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Monday July 3, 2006 - 19:29:23 GMT
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Forex- Euro Needs Hawkish Comments from ECB to Push Above 1.29

FXCM - DailyFX Fundamentals 07-03-06

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

• Euro Needs Hawkish Comments from ECB to Push Above 1.29
• Surprisingly Weak US Data Keeps Dollar Pressured
• Tankan Loses Out to Fukui Scandal and Escalating North Korea Tensions

US Dollar

On a day when we had mostly stronger economic data from the around the world, the disappointments in this morning’s US economic releases have only confirmed the overall dollar bearish tone in the markets. Analysts were originally forecasting for acceleration in manufacturing activity in the month of June and construction activity in the month of May. However surprise dips in both indexes raises the downside risks for second quarter GDP. The ISM index fell from 54.4 to 53.8 while construction spending dropped by 0.4 percent. Now more than ever, dollar bulls need to see consistently strong US economic data to hold onto their belief that the Federal Reserve will still be raising rates again in August. Even though, the central bank delivered a less hawkish statement last week, the odds for an August rate hike are still above even at 55 percent. This indicates that there is small majority favoring a follow-up move. Therefore economic data over the next six weeks is even more important. If the two jobs reports, 1 ISM, 1 retail sales and 1 consumer price index tips the balance either way, we could have the speculators on the other end of the spectrum rushing out of their positions and into new ones. Our first critical piece of US data that could either cement the most recent hike as the last one or open the door for another move is Friday’s non-farm payrolls report. After being significantly disappointed last month, analysts are aiming high once again. In June, analysts predicted that 170k jobs were created in the month of May but only 75k jobs were actually created. The month prior, they were predicting 200k job growth, but only 138k jobs were created. This time around, their forecasts is for US companies to add 175k people to their payrolls, and even though US jobless claims have been at very low levels, which would otherwise support a healthy labor market, just because companies are not firing, does not necessarily mean that they are hiring. Whether the actual release will be able to meet up to the lofty expectations is even more questionable given today’s ISM number. The employment component of the report fell to the lowest level since October 2003.

Euro

Clear strength in Eurozone economic data and comparative weakness in US economic data continues to fuels gains in the EUR/USD. For the region as a whole, manufacturing sector PMI increased from 57.0 to a more than expected 57.5. Even though activity in France fell slightly, strength in German and Italian manufacturing activity more than compensated for the weakness. Improvements were seen across the board, but the most notable improvement was in the employment index. This strength is further supported by the drop in the Eurozone’s employment rate from 8.0 percent to 7.9 percent in May. The pickup in the labor market and the potential upside risk it poses for wage inflation confirms the need for the European Central Bank to raise interest rates soon. The central bank will be announcing an interest decision on Thursday and ECB President Trichet will be scheduled to make a press conference afterwards. Although no changes to interest rates are expected at this meeting, the market will be looking for clues on how soon the ECB will move. Having left out the word “vigilant” from his comments at the last press conference, we expect hawkish comments to be reintroduced on Thursday. Other members of the ECB have already made a string of comments on the need to raise interest rates soon. An end of August rate hike has the highest likelihood, but there are two more meetings that are not accompanied by a press conference before then. Hawkish comments will be seen as positive for the Euro, but if Trichet is worried about the level of the Euro and chooses to not give any signs that they are accelerating their tightening cycle later this week, we could see a top in the current Euro rally.

British Pound

In contrast to the Euro, the British pound is weaker against the US dollar. In fact, it is weaker against the Euro, Japanese Yen and Swiss Franc as well. UK economic data was actually quite strong this morning with the PMI manufacturing index rising from 53.2 to 55.1, the highest level since July 2004. Mixed economic data had the market guessing that there would not be any acceleration in manufacturing activity, but even though it did, the positive report did little to boost the British pound. Service sector output was unchanged in the month of April but the index is relatively new. There is a great deal of UK economic data due for release this week, but following the more neutral comments from the Bank of England last week and the death of BoE member Walton, it is extremely unlikely that the central bank will move on interest rates anytime soon. Therefore their rate decision on Thursday should be a non-event.

Japanese Yen

The rally in the Japanese Yen following the stronger Tankan survey of business confidence was relatively short lived. Even though the Tankan report showed that confidence among large manufacturers increased from 20 to 21 and confidence among non-manufacturers increased from 18 to 21, it was not enough to offset the negative yen sentiment in the market. Traders are still jittery about whether Fukui will be able to hold onto his job while tension with North Korea has escalated to another level with the country threatening a nuclear war if the US makes a preemptive attack. Although the Tankan was strong and indicates that the Bank of Japan will have to drop their zero interest rate policy soon, the government is still pressuring them to retain this policy for longer. Government spokesman Abe said that deflation has not been completely eradicated and that the central bank should cooperate with the government in battling deflation by keeping rates at zero for the time being. With the scandal surrounding Fukui, we do not expect a July rate hike, but at this point, one in August or September is not out of the question.

 

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