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Thursday March 2, 2006 - 21:39:42 GMT

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Forex: Hawkish ECB Comments Put Fed’s End in Focus

DailyFX Fundamentals 03-02-06

By Kathy Lien, Chief Strategist of

• Hawkish ECB Comments Put Fed’s End in Focus
• Canadian Dollar Jumps to 14 Year High
• Good Japanese Data Could Send USD/JPY to 115

US Dollar

Yesterday we had cautioned against celebrating the good ISM number prematurely and thank goodness for the warning since the dollar gave back all of the previous day’s gains and then some. The catalyst for the move is once again interest rates, but this time from a slightly different perspective. The market is rallying the currencies of countries that are expected to increase interest rates steadily and continuously this year, like the Euro, Japanese Yen and Canadian Dollar while punishing the US dollar because the Federal Reserve is nearly done. The first interest rate hike since December of last year from the ECB has refreshed to traders the notion that there is a new kid on the block who will be raising interest rates. Recent data has been showing signs of slower growth here in the US which already has some traders worried that the Federal Reserve has little chances of overshooting interest rates, making 5 percent the likely cap. The only release out of the US today was jobless claims which came in slightly higher than expected, rising 294k compared to the market’s 285k forecast. Tomorrow should be a bit more helpful for the US dollar in allowing US fundamentals to take the drivers’ seat for a while on the back of the service sector ISM or the University of Michigan consumer confidence reports. Meanwhile the big story today was really the Canadian dollar, which rallied to a 14 year high against the US dollar. The combination of strong data released this week and rallying oil prices has the market thinking about opportunities in the Loonie once again, especially since Canada is also one of the few central banks looking to continue raising rates consistently this year. A surge in acquisitions is also fueling the CAD’s rise. The country’s deep pool of natural resources is tempting everyone from Britain to China. Taking a look at a long-term chart, USD/CAD may not find support until the November 29, 1991 low of 1.1190.


As expected, the European Central bank increased interest rates by a quarter of a point to 2.50 percent. Even though Trichet tried to hold back from making overly hawkish comments, the market interpreted his optimistic outlook on growth and the central bank’s higher revisions to mean that the ECB has full intentions to continue tightening monetary policy. They expect GDP growth to accelerate to 1.7-2.5 percent this year and for inflation to be between 1.9-2.5 percent. Furthermore, they also believe that inflation faces the risk of growing even more if energy prices remain high. However, Trichet added that they did not decide on a series of rate hikes and never precommits unconditionally. Yet, these comments were pretty much shrugged off once he said that the ECB stands ready to “do what is necessary” and interest rates are now still “very stimulative.” With more interest rate hikes ahead, the Euro has staged a strong rally today. In fact, the rally was so significant that our FXCM Speculative Sentiment index actually flipped from net long to net short. In our weekly release this morning, positioning was net long and had remained so for the past month. Positions completely flipped by the end of the day with the USD/CHF ratio short but near parity. This suggests that we may have finally seen a true bottom in the EUR/USD.

British Pound

Like the Euro, the British pound staged a strong recovery today. However even though the percentage gain in the British pound paled in comparison to the percentage gain in the Euro, after starting the day deep in the red, the intraday recovery was far more impressive. The only piece of economic data released from the UK was the construction sector PMI index which increased from 50.7 to 51.9 last month. This was slightly more than expected and continues to confirm the stabilization that is occurring in the housing sector. If you recall, yesterday, mortgage lending figures rose more than expected. As a service sector based economy, tomorrow’s service sector PMI survey will be worth watching to see if we can get continued gains in the GBP/USD. Given the strength of today’s recovery, we would be surprised not to see an extension move tomorrow.

Japanese Yen

Tonight is a big night in Japan with a number of key economic data due for release. We are expecting the consumer price index, workers’ household spending, labor cash earnings and the jobless rate. Any of these pieces could move markets independently, but collectively, they pose a bigger risk for the Japanese Yen. The unemployment rate is expected to remain unchanged at 4.4 percent, but workers household spending is expected to jump significantly. The most important number to watch however will be the consumer price figures. It is no secret that the Bank of Japan is looking for positive CPI before increasing interest rates. Therefore, if we get a nice jump in consumer prices, we could also see a nice pop in Yen. In an environment where the market has just turned bearish dollars, strong Yen data could send the USD/JPY currency pair tumbling down to 115.


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