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FXCM - Dollar Extends Slide as We Inch Closer to a Pause

DailyFX Fundamentals 07-20-06

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

• Dollar Extends Slide as We Inch Closer to a Pause
• Swiss Data Still Confirm Need for Another SNB Rate Hike
• British Pound Breaks Out on Strong Retail Sales

US Dollar

Bernanke stuck to his guns at his second back to back testimony on the economy and monetary policy. Despite pressure to elaborate on the messages that he has been sending, Bernanke reiterated his toned down comments and left the market still guessing on whether we will see another interest rate hike in August. The minutes from the June 28-29 FOMC meeting were equally subdued. Confirming how close the Fed is to pausing on interest rates, the minutes indicated that the decision to raise interest rates at the last meeting was a “close call.” Furthermore, many of the FOMC members warned about the difficulties in terms of what to do next with monetary policy. According to former FOMC member McTeer, “normally, its fairly clear.” The fact that it is “uncertain” this time suggests that the Fed may really be concerned about the risks that lie ahead. At this point, the futures market is pricing in a less than 50 percent probability of an August rate hike. The odds have fallen significantly since the stronger inflation numbers that we saw on Monday and Tuesday. Today’s weaker economic reports provide additional evidence of the biggest risk, which is that an overly aggressive Fed could cripple the US economy. This may be a bit dramatic, but a meaningful slowdown is not. Everyone from bank analysts to interest rate traders are pricing in much weaker conditions in 2007. Leading indicators have already grown at a slower pace in the month of June following two straight months of negative readings. Meanwhile the Philadelphia Fed survey took a sharp plunge from 13.1 to 6.0, the lowest reading since January. Although a positive reading still indicates growth, the combination of today’s weakness along with a big drop in the Empire State survey reported on Monday suggests that we could see an equally meaningful drop in the ISM report for the same month. There was one piece of good news that came out, namely jobless claims, which shrank from 334k to 304k. Claims continue to be at very encouraging levels and indicate that for the time, even though the economic outlook is uncertain, companies have yet to institute any major layoffs, which should keep consumer spending stable.

Euro

The Euro is continuing to recover with another positive day on the books. There was little Eurozone economic data released overnight aside from the French current account deficit, which widened less than expected in the month of May. There was great deal of data out of Switzerland on the other hand. The Swiss trade surplus dropped from 1.04 billion to 0.94 billion in the month of June. Although the Swiss economy is still performing well, they too have been hit by the rise in oil prices. Even though producer prices in Switzerland remained flat last month, the annualized pace of price growth accelerated from 2.9 percent to a more than expected 3.1 percent. This supports the case for additional interest rate hikes by the Swiss National Bank this year. With no US economic data due for release tomorrow, the degree of French consumer spending last month could be the primary driver of the EUR/USD. Analysts are predicting flat spending and if that is really the case, the EUR/USD could retrace some of the past two day’s gains. However, even if does, it is important to not lose sight of the broader picture. The US Federal Reserve is preparing to drop the curtain on its tightening campaign while the European Central Bank is delivering some new performances. This divergence in policy, when confirmed will mark a major shift in the trend of the EUR/USD.


British Pound

The British pound is outperforming the Euro once again with three days of consecutive gains against the US dollar. After Tuesday’s report that inflation hit a nine month high in the month of June, pound bulls have more to be happy about. Retail sales last month more than doubled expectations, rising by 0.9 percent after increasing an upwardly revised 0.7 percent the month prior. It is reported that the World Cup affect not only benefited Germany, but also the UK as the country’s citizens went out and bought household goods such as television sets, food and drink (aka beer) in masses. Hopefully UK consumers have moved beyond the thriftiness that we saw in earlier months and will continue to spend for months to come. Although the increased spending is certainly encouraging for the UK economy, it may not be enough to get the Monetary Policy Committee to act before they bring the committee up to full staff.

Japanese Yen

A barrage of Yen bearish news has weighed on the currency today. It has been quite some time since we have seen a broad based move in the currency pair, but today, the yen has weakened against all of the majors. The OECD warned against more interest rate hikes from the Bank of Japan. They said that deflationary pressures still exist and that Japan should make sure that inflation is sufficiently positive to minimize a negative shock that could push them back into deflation. Meanwhile the Reuters Tankan manufacturing index also declined by 4 points. As we suggested yesterday, the minutes from the Bank of Japan’s meeting mid last month failed to deliver any surprises. In fact, the monetary policy committee did not talk much about the rate decision that was to come this month. We still expect at least 2 months to pass before the Bank of Japan makes another move. They want to make sure that the economy is able to bear the tightening before delivering another one. Right now, in most of the world, it is a wait and see game.

 

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