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Friday July 1, 2005 - 20:12:04 GMT

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Forex: Euro Breaks Through 1.20; Little Follow Through

DailyFX Fundamentals 07-01-05

By Kathy Lien, Chief Strategist of

∑ Euro Breaks Through 1.20; Little Follow Through
∑ Dollar Rallies As US ISM Blows Through Expectations
∑ Yen Continues To Sell-Off Despite Improving Data

US Dollar
They have finally done it! Dollar bulls have managed to drive the EURUSD below 1.20 and keep it there. Interestingly enough, it appears that dollar bears failed to even put up much of a fight with the EURUSD mustering only a weak rebound after the break. Stronger ISM and University of Michigan consumer confidence numbers overshadowed the decline in the prices paid component of the ISM as well as the slide in construction spending. Despite mixed readings in the regional indices, the national index blew away expectations to increase for the first time since November of last year, helping to spark a surge of optimism that has already been injected into the market following the stronger GDP report released earlier this week. With the US markets closed on Monday, follow through buying may be limited. It will be interesting to see if prices can stay below 1.20 especially since next Fridayís non-farm payrolls report is expected to be a good one. Right now the estimate for payrolls is +189k, which is over double that of last monthís number. Jobless claims have been improving, which suggests that payrolls growth should also be growing. Aside from payrolls, the US calendar is fairly light next week with non-manufacturing ISM being the second most important event on the calendar. This suggests that for the most part, even if the EURUSD manages to climb back above 1.20, there probably will not be enough momentum to push it above 1.22, the top end of its recent trading band.


In another series of good Eurozone data, we saw the unemployment rate for the region dip lower from 8.9 percent to 8.8 percent and PMI manufacturing indexes across the region (for France, Germany and Italy) all improve during the month for the month of June. The recent trend of data confirms the amount of impact that currency movements can have on a countryís economy. Even though the European Central Bank has been standing pat on rates, the slide in the euro has helped to spur modest growth even in the face of rising energy costs. Politics however continues to dominate the headlines with German Chancellor Schroeder facing a no-confidence vote that could eventually topple his government. With 2 more years left in his second term, Schroeder may be forced out of office sooner as Germany paves the way for early elections. Seventy percent of Germans polled are bitter and want another election in September. The votes reflect their dissatisfaction with the performance of the economy and Schroederís unpopular reforms.

British Pound

Plunging close to 600 pips over the past week, the British pound came under heavy selling pressure following a barrage of weaker economic data. Even today's stronger PMI survey could not help the currency pair overcome the bearish momentum. The price action in the GBPUSD illustrates the importance of interest rates and carry on currencies. The pound rallied significantly between 2003 and for most of 2004, which was a time when the UK was raising rates aggressively while the US was dragging their feet. This time around, we have the same divergence but a role reversal. The UK is seeing a more compelling reason to cut rates while the US on the other hand is rolling ahead with its rate hikes. This has caused the gap between UK interest rates and US interest rates to move closer, providing a perfect reason for the pound's recent price action. Meanwhile, the big event today was actually the passing of the baton of the EU Presidency from the Dutch to the British. The reception abroad is far from supportive with a number of European papers mulling on whether the UK is really the best choice as a leader to pull the region out of its current crisis. Especially since they have been one of the most skeptical on the fate of the EU and it was in part their refusal to give up their rebates that resulted in the collapse of the EU budget talks. On July 12, Gordon Brown will be unveiling the UK's plans for the region's economic policies to EU Finance Ministers. It will be interesting to see not only their suggested proposals, but also how the other members of the EU respond to them.

Japanese Yen

Like a brilliant winning streak, the dollar rallied against the Japanese Yen for the eighth consecutive trading session thanks to both the currency pairís growing interest rate premium and rebounding crude oil prices. However last nightís much awaited quarterly Tankan Survey provides a glimpse of the discrepancy between Yen price action and Japanese data. The Tankan report is the Bank of Japanís quarterly business sentiment report that tends to be well correlated with GDP. The index increased from +14 to +18, with a sharp rise in capital spending plans. Improvements were seen pretty much across the board in the underlying components, which further illustrates the gradual improvements that we are seeing in the Japanese economy as a whole. Yet fundamentals can only diverge from price action for so long before they eventually have to snap back, with has the potential of causing sharp reversal moves in the currency pair.


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