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Friday February 3, 2006 - 21:44:15 GMT
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Forex: Light Week Ahead Could Bring Consolidation in EUR/USD

DailyFX Fundamentals 02-03-06

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

• Light Week Ahead Could Bring Consolidation in EUR/USD
• Euro Outperforms British Pound Thanks to Stronger Data
• USDJPY Rallies Close to 500 Pips In 3 Weeks

US Dollar

It has been quite a wild day in the market today. Non-farm payrolls fell short of expectations, yet the dollar skyrocketed. What is most interesting of all however was that the sell-off in the EUR/USD stopped right at 1.1970, the exact potential support level that we mentioned in yesterday’s Speculative Sentiment report. In fact, in the report, we had said “Presently, the ratio is net long without a confirmation from USD/CHF, which suggests that even though our bias remains to the downside, the sell-off could be limited to the next support zone at 1.1970.” Right now (as of 2/3 close) the SSI ratios remain relatively the same as yesterday and USDCHF although teetering near parity is still not giving a confirmation signal to sell the EUR/USD. As such, even though the sell-off in the EUR/USD was fairly extensive today, for the time being, we may see one of two scenarios unfold; either a larger relief rally before prices head lower once again or that 1.1970 simply becomes the hard support level for the EUR/USD. Now admittedly, the dollar’s reaction today was not completely irrational. Even though the headline payrolls number was weaker than expected, the other components of the report were actually quite encouraging. The unemployment rate dipped to 4.7 percent from 4.9 percent, which is the lowest level since July 2001. Average hourly earnings remained unchanged, but the December figure was revised higher from 0.3 percent to 0.4 percent. December payrolls were also revised from 108k to 140k. So if you tack on the 32k improvement from last month, the headline figure then comes much closer to the consensus forecast. Bottom-line line, for most dollar bulls, triple digit payrolls is already good enough and today’s report does little to stifle expectations for a March 28 rate hike. According to our friends at IFR, the April Fed Funds contract shows a 90% likelihood of a March hike and now a 60% likelihood of a May rate hike, which is part of the reason why the dollar rallied today. Other data released today was mixed. Factory orders came in slightly stronger than expected, rising 1.1 percent in December after an upwardly revised 3.3 percent increase the previous month. Consumer confidence fell to 91.2 from, 93.4 while the service sector ISM index dipped to 56.8 from 61.0 in January. Although service sector growth is still continuing, as we have seen in the manufacturing sector, the pace of growth is slowing. After a week of big swings, we could settle into a bit of range trading with a very light US economic calendar next week. The trade balance report on Friday is only the release that has potential to move the market.

Euro

Bullish momentum in US dollar forced the Euro lower today despite more encouraging economic data. Taking a look at today’s reports, it seems as if Trichet may have had them at his fingertips before yesterday’s ECB meeting. The flash consumer price report for the month of January signaled higher inflation pressure last month. The CPI increased to 2.4 percent from 2.2 percent, which was above the market’s 2.3 percent forecast and the first time in four months that inflation accelerated. Unlike the US, service sector PMI for the Eurozone increased from 56.8 to 57.0, confirming the gradual growth that Trichet was referencing. Improvements in Germany led growth as activity slowed in France and Italy. December retail sales grew by 0.1 percent, right in line with expectations. Sales for November were also revised from negative 0.1 percent to flat. Overall, it seems that despite some wrinkles in data earlier this week, Trichet reassured the market that they are still thinking about a rate hike this quarter. Should German industrial production, CPI, factory orders and retail PMI come out strongly, we could see Euro bulls return to the market.

British Pound

Like all of the other majors, the British pound was dragged lower by the dollar’s impressive rally. Against the Euro, the pound underperformed as the CIPS service sector PMI fell from 57.9 to 57.0. In contrast, as already noted in the Euro section, the data released from the Eurozone was mostly stronger than expected. However, the outlook for the UK economy is still encouraging. The details of the service sector PMI report indicate that expectations of businesses are at a 10 month high. In the week ahead, the UK economic calendar is fairly busy with BRC retail sales, house prices, industrial production and the trade balance scheduled for release. The Bank of England is also scheduled to meet and discuss interest rates on Thursday. No changes to the repo rate is expected and as usual, if the BoE leaves rates unchanged, they will also refrain from making any additional comments, which means that in all likelihood, the BoE meeting will be a non-event.

Japanese Yen

The US dollar surged higher once again against the Japanese Yen. In fact over the past 3 weeks, USD/JPY has rallied close to 500 pips. Given such an impressive rally, we are tempted to ask when USD/JPY will top out. However, for those of you who share a similar thought, it is important to remember that USD/JPY is a very trending currency pair, which means that once it finds its trend, it could overshoot even the most optimistic forecasts. Data from Japan is back loaded with confidence, spending and the BoJ Monthly monetary policy report not due until Thursday and Friday. This means that given the light US AND Japanese economic calendars, we could see a bit consolidation at current levels. Overall, the dollar will be leader of the pair as the Bank of Japan finds its hands tied by the Japanese government while the Fed prepare itself for yet another interest rate hike.

 

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