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Tuesday March 4, 2008 - 03:00:26 GMT

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FOREX RESEARCH - Should You Stay Short US Dollars?

Written by Kathy Lien, Chief Strategist

• Interest Rate Decisions Ahead for Australia and Canada
• Euro Hits New Highs, ECB Should Remain Hawkish

Should You Stay Short US Dollars?
It is no secret that the US dollar is weak especially since it has fallen to a new record low against the Euro and a 3 year low against the Japanese Yen today. However the EURUSD’s intraday correction has many traders wondering whether they should stay short US dollars. Fundamentally manufacturing PMI and construction spending were weak and we believe that the rest of this week’s US data should also be dollar negative. After last month’s horrid service sector ISM and non-farm payroll reports, the forecasts indicate that economists are hoping for a rebound in February that would suggest that the US economy is not doing as bad as everyone has feared. However this may be overly optimistic because on Main Street, it already feels like the US economy has fallen into a recession. The last time service sector PMI plunged to the levels that it did last month, 300k jobs were cut from US payrolls. Although we do believe that job losses will not be as severe in the month of February, we also do not believe that there will be a significant recovery. Dollar bulls have a lot more to lose than dollar bears not only with the NFP number, but also with the upcoming interest rate decisions. Six central banks are holding monetary policy meetings this week. All but one of them is expected to either leave interest rates unchanged or raise them. This will come in stark contrast with the Federal Reserve who is expected to cut interest rates by at least another 100bp before the end of the year. Fed fund futures are now pricing in a 76 percent chance that the Fed will cut interest rates by 75bp rate cut on March 18 and only a 24 percent chance that they will cut them by 50bp. In addition, according to the latest commitment of traders report, the 52 week COT index has yet to reach extreme levels which mean that more selling is possible, but shorter term readings are nearing those levels. Euro positioning on the other hand does not mirror that of the dollar which suggests that the Euro could climb to 1.55. Continuation is also the signal that is flashing from our FXCM Speculative Sentiment Index, which is why anyone already short US dollars should remain short.

Interest Rate Decisions Ahead for Australia and Canada
The Australian and Canadian dollars will be in play over the next 24 hours with monetary policy decisions expected from both countries. That is where the similarities end however because the Reserve of Australia is expected to raise interest rates by 25bp to 12 year highs while the Bank of Canada is expected to cut rates by 25bp to 3.75 percent. Another quarter point rate hike was priced in for Australia after the market learned that the RBA actually contemplated raising rates by 50bp at the last monetary policy meeting. Since then economic data from Australia only served to confirm the resiliency of the Australian economy. The labor market has been hot, and both manufacturing sector PMI and corporate profitability has rebounded. We also expect retail sales to be strong in the month of February. The only thing to watch out for is more neutral comments from the RBA. As for Canada, economic data has been soft and today’s GDP number indicates that growth slowed to a mere 0.8 percent in the fourth quarter. The weakness of growth has spurred some analysts to call for a half point cut from the Bank of Canada tomorrow. We believe that the BoC will only cut by 25bp but at the same time, they will remain dovish.

Tell us what you think on the Canadian dollar Forum.

Euro Hits New Highs, ECB Should Remain Hawkish
The Euro hit a new all time high of 1.5275 against the US dollar following stronger Eurozone economic data and weaker US numbers. The European Central Bank is widely expected to keep interest rates unchanged at 4.00 percent and as usual it will not be the rate decision that moves markets, but Trichet’s comments at the accompanying press conference. Recent economic data gives the central bank President all the justification that he needs to remain hawkish, especially as oil, gold and corn prices climb to record highs. Unlike the Federal Reserve, where Bernanke is placing greater emphasis on growth than inflation, the ECB devotes nearly 100 percent of their efforts towards fighting inflation. They have the unique luxury of doing so with economic data reflecting a relatively stable economy. Tomorrow’s Eurozone PPI and GDP numbers should confirm this trend. For that reason, we continue to believe that the EURUSD will press even higher and any retracement should be seen as an opportunity to add to long positions. Meanwhile, Switzerland will also be releasing consumer prices and GDP tomorrow. The franc is mixed and even though these are relatively important numbers, we doubt that it will have a lasting impact on the currency.

Visit the Euro Currency Room for resources dedicated specifically to the Euro.

British Pound Underperforms Despite Stronger Economic Data
The British pound underperformed both the Euro and US dollar despite stronger economic data which indicates that the market is just as bearish pounds as they are dollars. The rebound in manufacturing sector PMI last month is encouraging but not enough to offset the market’s caution ahead of Thursday’s Bank of England rate decision. Although the BoE is expected to leave interest rates unchanged, it should only be a matter of time before rates are reduced once again.

Visit the British Pound Currency Room for resources dedicated specifically to the Euro.

USDJPY Falls to 3 Year Lows
The US dollar fell to a 3 year low against the Japanese Yen on the back of stronger Japanese economic data, disappointing US data and continual weakness in US equities. Labor cash earnings jumped 1.0 percent in the month of January which suggests that the Japanese economy may be recovering. Meanwhile the NASDAQ dropped to the lowest level since October 2006 weighing on all carry trades.

Visit the Japanese Yen Currency Room for resources dedicated specifically to the Euro.





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