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Market Commentary

Market Commentary: (Updated: Monday, July 12, 2010)

Europe continues to be at the center of the heated debate surrounding the global currency market. The fiscal erosion and deteriorating creditworthiness of southern European economies have weakened the near-term outlook of the EUR and triggered another round of disorderly currency adjustments and heightened global risk aversion. Also weighing down the EUR is the shift in market sentiment as concerns about the results of stress tests on European banks prompted investors to trim long positions in the regional currency. The European Central Bank is scheduled to release the outcome of the commercial bank stress tests on July 23rd. As expected, the ECB held rates steady at the most recent meeting. For the most part, the US dollar has been the primary beneficiary of increasing bearish sentiment towards the EUR with a revival of a flight-to-liquidity bias. However, most recently the USD has seen a bout of renewed weakness with recent talk that the US economy could be on the brink of a double dip recession. Persistent weakness in the labor and housing markets as well as discouraging manufacturing activity has instilled a negative USD sentiment. In Canada, the Canadian dollar is strongly supported by the strength of its financial system, high energy prices, and rising interest rates. In June, the Bank of Canada became the first central bank among the G7 nations to begin tightening interest rates after the financial crisis. All of these factors combined continues to make CAD a market favorite among global investors, proving that a move towards parity against the USD by year-end is very likely. In the UK, softening price pressures will allow the Bank of England to maintain a neutral policy stance over the coming months as officials expect inflation to fall back towards the 2 percent target. Nonetheless, the BoE is anticipated to hold its key rate at 0.50 percent at this month’s meeting and maintain its asset purchase target at GBP 200bn in an effort to encourage a sustainable recovery. In Japan, the late June global equity sell-off, combined with the sharp deterioration in the yield advantage that US bonds have enjoyed over their Japanese counterparts, helped push JPY to its strongest level since late 2009. However, Japan’s fundamental outlook suggests that this trend will be temporary. JPY is expected to weaken as risk aversion eases and speculators move back to net short against the yen as Japanese monetary dynamics leave it vulnerable to being used as a funding currency.

Renewed USD weakness, evidence of global economic slowdown, prolonged monetary stimulus in developed economies, and European banking sector audits continue to sway capital flows in global currency markets.

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