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Friday July 16, 2010 - 01:36:28 GMT
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Weak U.S. Economic Data Driving Force Behind Euro, Pound Rallies

The U.S. Dollar was crushed on Thursday by a soaring Euro and British Pound. Economic worries pressured the Dollar all day as investors left the greenback in favor of the currencies backed by the stronger economies. The fact that the U.S. is still wallowing in debt while the European and British governments talk about austerity measures and cutting costs may have also contributed to the weakness in the Dollar.


Because of the sharp sell-off in the Euro and Sterling earlier in the year, some are attributing the current rally to a short-squeeze. In other words, bearish investors are being forced out of the market not by fresh buying, but by short-traders scrambling to get out. In this case, it’s not the weakening U.S. economy driving traders into the Euro and Sterling, but rather short traders paying anything to protect what’s left of their profitable positions from the Spring.


What is clear at this time is that the U.S. economic data continues to show weakness. In addition to the actual released figures, economists are contributing to the weakness by downgrading U.S. growth targets.


Less than one day after the Fed said that GDP would slow and the jobs outlook would remain sluggish, more bearish data was released on Thursday.  Today the New York Fed’s Empire State Survey fell to 5.08, its lowest reading since December. Also the Philadelphia Fed Manufacturing Survey declined to 5.1 in July, well below pre-report guesses of 10.0, reaching its lowest level since August 2009. 


Although industrial production posted a more than expected gain of 0.1 percent, the core manufacturing component fell 0.4 percent, more than expected and the first decline in four months. Finally, the third consecutive monthly decline in producer prices renewed concerns about a deflationary scenario developing.


This week a plethora of data along with a dovish Fed outlook is pointing to a weaker economy which is likely to keep the pressure on the Dollar. Interest rates are also expected to remain low for a prolonged period of time since the latest inflation data suggests the Fed cannot move them higher. Furthermore, there is renewed talk of new stimulus measures which will mean more Dollars flooding the markets. All of this is prompting a call for a weaker Dollar over the near-term. This was particularly event in the Euro and British Pound on Thursday.


The EUR USD surged to the upside on Thursday as a combination of weak U.S. economic data and better than expected demand for Spain’s debt triggered a sharp breakout to the upside. Before the U.S. markets opened, the Euro was receiving support from the news that Spain raised nearly $3.85 billion in 15-year bonds.


Technically, today’s rally in the Euro took out a key 50% level at 1.2783 and now appears to have enough upside momentum to challenge the Fibonacci retracement price at 1.2998.  In the best case scenario, one can project that the current upside momentum and gloomy economic outlook for the U.S. economy is enough to drive the Euro up to at least 50% of the entire sovereign debt break at 1.3510.


The GBP USD also soared on Thursday, putting this market in a position to test a cluster of former tops at 1.5497 and 1.5523 on its way to a major 50% price level at 1.5635.


The fact that U.K. inflation is rising and U.S. inflation is falling was enough to drive investors into the British Pound at the expense of the Dollar. This is because the rising inflation rate is bringing the Bank of England closer to hiking interest rates while the falling inflation rate in the U.S. is keeping the pressure on the Fed to keep interest rates at historically low levels. Once again investors are going after the highest yields, prompting strong the strong demand rally for the Sterling.


Following Wednesday’s weak assessment of the economy by the Fed, the U.S. released data today pointing toward low inflation and weakness in manufacturing. This news raised concerns about the near-term health of the U.S. economy, encouraging traders to think that U.S. fundamentals are making the Dollar a less attractive alternative to investors. Furthermore, now that the European Central Bank has taken steps to aid ailing nations, investors want to move on from the sovereign debt issues in Europe.


Stronger demand for the Euro is likely to continue until late next week when investors are likely to begin paring positions ahead of the release of the European bank stress tests. On Wednesday, rumors began circulating that eleven European banks are expected to fail their stress tests. As we approach the release date, this type of rumor could encourage investors to take profits after the recent rise and pare back positions until the uncertainty clears up. Until the report is released on July 23rd, look for trend traders to continue to drive the EUR USD higher as long as U.S. economic data remains on the weak side.


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