Saturday, June 26, 2010

Uncertainty to keep investors cautious

NEW YORK: Unanswered questions about the U.S. economy, China's exchange rate and Europe's debt woes are likely to keep currency traders cautious next week, starting Monday June 28, a development that should favor the dollar over the euro.

For investors able to take a longer view, however, the best buying opportunities are likely to involve currencies such as those of Australia and Canada, which boast commodity riches, low debt burdens, policy flexibility and close links with fast-growing developing markets.

Analysts expect the euro, which neared $1.25 this week after plumbing a multi-year low beneath $1.19 in early June, to retreat toward $1.20 in the days ahead as central bank buying fades and worries about euro zone debt burdens linger.

"We think the euro relief rally has come and gone. There's no momentum left," said BNY Mellon strategist Michael Woolfolk. "Frankly, it demonstrates how few people want to remain long euros. It's just a question of how short one wants to be."

Investors will also keep one eye on China's yuan a week after Beijing said it would loosen the currency's peg against the dollar and allow more exchange rate flexibility.

The yuan's moves since the announcement have been minor, but Chinese authorities did set the yuan's daily reference rate -- the mid-point of its daily trading range -- at 6.7896 on Friday, the highest level since its July 2005 revaluation.

"It's an issue that's going to percolate for some time, as a policy announcement is simply insufficient for rapidly changing a grossly undervalued exchange rate," said Lawrence Goodman, president of the New York-based Center for Financial Stability, a non-profit financial think tank.


Runaway deficits in several euro zone countries and the severe spending cuts needed to rein them in have hurt the euro on the view that the euro zone will grow much more slowly than the U.S. economy.

But U.S. data has raised some questions about the strength of recovery across the Atlantic, with labor and housing in particular causing concern. The Federal Reserve unnerved markets this week with dovish remarks on the economic outlook, which were interpreted by some as meaning record low interest rates could stay on hold until well into 2011.

To that end, analysts said next week's U.S. employment, manufacturing and consumer confidence data would be important. Economics polled by Reuters expect employers cut 100,000 jobs in June, reflecting the end of temporary census hiring.

The immediate impact of soft data would likely be dollar positive, as anxious investors sell higher-risk currencies and assets and take refuge in the dollar.

Uncertainty about the strength of U.S. recovery, though, may start nipping at the dollar's heels if investors ditch expectations of tighter U.S. monetary and fiscal policy.


Debate about how quickly countries should move away from emergency stimulus spending and toward fiscal and monetary belt-tightening was also dominating a G20 summit in Toronto.

The United States has warned against implementing austerity plans too quickly, while Germany says such moves are needed urgently.

"The divergence in opinion is not entirely irrelevant to foreign exchange markets," said Credit Agricole strategist Daragh Maher. He noted that sterling rallied sharply against the euro and dollar this week after Britain's government announced its most austere budget in a generation, convincing investors it was serious about cutting its deficit.

It is in this area, some analysts say, that smaller currencies like the Canadian and Australian dollars look especially attractive, as both those economies are growing and have much more favorable fiscal positions than do the larger U.S. euro zone and Japanese economies.

Goodman said countries with "fiscal space," or the ability to expand public spending efforts if needed, should prove the most attractive buying opportunities. These include currencies from Australia, Canada, Russia, Chile and Singapore.

Countries already laboring under high debt burdens and with less room to increase spending are less attractive.

"Now more than ever," he said, "balance sheets matter for currencies." - Reuters

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