Dollar drifts lower against the euro

news.ft.com By Christopher Swann Published: January 22 2003 20:40 | Last Updated: January 22 2003 20:40

The euro continued to edge higher against the dollar on Wednesday amid mounting tensions between the US and Iraq.

The recent bout of more aggressive rhetoric from the US administration has kept the dollar under pressure in recent days. On Wednesday, the dollar hit a fresh three-year low against the euro at $1.0744.

Traders said that $1.10 now appeared in sight.

Risk reversals - an indication of the bias of the options market - provided an interesting hint into the psychology of the marketon Wednesday. Although euro calls continue to trade at a premium to euro puts - suggesting the market still expects a rising euro - this premium is at its lowest level so far this year.

Marc Chandler, chief currency strategist at HSBC in New York, said this could be explained by traders long of euros trying to hedge against a fall in the currency. "This hints that many of those who hold a long euro postion do want some protection, but are not willing to sell their spot position," he said. "This is an encouraging sign for the euro," he added.

Rising risk aversion in financial markets continued to support the Swiss franc - still the world's favoured safe-haven currency. The Swiss franc continued to hover close to the four-year highs hit against the dollar earlier in the week.

There was a grim inevitability to Venezuela's decision on Wednesday to shut down trading in the bolivar. So far this year the currency has fallen 24 per cent, following a 44 per cent slide last year. This is as close as a currency gets to sky diving.

Since the country's debilitating strike began six weeks ago foreign exchange reserves have fallen $1.9bn. An estimated $900m of reserves have been lost in the past week alone.

Given the poor historical record of capital controls, it is not surprising that some are questioning the sustainability of the Venezuelan move. "Capital controls tend to be quite leaky," said David Ross, emerging market economist at 4Cast, the economic consultancy. But most are viewing the measures as a mere expedient.

Hopes remain high that US mediation will bring about an acceptable solution. Marc Chandler, chief currency strategist at HSBC in New York, said that Venezuela's financial position gave cause for optimism.

Foreign debt servicing should total around $4bn this year. Foreign exchange reserves are still thought to stand at around $11bn.

When the strike does end, a sharp rise in the bolivar seems inevitable. But it will take a brave trader to try to pick the turning point.

"There is no sense standing in front of a freight train," said Mr Chandler.

The towering interest rates that have supported the Norwegian krone are gradually being chipped away. Wednesday's 50 basis point cut takes rates down to 6 per cent - the lowest level since June 2000.

Given how widely anticipated the cut was, it is little surprise that Norwegian krone failed to weaken. Indeed it strengthened against the euro. But this was a typical "sell the rumour, buy the fact" reaction from the market.

Opinion is now sharply divided about where the market goes next. Marc Chandler said that after a period of consolidation the Norwegian krone should regain some strength - supported by high interest rates and buoyant oil prices. "There is also little indication that the Norwegian authorities will intervene to combat the market," said Mr Chandler.

Others worry that the market's enthusiasm for the krone had gone way too far and a sustained period of profit taking is now in order.

Although policy makers have showed no enthusiasm for intervention, they have indicated their displeasure with the strength of the krone and have cut rates swiftly in order to diminish the currency's appeal.

The weak industrial production figures since the summer of last year in Norway, suggests that the strength of the exchange rate is now inflicting serious damage on the economy.

In addition, the krone's thin liquidity will make it hard for traders to exit their position in a hurry.