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Tuesday August 5, 2008 - 22:58:20 GMT

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Forex - US Dollar: Will the Bulls Bail Out as FOMC Leaves Rates at 2.00%, Signals Neutral Stance Going Forward?


• British Pound Manages to Hold Above Support At 1.9525
• Commodity Currencies: Aussie Gets Slammed as the Reserve Bank of Australia Turns Dovish

US Dollar: Will the Bulls Bail Out as FOMC Leaves Rates at 2.00%, Signals Neutral Stance Going Forward?

The Federal Reserve left rates unchanged at 2.00 percent – as expected – but as usual, it was the FOMC’s policy statement that made all the difference for the US dollar. The Committee essentially said that they would leave rates steady at 2.00 percent going forward, as they noted downside risks to growth and upside risks to inflation. Furthermore, the statement said that “the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity should help to promote moderate economic growth.” With the FOMC shying away from their hawkish bias, fed fund futures are now only pricing in a 25.8 percent chance of a 25bp hike in September, down from 30.2 percent yesterday. This is why the greenback edged back versus many of the majors, though the currency has struggled to move against the euro. Indeed, we tend to see that when it comes to FOMC rate decisions and policy statements, the underlying sentiment does not always feed through until the next day. Meanwhile, business activity in the non-manufacturing sector, which composes a large majority of US GDP, contracted for the second consecutive month in July according to the latest ISM survey. However, the index did manage to rise slightly to a reading of 49.5 from 48.2 thanks to a jump in the employment component to 47.1 from 43.8. Nevertheless, this still indicates worsening labor market conditions. My fundamental bias for the US dollar on Wednesday: bearish. Overall, the odds are becoming stacked against US dollar bulls given these recent developments and there are no major economic releases scheduled tomorrow to help counter this sentiment.

Euro Struggles Under Weight of Weak Euro-zone Retail Sales – Chance for Recovery Tomorrow

Economic indicators out of the Euro-zone continue to disappoint, as retail sales dropped 0.6 percent during the month of June, dragging the annual rate of growth down to a worse-than-expected -3.1 percent. Likewise, Euro-zone services PMI was confirmed at a reading of 48.3 in July, down from 49.1, which marks not only the second straight month of contraction but also a five year low. While ECB President Jean-Claude Trichet was fairly clear in stating that there were significant downside risks to growth during his monthly press conference in July, when the central bank hiked rates to 4.25 percent, he maintained that growth was “moderate” and “ongoing.” However, given these broad indications of slowing expansion, Mr. Trichet may be more inclined to admit the deterioration in the economy during his 8:30 EDT press conference on Thursday. Looking ahead to Wednesday, German factory orders are expected to rise slightly during the month of June, but the annual rate is anticipated to drop to -4.7 percent. While the PMI Manufacturing reports for Germany during that period did reflect growth during that month, the index has steadily fallen throughout the year, creating some downside risks for this release. However, the currency is more likely to continue trading as an anti-dollar vehicle throughout the day, and as a result, lingering sentiment from the FOMC’s policy statement may have a greater impact. My fundamental bias for the euro on Wednesday: bullish. Check out our Chief Strategist’s forecast for EUR/USD.

British Pound Manages to Hold Above Support At 1.9525

The British pound tumbled toward support at 1.9525 on Tuesday as UK industrial output contracted for the second month in a row and kept the annual rate down to -1.6 percent. While energy and mining producers are keeping pace, manufacturers are clearly suffering as output has fallen negative in five of the past seven months. Looking ahead to tomorrow morning, we’ll see the release of BRC Shop Prices for the month of July, but given persistent price growth in the UK economy, there’s some upside potential for this report. However, I think that like the euro, the British pound may trade more based on anti-dollar sentiment. As a result, my fundamental bias for the British pound on Wednesday is bullish.

Commodity Currencies: Aussie Gets Slammed as the Reserve Bank of Australia Turns Dovish

Broad declines in commodities like oil and gold led the Canadian, New Zealand, and Australian dollars lower, but AUD/USD took a particularly hard hit thanks to dovish sentiment by the Reserve Bank of Australia. Indeed, the RBA left rates steady as expected at 7.25 percent, but the Board’s policy statement was straightforward in suggesting that their next move would likely be a rate cut, as they said, “with demand slowing, the Board’s view is that scope to move towards a less restrictive stance of monetary policy in the period ahead is increasing.” While the most recent CPI numbers were surprisingly strong, indicators of economic growth in Australia have been broadly weak and the upcoming releases of the Home Loan Index and AiG’s Performance of Construction Index are anticipated to reflect the same thing. Likewise, Canada’s Ivey PMI report is forecasted to fall to a reading of 61.0 from 69.6 in July, pointing towards rapidly deteriorating business activity. My fundamental bias for the Australian and Canadian dollars on Wednesday: bearish. However, traders should beware of sharp moves in oil and gold, as this could shake up the currencies.

Japanese Yen Holds Despite Rally In Equities

The Japanese yen rose slightly versus the majority of the majors, but fell against the US dollar as indicators of risk sentiment – such as the CBOE’s VIX Index – declined while and US equity markets rallied. There was no pertinent economic data on hand for the currency, though it’s questionable if that matters as the yen is likely waiting for the next big shift in risk appetite market-wide. Like many markets, indexes like the DJIA may not fully respond to the Federal Reserve news until Wednesday’s trading session, and as a result, there’s still downside potential for USD/JPY. My fundamental bias for the Japanese yen: slightly bullish.  

**New Coverage of Emerging Markets – South African Rand Dragged Down By Gold, Mexican Peso, Turkish Lira Hold Strong

Emerging market currencies like the Mexican peso and Turkish Lira edged lower on Tuesday, but both remain relatively strong as the Banco de Mexico and the Central Bank of the Republic of Turkey (CBRT) both remain hawkish and likely to hike rates again before year-end as price pressures persist. The Mexican Peso was weighed down a bit as consumer confidence fell to a 7-year low of 88.4 from 90.7, as these increasing costs limit disposable income. Meanwhile, the South African Rand plummeted versus the greenback thanks to a 2.4 percent drop in gold futures to $886.10/oz. South Africa is extremely dependent upon exports for growth, and with prices falling, the value of those exports will only serve to erode the nation’s trade balance. Looking ahead to tomorrow, there is no data scheduled for release so traders should keep an eye on commodities and the US dollar for direction.

For more in-depth analysis on the MXN, ZAR, TRY, HKD, and SGD published every Friday, please see our Emerging Market FX Weekly.



Written by Terri Belkas, Currency Strategist for

Glad to see our new coverage of emerging market currencies? Let us know: [email protected]om



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