Central Banks buying euro at $1.35 says UBS

Central banks are rumored to be buying euros at $1.35, boding poorly for long-term dollar prospects, according to the UBS Investor’s Guide report dated 6 July 2007. In spite of solid data and the Fed emphasizing inflation risk in its last meeting, EURUSD has moved steadily upwards. The rebuilding of emerging market and G10 carry positions has been USD-negative. EURUSD continues to follow yield expectations, and as markets are again slightly biased towards Fed easing (although not expecting cuts) and looking for more hikes by the ECB, EURUSD has trudged on upwards. Credit scares in US markets weighed broadly on the USD. A major surprise could test the strong technical resistance at 1.3668: UBS analysts think such a surprise is more likely to come from the US, as markets are already expecting strong European figures. It will certainly take more than dismal US housing figures, as these no longer shock anybody.

 

No Japan rate hike?

From a technical perspective, USDJPY is at a crucial level. Since peaking at 124, USDJPY has been in a correction phase, which is crossing the uptrend dating back to this February, note UBS analysts. So far, these corrections have been yen-selling opportunities, while fundamentals are indicative of a lower USDJPY.

If a breakout below the uptrend occurs, UBS Research see sharp downward moves. The

short-tem-biased Asian community is extremely JPY-short, which would lead to rapid unwinding of existing positions. In such an environment, moves to 120 or even 119 could happen in a matter of days. So far, UBS analysts are sticking to their peak view of 125, but  would set a stop loss at 121.7.

Regarding the upcoming BoJ rate decision, UBS Research do not expect a surprise 25 bp hike, assuming instead that the BoJ will remain on hold until August. Verbal statements to support the JPY are in our view of little help if they do not lead to higher overnight rates, as happened in Switzerland.

 

Testing the bottom of its range

USDCHF temporarily fell below 1.21 recently, for two different reasons. First, the

CHF strengthened as a result of Swiss National Bank (SNB) intervention in the repo market; later, the USD weakened because of the strong performance of high-yielding

currencies. “In our view, USDCHF will remain trapped in its trading range between 1.20 and 1.26, so we see limited USDCHF downward potential,” note UBS analysts. The CHF – a favorite funding currency for carry trades – will remain at its present level as a result of the current risk-loving environment, and the intervention of the SNB will prevent it from weakening much further. At the same time, we think the USD weakness may be overdone in the current environment, but could become worse later in the year, conclude UBS analysts.