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Wednesday March 26, 2008 - 21:49:57 GMT
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Forex Research - Euro Breaks 1.58, Is the Next Stop 1.60?

Wednesday, 26 March 2008 21:35:01 GMT

Written by Kathy Lien, Chief Strategist

• Federal Reserve Needs to Continue to Cut Interest Rates
• Bank of England Still Expected to Cut Interest Rates

Euro Breaks 1.58, Is the Next Stop 1.60?

The Euro broke 1.58 against the US dollar today, leaving many traders wondering whether the next stop will be 1.60.  Economic data out of the Eurozone continues to beat expectations while data from the US consistently falls short. As we predicted in yesterday’s Daily Fundamentals, German business confidence improved in the month of March.  Once again, analysts had underestimated the resilience of German corporations even though the rise in the flash estimates for the service and manufacturing sector PMI reports should have given them a clue that business activity accelerated.   In fact, German businesses have not been this confident in 7 months.  Eurozone industrial new orders also increased strongly in the month of January, adding fuel to the rally in the EUR/USD.  The market completely ignored the sharp deterioration in the Eurozone current account balance which was the only thing that would have been impacted by the strength of the Euro.  Just from an economic data perspective, the EUR/USD has a good chance of testing 1.60.  Meanwhile, the big story of the day was French President Sarkozy’s call for the UK to join forces with them to pressure the US into strengthening the dollar.  That is nothing but wishful thinking considering that the US would never bow to the pressure of France or the UK at a time when they need a weak dollar to boost exports.  Although Trichet noted that excessive volatility in the currency market is undesirable for growth, he also added that there is “no need to change framework due to market turmoil.”  In other words, inflation is still a big problem and for that reason intervention is off the table for the ECB.  Earlier this month, we had said that the ECB would not consider verbal intervention until the EUR/USD broke 1.60.  In 2004, the last time the central bank become extremely worried about the movements in the Euro, the currency had rallied 13 percent in 2 months.  If we count 1.59 as the record high in the Euro, the currency pair has only appreciated 10 percent over the last 2 months.   A 13 percent move would put the EUR/USD at 1.62. 

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

Federal Reserve Needs to Continue to Cut Interest Rates

The Federal Reserve needs to continue to cut interest rates because the US economy is struggling to stay afloat. Durable goods plunged 1.7 percent last month with sales excluding autos dropping 2.6 percent.  New home sales also fell to a 13 year low with average prices declining from $250,800 to $244,100.  Unlike existing homes which were supported by the sale of foreclosures, lower prices failed to help the sale of new homes.  Not only are we already seeing a decline in consumer spending, but with housing market valuations continuing to fall, consumers may feel an even bigger pinch in their pocketbooks.  Fed fund futures have moved back to pricing in a fifty-fifty chance of a 25 or 50bp rate cut next month.  The volatility of rate cut expectations have made them increasingly unreliable.  If economic data continues to deteriorate, the Federal Reserve will naturally have to lean towards a larger rate cut.  Barry Ritholtz posted a fascinating chart in his blog today about discount window borrowing courtesy of Bill King.  In the past 28 years, there has been only 4 major jumps in the amount of borrowing by financial institutions at the Fed’s discount window.  The first was the Continental Illinois bailout in the 1980s, the second was the Savings and Loan Crisis, the third was 9/11 and the fourth is the current credit crisis.  With the Federal Reserve widening the range of acceptable collateral, banks have not been shy about tapping the discount rate window which indicates how troublesome the latest credit crisis has become. Tomorrow we have the final fourth quarter GDP numbers due for release; revisions are not expected.  

Bank of England Still Expected to Cut Interest Rates

The British pound has extended its gains against the US dollar but it continues to underperform the Euro.  Although there was no UK economic data released this morning, the market now believes that the Bank of England is on track to cut interest rates next month.  In a testimony before legislators, King admitted that given current market conditions, the central bank is more predisposed to cutting interest rates even though they are in no hurry to follow in the footsteps of the Federal Reserve who has taken historic measures in an attempt to stabilize the credit markets.  Bank of England member Sentence also reminded the markets about the difficult times ahead for the UK economy.  He argues that although concerns for a recession are overstated, consumer spending should continue to weaken. 

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

New Zealand and Canadian Dollars Pull Back, Australian Dollar Extends Gains

Compared to the beginning of the weak, the commodity currencies have taken a break as trading ranges narrow.  There was no economic data released from any of the three commodity producing countries over the past 24 hours and even a sharp jump in oil prices has failed to lift the Canadian dollar.  Only the New Zealand had news to report.  Finance Minister Cullen continued to warn that the New Zealand economy faces serious challenges and is not immune from the global slowdown.  These comments come ahead of the trade balance report which suggest that exports may have taken a hit in the month of February.  Australia will also be releasing their leading indicators numbers tonight; no bit surprises are expected because even though global growth is slowing, the Australian labor market has been hot.

Tell us what you think on the Canadian dollar Forum.

USDJPY Below 100

With both the US economy and Japanese economy weakening, USDJPY is back below 100.  The trade surplus narrowed significantly in the month of February and we expect this trend to continue given the sharp appreciation of the Japanese Yen this month.  Although this should help to reduce inflationary pressures, it will also take a big toll on the export dependent economy.

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

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By Kathy Lien, Chief Strategist of DailyFX.com

Contact Kathy Lien about this article at klien@dailyfx.com






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