Currencies Struggle To Extend Gains

New highs were made in currencies overnight but this morning, the Euro and Swiss Franc are struggling to hold onto their gains. Both currencies rose to their strongest level in nearly two years against the U.S. dollar and demand for euros can be seen against all pairs. However without fundamental data to support the move to new highs, the EUR and CHF may find it difficult to extend beyond current levels in near term. In fact all of the major currencies are vulnerable to a near term correction until more significant U.S. data is released next week simply because many of the pairs have extended to extreme levels. Don't expect a deep correction though because the pressure on Treasury yields prevents a meaningful recovery in the dollar.

This morning's U.S. economic reports were mixed with jobless claims edging lower and the trade balance widening slightly. Claims fell to 350k in the week of October 19, down from 362k. Economists were looking for a stronger number but the release as a whole continues to be distorted by the backlog in California according to the Bureau of Labor Statistics. The agency also said they can't accurately determine how many non-federal workers filed for claims but Federal workers filed 44.1k claims two weeks ago. In other words, given the labor department's skepticism of jobless claims, the data is basically unreliable. In the month of August, the trade deficit rose to -$38.8B from -$38.6B. This small deterioration was better than expected and caused by stagnation in imports and exports.

EU Data
The euro, on the other hand, shrugged off weaker flash PMIs for the month of October. While manufacturing sector activity strengthened slightly this month, service sector activity slowed more significantly, causing the euro-zone PMI composite index to drop from 52.2 to 51.5. France experienced deterioration in both parts of the economy but Germany only saw slower growth in the service sector. Considering that this is the first decline in the PMI composite index since April, there's no need to ring alarms because faster manufacturing activity in China, the temporary resolution of the U.S. fiscal debt crisis and stronger investor demand (as measured by the ZEW) could fuel a recovery in the coming months.

Finally we still have our eyes on China. Manufacturing activity improved in the month of October according to HSBC but short term interest rates continue to rise rapidly. The seven-day repo rate is now at a four-month high and this move is caused by the central bank's decision to refrain from injecting liquidity this week. We will keep an eye on this story because a persistent rise in Chinese yields could add pressure on Asian stocks, translating into potential weakness for high beta currencies.

Kathy Lien, Managing Director of FX Strategy for BK Asset Management.