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Monday January 23, 2006 - 22:05:37 GMT
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Forex: Fed President Comments Was the Straw that Broke the Dollarís Back

DailyFX Fundamentals 01-23-06

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

ē Fed President Comments Was the Straw that Broke the Dollarís Back
ē Hawkish Comments from ECB Sends Euro Soaring
ē Livedoor Scandal Still Having an Impact on the Yen

US Dollar

After over 2 weeks of consistent rangetrading, we are finally seeing some interesting price action and volatility in the markets as the dollar collapses across the board against the majors. With Fed President and FOMC voting member Geithner warning about growth and the deficits, tensions still brewing with Iran, oil prices less than $2 away from $70 a barrel, concerns for earnings this week and a not so optimistic leading indicators report, it is not surprise that the past few weeks of consolidation has led to a breakout to the downside in the dollar. This week is the busiest period for fourth quarter earnings with over 140 companies from the S&P 500 reporting results. Given that the only pieces of US data worth watching this week is not due for release until Thursday (durable goods) and Friday (GDP), how the stock market responds to earnings releases could easily impact trading in the dollar. If the earnings releases come with warnings labels, traders should watch out as the Fed may interpret this as expectations for waning consumer demand. Either way, the market is certainly on the lookout for more signs of whether we will have one, two or three more interest rate hikes left in the pipeline. We are closing in on the January 31st FOMC meeting and the big question is whether the statement will be even more neutral than the previous one as Greenspan pens his last words on monetary policy. With the economy at a crossroad, he may very well want to leave the door wide open for Bernanke to take any path he wishes because ultimately, Bernanke is the one that has to deal with the consequences. Leading indicators were released at 0.1 percent this morning, against the marketís 0.2 percent forecast. The generous revision from 0.5 percent to 0.9 percent for the month of November helped to offset some of the pessimism.

Euro

The Euro is trading at four month highs against the dollar today as the diverging interest rate outlook for the Eurozone and the US become even clearer. On a day devoid of any economic data, hawkish comments from ECB Liebscher rattled the markets. After leaving out the word ďvigilantĒ from his recent comments, ECB President Trichet instilled a bit of bearishness in the Euro, as the market interpreted his choice of wording to mean that the central bank may have become a bit less hawkish. However, Liebscherís comments today has given Euro bulls a reason to return in force, especially since there can be no misinterpretation of his view that rates are ďvery, very low" and current policy is "very expansive". What is most surprising to us is the timing of his comments. With the EUR/USD hovering around the 1.23 level, the ECB should be less hawkish in fear that the stronger Euro would hurt exports. Yet, they are appearing to be less worried than they may have been before. Although, Liebscher represents the ECB as a whole, we will be waiting for confirmation by the ECB President himself to truly believe that a rate hike by the central bank will come sooner rather than later.

British Pound

The British pound joined the anti-dollar party today by rallying over 175 pips against the dollar. However, the story was very different against the Euro and Swiss Franc, which managed to gain strength against the pound. The underperformance of the pound against the Euro continues to confirm the extent and impact that interest rate outlooks can have on a currency pairís trading behavior. The Bank of England is slated to release the minutes from their January 11-12 monetary policy meeting this Wednesday. Like the prior meeting, the BoE is expected to have voted 8-1 to keep interest rates unchanged at 4.50 percent earlier this month. Nickell should once again be the dissenting member favoring a quarter point cut. However, should he move to neutral, we could see a strong rally in the British pound. On the flip side, if another member sides with Nickell, the pound could see a deep slide. With the pickup in oil prices and the improvements in the retail sales data reported last Friday, the higher probability scenario is for Nickell to stand pat or shift to neutral.

Japanese Yen

The performance of the Japanese Yen against the majors was all over the board today with the Yen strengthening against the US, Canadian and Australian dollars, but weakening against the Euro, Swiss Franc and British pound. The Livedoor scandal may still be having its affect on the Japanese Yen. A gap lower as well as another day of triple digit losses in the Nikkei could have more investors buying Yen to meet margin calls. If the bleeding exacerbates, at some point, there could be a mass exodus of foreign capital from the Japanese stock market which could mean that the Yen weakness that we are currently seeing in the EUR, CHF and GBP could filter into the USD, AUD and CAD. Comments from BoJ Governor Fukui late last week couldnít have come at a better time. Widely interpreted as a possible bowing to governmental pressure, Fukui has said that he will consider various indicators when making a decision on monetary policy and will not rush to end quantitative easing if prices do not rise. The government has asked that the BoJ monitor the GDP deflator as a measure of inflation and requested patience. With the Nikkei taking such a deep slide, the BoJ has a good excuse to ďobeyĒ the governmentís requests.

 

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