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Monday June 19, 2006 - 21:09:41 GMT

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Forex: Even Weak Housing Data and North Korea Fails to Keep Away Dollar Bulls

DailyFX Fundamentals 06-19-06

By Kathy Lien, Chief Strategist of

• Even Weak Housing Data and North Korea Fails to Keep Away Dollar Bulls
• ECB Member Weber Reiterates the Central Bank’s Hawkish Stance
• Yen Juggles North Korean Risks with Talk of Ratings Upgrade by Moody’s

US Dollar

On the first day of the new trading week, we learned early on that inflation will continue to be the market’s primary focus – regardless of how bad the news may be for the US dollar. The housing market is showing more signs of giving way, which is an extremely dangerous development for the US economy. The National Association of Home Builder’s confidence index fell from 46 to 42 to an eleven year low. Homebuilders are becoming increasingly pessimistic on the future outlook for sales as prospective buyers begin to dissipate. Even if we do not see an immediate slowdown in new or existing home sales, we will probably begin to see the rapid pace of new home construction slow significantly. This trend will have ripple effects far beyond the construction sector to the viability of real estate agents and brokers as well as the profitability of home improvement stores such as Lowes and Home Depot. A deflation of the housing market bubble is inevitable, but the question that remains is whether we will just see some modest cooling or an all-out collapse. So far, the housing market only appears to be cooling but with signs of trouble reported in states such as California and Arizona, the risks are clear. Much of the country’s growth and consumer spending has been fueled by the rise in the housing market. If it gives, we could be facing a great deal of volatility. Therefore is the Federal Reserve’s strong stance on inflation and the market’s clear disregard for the data the smartest move? Regardless of the answer, it is what is happening right now as traders shrug off the housing market index and fresh tensions with North Korea to key completely off of the hawkish comments from Fed Presidents Guynn and Fisher. With the Federal Reserve meeting less than 10 days away now, another dose of tightening has become a reality. Yet, it may soon begin to be important to think about what comes after the June meeting. Even though the Fed is set to deliver another quarter point hike, will they signal that more is to come or will they opt to neutralize their statement? This remains the key question, especially since the market has already fully priced in the rate hike. Meanwhile, to our dismay, having finally had a chance to breathe a sigh of relief that Iran has called the international package of incentives for an end to their nuclear enrichment program a “step forward” in a long and tension filled battle of who will blink first, an old aggressor has reemerged. Although North Korea does not control a large part of the world’s oil stockpiles like Iran does, their proximity to Japan and the US’ already difficult relations with them still makes their threat risky. If tensions escalate and North Korea moves forward with testing of their long-range missile, expect the markets to become even more jittery.


After struggling to recover late last week, the downtrend in the EUR/USD remained so dominant that the Euro gave way once again to dollar strength. Weaker economic data certainly did not help as well as the region’s trade deficit widened to –EUR0.9 billion in the month of April from a downwardly revised –EUR0.3 billion. Although exports continued to grow, imports were surprisingly strong. This was attributed to the higher price of oil as well as the strong Euro. In the month of April, the EUR/USD rose from 1.22 to 1.24. We expect the balance to worsen in the month of May as the Euro shot from 1.24 to 1.2970. According to ECB council member Weber, the central bank remains hawkish and believes that they need to continue to be vigilant with inflation. Although Trichet’s comments were a bit tamer at the last meeting, there is no doubt that the central bank will be delivering more rate hikes. However, any tightening will come gradually and more conservatively, allowing them to extend their tightening cycle longer than the Federal Reserve’s. Meanwhile Switzerland reported stronger than expected industrial production figures. First quarter IP fell by only 1.9 percent compared to a 3.8 percent forecast (the previous figure was revised up from 6.8 percent to 7.1 percent). This also boosted the annualized rate from 4.1 percent to 9.2 percent. The Swiss economy has been holding steady with consumer prices, first quarter GDP and the unemployment rate all coming in stronger than expected, validating the central bank’s recent interest rate hike.

British Pound

With barely any economic data on the UK calendar today, the British pound continues to track the movements in the Euro. After rallying at the tail end of last week, the currency lost ground to the US dollar. According to online property site Rightmove, house prices increased 0.8 percent last month, which was right in line with expectations. There is little to expect from the UK this week. Even though the Bank of England will be releasing the minutes from their most recent meeting on Wednesday, no surprises are expected since recent economic data gives them little reason to sway far from their neutral stance. However if they had to pick a side, based upon recent comments from Chancellor Brown, the BoE still remains vigilant or slightly hawkish.

Japanese Yen

The Japanese Yen tumbled against the US dollar today but gained strength against all of the other major currencies. If North Korea’s missile testing even comes close to Japan, the consequences would be extremely Yen negative. Japanese officials have already warned that Japan will respond “harshly” with the backing of the US and possibly even Australia if the missile is launched. Geopolitical tensions are never good for the dollar but in this case, it is worse for the Japanese Yen. Offsetting some of the Yen bearishness however was news that Moody’s could be raising Japan’s sovereign rating over the next 12-18 months. This would be huge because Japan’s current rating prevents some funds with minimum rating requirements to invest in the country. Though far off, if the upgrade comes, we could see a surge in demand for Japanese stocks and bonds.


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