Weekly Market Commentary

Will the world stop using the dollar to settle oil trades between counterparties?

The British newspaper The Independent reported on Tuesday that Gulf Arab states were in secret talks with Russia, China, Japan and France to replace the US dollar with a basket of currencies in the trading of oil. It cited unidentified sources from Gulf Arab states and Chinese banking sources in Hong Kong.

The newspaper said the proposal was for trade in crude oil to move over nine years to a basket of currencies including the Japanese yen and Chinese yuan, the euro, gold and a new, unified currency planned for nations in the Gulf Cooperation Council, including Saudi Arabia, the United Arab Emirates, Kuwait and Qatar. While ending the use of the dollar as the currency used to settle oil trades between counterparties - as Iran has already done - would be relatively easy, replacing the currency in which oil is priced would require a massive effort.

The dollar was also penalised by the US Employment Report last Friday. The US economy has shed 263,000 jobs in September and the unemployment rate rose to 9.80 per cent, reaching its highest level since June 1983 after 21 consecutive months of job destruction! These statistics call for a continuation of the status quo of the US Federal Reserve on interest rates. That prospect has been weighing on the dollar for several weeks now and there is growing speculation that it may replace the yen as the funding currency for "carry trades", where investors borrow in low-yielding currencies to buy assets with more attractive returns.

This bearish news for the US dollar offset the remarks by the President of the European Central Bank, Jean Claude Trichet, who said that the need to rebalance the global economy does not mean at all that the dollar should depreciate against the euro. On the question whether such balancing should result in a weaker dollar and a stronger euro, he said, "this does not imply any modification of the bilateral position between the dollar and the euro, not at all".

The dollar was supported by the US Treasury Secretary Timothy Geithner, who spoke last week about the importance of a strong currency for the United States. "A strong dollar is very important for this country, I mean it and it is important that people understand this," he told a forum. The United States intends to live within its means and not spend so much and create budget deficits as in the past, he said. We must persuade the rest of the world.

In our opinion, the fact that the G7 meeting omitted to state any common view in its statement that it is in the best interest to have a stable (not to say strong) dollar has also sent a signal to the market and some traders who think the "punish the printers" mantra is very much alive. ("Punish the printers" sell currencies of central banks which are expanding their balance sheets fastest). We still think the US dollar will strengthen against the euro. The Fed is unlikely to tighten policy until well into next year, but so is the ECB.

This week we expect President Trichet to use the ECB monthly meeting to reiterate the Central Bank will keep rates low for the next two to three quarters. As a result EUR/USD is likely to keep driven by investor confidence globally while USD/JPY will remain under pressure as Japan's new government keeps signalling that it is willing to live with the JPY at current levels.

Upcoming FX Key events

The BoE and ECB have their monetary policy meetings today. Although there are no expectations of a rate change, any statements/comments regarding exit from loose monetary policy, currency strength, etc. from either central bank will be closely watched by the market.

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FX Technical Key points

EUR/USD is bearish, target 1.4420, key reversal point 1.4850

USD/JPY bearish, target 87.10, key reversal point 91.70

GBP/USD is bearish, target 1.5050, key reversal point 1.6200

USD/CHF is bearish, target 1.0150, key reversal point 1.0550

AUD/USD is bullish, target 0.9000, key reversal point 0.8600

NZD/USD is bullish, target 0.7550, key reversal point 0.7000.

Mr Longchamp is head of trading at RTFX Ltd.

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