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Can the Fed Give Dollar Bulls Hope?

DailyFX Fundamentals 08-05-05

By Kathy Lien, Chief Strategist of www.dailyfx.com

· Can the Fed Give Dollar Bulls Hope?
· Yen Traders Shaky Ahead of Japanese Postal Vote
· Strong German Industrial Production Keeps Euro Afloat

US Dollar

We had a strong non-farm payrolls number released this morning for the month of July, but that did little for the US dollar. Against the euro, the dollar rallied 80 pips on the back of the release, but throughout the US trading session the greenback ended up giving back 40 of those pips. What this tells us is that the market was expecting a good release, had already priced it in and the upside surprise was not enough to shift market sentiment. Yet the strength of the number should not be underestimated. After 2 months of disappointments, we finally saw a month of surprise. The US economy added 207,000 jobs in the month of July and also tacked on an additional 20,000 jobs in June. Average hourly earnings ticked higher by 0.4%, double the amount expected. This means that we are off to a great start going into Tuesday’s FOMC meeting. A 25bp rate hike to 3.50% has already been priced into the market. Today's blockbuster report makes 4.00% almost a certainly with the Fed possibly even overshooting to 4.25%. Normally the Fed would probably stop at 4.00%, but the conundrum in long-term rates will tempt them to raise interest rates beyond what may be appropriate. The longer long-term rates remain low, the longer the Federal Reserve has to continue raising interest rates. With the rate hike mostly priced in though, all eyes will be on the FOMC statement. Higher oil prices may force the Fed to upgrade their inflation assessment, which could be mildly bullish for the dollar. However, the dollar rally may be short-lived even if the Fed does continue to raise interest rates. With oil prices solidly above $60 a barrel, the Fed may also upgrade the risks for inflation. Right now consumers are somewhat shielded from the skyrocketing cost of oil because they have the capability of lowering consumption and opting to car pool or use mass transit as oil prices rise. However, once the weather starts turning cooler and everyone needs to get their heaters running once again, $60 oil may be too much for the average consumer to bear. This could be the tipping point for the US economy, and if this really is the case, it would be very bearish for the US dollar.

Euro

The resilience of the Euro in the face of strong US data is impressive. It has now become the battle of which is stronger - US data or Eurozone data. German industrial production jumped 1.4% in the month of June, which was almost five times higher than the market’s forecast and a sharp rebound from the 0.2% contraction that we saw back in the month of May. We have been seeing encouraging data from the Eurozone, especially Germany all week and we expect this to continue to remain the theme into next week. At the rate that we are going, the members of the ECB will be relieved that they may be facing less pressure to lower interest rates. If data continues at this pace, we could see persistent demand for the Euro.

British Pound

After seven days of consecutive gains, the British pound finally gave back some of its recent gains. The slide however was limited thanks to mixed UK data. Although industrial production was unchanged in the month of June, the annualized contraction in industrial production came in at –1.9% compared to –2.3%. Manufacturing production rebounded by 0.2% and fell a less than expected -1.0% in June. House prices were less encouraging, increasing an in line 0.2% with the annualized pace slowing to 2.3% from 3.7%. Overall, the data points to weakness but not yet enough to warrant another rate cut, especially after yesterday’s strong service sector PMI survey. News that a building materials group in France launched a GBP3.68 billion hostile takeover bid for a UK plasterboard company also helped to keep the pound supported. The market will be closely anticipating the Bank of England’s Quarterly Inflation report next week, which should shed additional light on whether inflation is enough of a concern that this past week’s rate hike will be the only one that we see this year.

Japanese Yen

Japanese yen traders have a lot to look forward to at the open of trading next week. The postal privatization vote has been postponed to Monday August 8. We are sure that Koizumi will be working hard this weekend to drum up more votes for what may be the most important bill of his career. If the bill is rejected, there could be a sharp knee jerk sell-off in the Japanese Yen because Prime Minister Koizumi has vowed to call for early elections. It is widely speculated that he could actually lose at which point there could be a lot of short-term uncertainty in the Yen. If the bill is passed, we will probably see a relief rally. In terms of economics, the Japanese economic calendar is very busy next week with the trade balance, current account balance, consumer goods price inflation, consumer confidence, GDP, and industrial production all slated for release along with the Bank of Japan’s monthly report and minutes from their monetary policy meeting. Meanwhile the economic data released out of Japan overnight was very mixed. Leading economic indicators leaped from 36.4% to 60%, which means that the economy went from contractionary into expansionary. However household spending fell 1.2% on a monthly basis and –0.1% annualized.

 

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