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Saturday July 26, 2008 - 02:25:59 GMT

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Forex Research - Dollar Rallies on Strong Data, but Watch Out for a Big Week

• The ECB Has Room to Raise Interest Rates?!
• Is the UK Headed for a Recession?

Dollar Rallies on Strong Data, but Watch Out for a Big Week
Stronger economic data has driven the US dollar higher against many of the major currencies. New home sales, consumer confidence and durable goods were all better than the market expected, a sign that the mood of US consumers and businesses may be changing. The number of new homes sold in the month of June was more than the market expected, but the big surprise was the 50,000 unit revision to the past 3 months of data and the reduction in inventory. The numbers indicate that there is still decent activity in the housing market and even though house prices are down on an annualized basis, the median price of a home sold has increased from the prior month. The final University of Michigan consumer confidence numbers also rebounded to a 3 month high after falling to a 28 year low in June while durable goods increased 0.8 percent compared to the market’s -0.3 percent forecast. Today’s economic releases were almost too good to be true and for that reason, we are cautiously bullish. With that said, it is quite impressive that the US dollar has shaken off risk aversion. The divergence between the price action of the US dollar, the stock market, gold and oil prices indicate that risk aversion yesterday was limited despite the 280 point drop in the Dow. If you recall, the dollar dropped only against the Japanese Yen, and rallied against all of the other G10 currencies. Looking ahead, consumer confidence and house prices are due for release on Tuesday. Given this week’s upside surprises, both reports could be dollar bullish. However second quarter GDP, non-farm payrolls and manufacturing ISM which are due at the end of the week could turn things around for the dollar. There have been no end to the layoff announcements and not only do we believe that non-farm payrolls will drop for the seventh straight month, but the job losses could be far worse than the market’s -75k forecast.

The ECB Has Room to Raise Interest Rates?!
The Euro strengthened against the US dollar but the rally has been marginal. Unsurprisingly, inflation last month was hot with import prices rising 1.5 percent in Germany. Despite the recent deterioration in Eurozone economic data, European Central Bank officials have been revving up their degree of hawkishness which leads many people to wonder whether the ECB is digging themselves into a hole. ECB member Liebscher said this morning that the central bank has room to raise interest rates and that it is absolutely necessary to prevent any possibilities of so-called second-round effects. Unlike the Federal Reserve who needs to worry about growth as much as inflation, targeting inflation is the ECB’s primary focus. In order to get their attention, we may need to start seeing negative quarterly GDP growth. The central bank only worries about growth when it has fallen below potential. Recent economic data clearly indicates that the region is slowing and if oil prices remain at $125 a barrel, the ECB’s concerns about inflation will start to ease, allowing them to become more sensitive to growth. In the week ahead, retail PMI and German unemployment are the big Eurozone releases. We expect this data to continue to be Euro bearish. Meanwhile Switzerland will be releasing the UBS Consumption Index and the KoF report of leading indicators.

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

Is the UK Headed for a Recession?
GDP growth slowed in the second quarter, but the British pound managed to rally. The pace of growth has fallen from an annualized rate of 2.3 to 1.6 percent, the lowest level since the first quarter of 2002 and equaling the 15 year low. Weak consumer spending has been the primary drag on the UK economy and given the recent trend of growth, the country could be headed for a recession which is defined by 2 quarters of negative GDP growth. The pace of deterioration in the UK economy has picked up towards the end of the second quarter which implies that unless there is a serious turnaround in the UK economy, the country could be headed for a contraction in the third quarter. We are bearish British pounds and expect the currency to underperform many of the major currencies. Aside from manufacturing PMI and some housing market data, the UK economic calendar is relatively light next week.

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

Oil Prices Continue to Fall, Taking the Canadian Dollar Lower
There was no economic data released from the 3 commodity producing countries today, leaving the price action of the currencies dependent upon oil prices. Crude continues to trend lower and ended the day at $123.39 a barrel. This has weighed heavily on the Canadian, Australian and New Zealand dollars. Although oil and gold prices will continue to play a big role in the price action of the commodity currencies, there are a few pieces of key data worth watching next week. New Zealand and Australia both have trade data due for release, Australia also has retail sales while Canada will be releasing their GDP report for the month of May.

Tell us what you think on the Canadian dollar Forum. 

Yen Crosses Rebound as Risk Appetite Stabilizes
The Japanese Yen crosses rebounded today as the stock market and risk appetite stabilizes. Like the rest of the world, Japan has also been hit by inflationary pressures. The latest inflation data shows that core inflation has hit a 10 year high due to rising food and gasoline prices. This has been a huge drag on the Japanese economy and part of the reason why the trade surplus fell for the first time in 5 years last month. The deterioration in trade was significant with the surplus falling a whopping 89 percent in June. Japan is having a particularly tough time with slowing export demand and surging import prices, which is why the BoJ has turned bearish on the economy. There are a lot of Japanese economic data due next week including the jobless rate, retail sales and industrial production.

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


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By Kathy Lien, Chief Strategist of

Contact Kathy Lien about this article at [email protected]


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