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Thursday March 6, 2008 - 23:38:59 GMT
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FOREX RESEARCH - 5 Reasons Why the US Dollar Will Continue to Fall

Written by Kathy Lien, Chief Strategist

• Don’t Expect Any Intervention from the ECB
• USD/JPY Hits 3 Year Low

5 Reasons Why the US Dollar Will Continue to Fall
The US dollar has fallen to a record low against the Euro and there are at least 5 reasons why the weakness will continue. The first is the most immediate, which is tomorrow’s non-farm payrolls report. Although the market is looking for a rebound in job growth, we actually believe that there could be significant job losses. As we mentioned in yesterday’s Daily Fundamentals, the last time service sector ISM contracted for 2 months in a row was back in late 2001. During that period there was actually 15 consecutive months of job losses with -300k being the biggest single month job loss and -147k the average. In comparison to these numbers, a back to back month of negative job growth seems like nothing. However if we do see two months of consecutive job losses, the dollar will continue to fall, taking the EURUSD up to another record high. The second reason is interest rates. Two year bond yields are currently yielding slightly more than 1.50 percent while the Fed Funds rate is at 3 percent. That is a difference of 150bp which means that in order for the gap to be neutral, the Fed would need to immediately cut interest rates by 150bp. Since 1990, the average spread between the 2 year treasury rates and Fed funds is approximately +50bp and over the past 10 years, it is +25bp. Therefore it is not rocket science to see that a gap of -150bp is a huge discrepancy. Lower interest rates equal a lower US dollar. The third reason is technicals. According to our Technical Analyst Jamie Saettele, a spike above 1.56 in the EUR/USD is very possible before dollar bulls see relief. Our latest FXCM Speculative Sentiment Index which is a contrarian indicator also calls for further gains in the Euro against the US dollar as speculative short positioning continues to grow. The hawkishness of the European Central Bank is the fifth and final reason why the US dollar could extend its losses. Not only did they leave interest rates unchanged today, but they also let the market know how serious they are about maintaining price stability, which means that rates should remain unchanged for the foreseeable future.

Don’t Expect Any Intervention from the ECB
The Euro hit an all time record high as ECB President Trichet left interest rates unchanged, remains hawkish and expresses no concern about the level of the currency. With the manufacturing and service sector continuing to expand, while retail sales and employment remain steady, there was no other choice for the ECB. Food and other commodity prices are hot and Trichet needs a strong currency and high interest rates to stand any chance of bringing inflation back below their 2 percent target. The Introductory statement was very hawkish with the words “price stability” used 8 times by Trichet. Although the ECB lowered their growth forecast, they upgraded their inflation forecasts, sending a strong message to the markets that interest rates will remain unchanged for some time. As for intervention, don’t expect the central bank to step in any time soon either verbally or physically. When Trichet used the words “brutal” to describe the currency’s move in 2004, the EUR/USD had rallied 13 percent in 2 months. Since the beginning of this year, the EUR/USD is only up 6 percent which explains why the central bank is not stressed about the latest moves. Meanwhile the Swiss franc is stronger across the board following a better than expected employment report. The unemployment rate dropped from 2.8 to 2.7 percent, a 5 ½ year low. Watch out for USD/CHF because could be the next currency pair to fall below parity.

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

USD/JPY Hits 3 Year Low
The 200 point drop in US stocks has triggered a round of selling in USD/JPY that took the currency pair down to a 3 year low. This is sure to put further strain on Japanese corporations who will see their profits dwindle as the US dollar continues to fall. The leading and coincident index both deteriorated in the month of January reflecting the softness of Japanese growth. There is no major support in USD/JPY until 101.70, the 2005 low. The S&P 500 and NASDAQ are also trading at the lowest levels since 2006. If this pessimism spills into Asia, we could see further weakness in the Yen crosses. At this time, the market’s appetite for risk is the only thing that matters.

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

British Pound Falls to Record Lows Against the Euro
The British pound fell to a record low against the Euro even though it climbed close to 1 percent against the US dollar. The divergent price action of the British pound indicates that the move in the currency pairs was driven not by the pound but by the Euro and US dollars. As the market expected, the Bank of England kept interest rates unchanged at 5.25 percent. No statement is released when the central bank fails to alter interest rates. The minutes will be released on March 19 and we suspect that some of members of the monetary policy committee such as Blanchflower voted in favor of cutting interest rates.

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

Australian, New Zealand and Canadian Dollars Sell Off

The Australian, New Zealand and Canadian dollars all sold off against the greenback. The biggest loser was the Aussie which was already suffering under the weight of a larger deficit. Imports were three times larger than exports which could be a growing problem as the US and Chinese economies begin to slow. There was no economic data released from New Zealand, but Canada actually reported stronger than expected IVEY PMI. After a series of disappointments, the surge to an 8 month high comes as a complete surprise. Canada will be releasing their employment report tomorrow morning before the US numbers. The rebound in the employment component of IVEY PMI suggests that employment growth should be stronger than the market’s 3k forecast.

Tell us what you think on the Canadian dollar Forum.

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