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Tuesday May 23, 2006 - 21:10:00 GMT
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Forex: Euro Faces Risks From Potentially Weak German IFO Report

DailyFX Fundamentals 05-23-06

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

• Euro Faces Risks From Potentially Weak German IFO Report
• Acquisitions Continue to Fuel Gains in British Pound
• Ratings Upgrade Does Little for Yen

US Dollar

Consolidation has been the main theme today with little meaningful price action in the dollar against the majors. The rise in gold prices has helped to rally the Australian and New Zealand dollars, but market activity has been limited to range trading at best. Commodity prices in general are all higher, weighing on the dollar. The Richmond Fed manufacturing index which tends to be a report with little significance came in so abysmally bad that tiny gains in the dollar were quickly reversed. Federal Reserve Chairman Ben Bernanke was scheduled to speak today but he stuck to the topic of personal finance. The only comment he was willing to make was that his CNBC episode was a “lapse of judgment.” Having learned first hand why Greenspan has always been ever so cautious with his words, Bernanke will probably be even more careful going forward. He has already said that he will be confining his comments to formal arenas which means that unless it’s a speaking engagement or a meeting about monetary policy or the economy specifically, do not expect any surprising comments from the new Fed Chairman, especially since he knows that we are at a crucial turning point in monetary policy and the market is tuning into his every syllable. The two key reports due out this week are durable goods and GDP. The market expects durable goods to come in negative. With the dollar sell-off showing signs of exhaustion over the past week, should the number come in strong, we could see a nice extension rally. Overall, profit taking will probably be the main theme this week since we are at standstill with interest rates. Aside from home sale reports none of the US data due out this week will give us much insight into how much further the Fed will go. Everything lies on how well the housing market holds up, how far commodity prices run, whether core prices keep up with the pace and if consumers are able to continue their aggressive pace of spending. Translating this into reports to watch, we have our eyes out specifically for home sale reports, CPI, personal spending, retail sales and oil.

Euro

The Euro is marginally stronger against the dollar today despite mixed economic data. The final German GDP for the first quarter was right in line with expectations, rising by 0.4 percent after stagnant growth the previous quarter. French business confidence dipped from 109 to 107 with the production indicator also falling. French consumer spending did pick up, rising 0.7 percent in April after falling 0.4 percent the previous month. However, industrial orders for the region dropped by a whopping 2.4 percent in March. Yet, the unfailingly hawkish nature of the European Central bank continues to keep the Euro propped. You cannot get more explicit than ECB Mersch’s comments this morning that the central bank “will continue to tighten monetary policy.” It is very clear that we are finally seeing some impact of the stronger Euro on the economy. Tomorrow we have the much awaited German IFO survey. The sharp disappointment in the ZEW survey suggests that the IFO could fall victim to the same fate. With industrial orders beginning to slide, manufacturing sentiment surveys topping out and the prospect of higher interest rates, business sentiment runs a high risk of contracting as well. If so, this would give Euro bulls a good reason to bank some of their massive profits ahead of the holiday weekend. Meanwhile over in Switzerland, the employment picture improved modestly with the employment level ticking up from 0.3 percent to 0.7 percent in the first quarter. The trade surplus for the month of April also increased from CHF0.61 billion to CHF0.91 billion. The only wrinkle to the day’s news was the April UBS consumption indicator which fell from 1.74 to 1.62.

British Pound

The British pound ends the day unchanged against both the Euro and the US dollar. Although there is quite a bit of data due out of the UK this week, none were released today. Both the CBI industrial trends and total business investment reports are expected to come out strongly confirming the improvements in the UK economy. More merger and acquisition news is also fueling bullishness in the pound. The latest has been talks that French company Credit Agricole may be making a bid for UK mortgage lender Alliance and Leicester. If true, this deal would be Credit Agricole’s largest purchase ever. Alliance and Leicester is valued at more than $6.4 billion or EUR 5 billion. On a smaller scale, Dutch based Philips Electronics has announced plans to buy Britain’s Avent for slightly less than 500 million pounds. The free market principles of the UK are definitely providing a big boost to the economy. It seems that even the strong pound is not scaring foreign investors away from making bids for UK companies.

Japanese Yen

The Japanese Yen is weaker across the board against the majors despite a ratings upgrade by Standard and Poors. Given the improvements in the Japanese economy, the ratings agency upgraded its long-term outlook on Japan from stable to positive. More specifically, they noted Japan’s rosier outlook, restructuring in the private sector, the resolution of the country’s bad debt problems and the elimination of deflationary pressure. Although the change to the ratings outlook means little for the Japanese markets since the country is still only rated AA- keeping many foreign funds that are mandated to only invest in AA countries away from JGBs. However, it does underscore the path that Japan is currently on. Bank of Japan governor Fukui added today that the central bank will be adjusting rates gradually while being extra careful to ensure that they do not destabilize the economy. The Bank of Japan has to contend with a strong yen and unlike the European Central Bank, they have already hinted at possible intervention if yen movements get out of hand.

 

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