment on the dollar remains decidedly mixed. Repeated assurances over the future of GSEs have managed to calm markets, but from a wider perspective, the saga of Fannie Mae and Freddie Mac’s future has dealt a blow to prestige of US assets and we believe a lot more action is necessary from the Fed and Treasury to restore confidence. Comments by the Kuwaiti Investment Authority’s leadership yesterday and a report in the Financial Times on investment intentions by reserve managers point to a growing sense of urgency amongst countries with large reserve holdings to shift into other assets. Such trends will continue to weigh on the dollar in the longer term. On the other hand, the outlook for the US and global economy, although still in flux, has decidedly improved for the better over the past quarter. The IMF has raised its forecast for global growth in 2008 but risks remain finely balanced. Inflation was identified as the key challenge to policymakers and this is consistent with our expectations that several G10 economies will need to tighten interest rates in the coming months. The dollar has been supported by losses in energy prices and although a combination of factors was behind the
move, concerns over weaker demand as the global economy cools has been a key element. Nevertheless we believe it may be too early to call the top in oil prices and the Fed’s inability to hike at this stage despite inflationary pressures will weigh on the dollar. Fluctuations in geopolitical risk premiums or long squeezes in oil accompanied by short squeezes in equity markets do not change the bigger picture. As such we continue to target EURUSD at 1.60 over 1 month reflecting US financial market concerns and elevated Eurozone inflation concerns. We target EURUSD at 1.53 over 3 months once we are more confident that oil’s impact on headline inflation is moderating. We are also short EURGBP as a trade recommendation, targeting the cross to fall to 0.74. There are no data out of the US today.