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Thursday December 20, 2007 - 11:25:08 GMT

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Forex Research - Dollar Books More Gains - Will PCE Force the Fed to Stop Cutting?


Thursday, 20 December 2007 10:12:29 GMT

Written by Boris Schlossberg, Senior Currency Strategist

Talking Points

•    Yen:  Trades around 113.00 as BOJ remains on hold
•    Pound:  Breaks 1.9900 as selling continues
•    Euro:  Data supportive but profit taking supersedes
•    US Dollar: PCE on tap

A relatively quiet night in currency trade as speculative flows are clearly winding down for the year and further profit taking in EURUSD continues. The greenback strengthened moderately into the London open with the pound losing another 100 points as the pair reached a low of 1.9877.

The decline in cable has been swift and vicious with markets now universally convinced that BoE is on the way to another rate cut in January. However, with the unit so badly oversold a small bounce to test the 2.0000 figure may well be due. Tomorrow’s UK Retail Sales are expected to register another lackluster reading but the report has actually surprised to the upside in the last 3 out of 4 months. Should the UK consumer demonstrate even a small degree of resiliency, traders may rethink their near unanimous assumption of imminent BoE easing and stage a short covering rally in GBPUSD.

Yet in the grander scheme of things sterling remains the weakest link amongst the majors especially if equity markets begin to top out next year. As we’ve noted many times before, the UK economy is basically a hedge fund economy and should global capital markets go into a funk in 2008, cable will be disproportionately affected.

Meanwhile the data out of the EZ was positive, but had little impact on trade. German consumer confidence recovered from a two year low to print at 4.5 versus 4.0 expected and in testament to the strength of the region’s recovery Italian unemployment fell to 5.9% - the lowest rate since records began in Q4 of 1992. Fundamentally the news remains supportive of the euro and confirms Jean-Claude Trichet’s emphasis on price stability rather than growth, but the unit still faces profit taking pressure and should today’s US data prove constrictive to the dollar could see a test of the 1.4300 figure in the North American session.

Although today’s US economic calendar is sparse  dominated primarily by the third and final revision of the Q3 GDP figures, the news may carry some value to the currency market focused on the core PCE reading.  The PCE data is the Fed’s favorite measure of inflation and should it be revised higher it could force the Fed to hold off on any additional monetary loosening until price pressures ease. That in turn could spur more dollar buying as the fears of yet another rate cut in January recede from trader’s minds and the profit taking in EURUSD continues to gain force.

Finally, today’s BOJ meeting provided no surprises for the market as the Japanese central bank kept the overnight lending rate at 50bp. In his press conference Governor Fukui noted that the “The process of risk re-evaluation triggered by the U.S. mortgage market will take a little bit more time.” The news confirms that BOJ will likely remain dormant at least through Q1 of 2008, but yen actually strengthened a bit in post announcement trade after Chinese authorities hiked rates for the sixth time this year .The rate moves will take effect from Friday with the deposit rate raised to 4.14% from 3.87% and the one-year lending rate to 7.47% from 7.29%. For the time being USDJPY is saddled with serious resistance at the 113.50 level, but if US inflation data and equity markets prove supportive the pair could make a run at that barrier later in the day.

What do you think will happen to the EUR/USD?
Join the discussion and voice your opinion on the DailyFX Forum.



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