By Zac, CountingPips.com
Today, I am pleased to share a forex interview/commentary on this week’s major events and forex trends with currency strategist at DailyFx.com, David Song. David studied macroeconomic policies under a visiting scholar at the Federal Reserve Bank of St. Louis while attending the Zicklin School of Business at Baruch College and incorporates both fundamentals and technicals in his analysis. David authors the daily briefings for the U.S. at DailyFx.com.
Q: Egypt has provided a new political factor in the markets to take note of this week. Can we look at the typical safe haven currencies to strengthen in the case of the situation becoming unstable? Which currencies would be worthwhile to monitor throughout this political crisis?
As tensions in Egypt intensify, the U.S. dollar and Swiss franc would be the two main beneficiaries from a flight to safety, while demands for the Japanese Yen could accelerate over the near-term as carry interest wanes. With political 
uncertainties bearing down on market sentiment, the Australian and New Zealand dollar are certainly at risk for a sharp reversal, and we may see a large break to the downside as investors scale back their appetite for risk.
Q: We have seen the euro continue to increase against the US dollar as well as a sharp rise in the futures commitment of traders report. Do you feel this is a fundamental change in sentiment for the euro that may last? Has the market put aside the worries of the sovereign debt crisis?
Indeed, demands for the euro have increased in recent weeks, but the short-term shift shouldn’t last for too long as European policy makers maintain a relaxed approach in addressing the sovereign debt crisis. With the turmoil in Egypt taking center stage, it seems as though the political tensions in North Africa have taken the spot light off of Europe, but the single-currency remains at risk as the EU fails to address the root cause of the crisis. It will certainly take some time to strengthen the European financial system as the governments operating under the fixed-exchange rate system face rising borrowing costs, and the risk for contagion may intensify over the coming months as the region copes with an uneven recovery.
Q: The US nonfarm payrolls government job report is due on Friday with the daily FX calendar showing an early projection of 135,000 jobs to be gained for January. Could a strong job result signify to the market a solid recovery is occurring in the US and would this necessarily coincide with US dollar strength?
A positive U.S. employment report could trigger a bullish reaction in the greenback, but the labor market still has ways to go to recoup the 8.5M job lost during the financial crisis. A 135K rise in non-farm payrolls is certainly a step in the right direction, but we would need to see a larger pick up in employment to underscore a solid recovery. Until we see the U.S. economy adding 500+K jobs on a monthly basis, the Fed is likely to retain a weakened outlook for growth and inflation, and the central bank may see scope to expand monetary policy further later this year as it aims to bring down unemployment.
Q: The British pound has had an interesting few weeks with a rise on higher than expected inflation and a potential outlook for a rate increase to a decline on worse than expected economic growth. Is the British currency inclined to show weakness on the outlook of the weak economic growth?
The British Pound may come under pressure this week as we expect the economic developments to reinforce a weakened outlook for future growth, and the risks for a double-dip recession could materialize going forward as the tough austerity measures dampen the prospects for a sustainable recovery. However, in light of the recent comments by the Bank of England, the hawkish tone held by the central bank should help to prop up the sterling, and the exchange rate may consolidate going into February as investors speculate the MPC to gradually normalize monetary policy later this year. In turn, the sterling may trend sideways ahead of the next interest rate decision on February 10, and there could be a growing split within the committee given the opposing views on growth and inflation.
Q: Does the GBP/USD seem to be overvalued at the moment near 1.6000 exchange rate?
Given the recent economic developments from the U.S. and U.K., a case could be made that the British Pound is overvalued after we saw the economy unexpectedly contract in the fourth-quarter. As the new coalition in the U.K. takes extraordinary steps to balance the budget deficit, the tough austerity measures are likely to bear down on the recovery, and the risk for a double-dip recession may materialize over the coming months as the government withdraws fiscal support. The recent strength behind the British Pound appears to be coming off of the hawkish tone held by the Bank of England, and the sterling may continue to retrace the decline from back in November as investors speculate the central bank to gradually normalize monetary policy later this year.
Q: The Reserve Bank of Australia’s interest rate decision is out this week with the RBA holding the interest rate steady. Due to it positive correlation with risk, do you feel the Aussie may be a risky prospect this week with a political crisis in Egypt and rate expectations holding steady?
As the Reserve Bank of Australia maintains its wait-and-see approach, a rise in risk aversion (flight to safety) coming off of the political crisis in Egypt could spark a sharp reversal in the Australian dollar. With Cyclone Yasi is expected to hit Australia this week, the natural disasters are likely to hamper the outlook for future growth as the region copes with the worst flood in eight decades, and the central bank may retain a neutral outlook for future policy as it expects inflation to stay within the 2-3 percent target over the medium-term.
Thank you David for taking the time for participating in this week’s forex interview. To read David’s latest currency analysis and trading strategies you can visit DailyFx.com.
