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Wednesday August 23, 2006 - 21:05:47 GMT
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Euro Weakens as Drop in Belgian Manufacturing Index Signals Fall in IFO

DailyFX Fundamentals 08-22-06

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

• Fate of Dollar Tomorrow is Dependent Upon Which is Weaker - IFO or Durable Goods
• Euro Weakens as Drop in Belgian Manufacturing Index Signals Fall in IFO
• British Pound Strengthens on Better CBI Survey

US Dollar

When it comes to trading currencies, everything boils down to strong versus weak. These three words perfectly characterized the price action that we saw in the currency market today as both US and European economic data fell short of expectations. Yet with data from both countries disappointing, some traders may have had difficulty figuring out who was the weaker of the two. This is where expectations come into play. The only data released from the US were housing related and unsurprisingly – they were bad. Existing home sales in the month of July was the weakest in 2.5 years while the inventory of unsold homes increased to the highest level in 13 years. There is no question that the housing sector is pulling back and both traders and economists have been expecting this for some time. However the pullback in the real estate sector only has meaning when it trickles down to the consumer and so far, even though the slowdown has been occurring for months now, the impact on consumer spending has been minimal. Just two weeks ago, retail sales for the month of July jumped 1.4 percent, the biggest rise in six months. Therefore even though we are worried that a failure to cut back spending now increases the risk of a nasty contraction later, until we actually see consumers react to the slowdown in the housing market, the impact on economic growth remains limited. In contrast, the weakness of the ZEW survey yesterday caught the market completely off guard. Top that off with the drop in the Belgian manufacturing survey reported earlier this morning and chances are that Eurozone data will continue to weaken. Yet tomorrow, whether the US dollar rises or falls will once again depend on who is weaker. The US is projected to report a drop in durable goods in the month of July while the Eurozone is expected to report a drop in the German IFO survey. The country that has the sharper drop will likely be the day’s bigger loser. Meanwhile oil prices continue to move lower which should relieve some of the pressures on the Fed to continue to raise interest rates. Growth is starting to become a problem and the downside risks outweigh the upside. As inflation pressures begin to subside, the central bank only has better reasons to keep rates on hold for the remainder of the year.

Euro

The only piece of data reported today from the Eurozone was the Belgian survey of manufacturing activity. Although Belgium is a tiny country, its activity index has a very strong correlation with the business activity survey of the largest country in the Eurozone. In fact, traders and economists have found that it is far more reliable to use the Belgium index instead of the ZEW survey to forecast the outcome of the IFO survey. Therefore the 2 point drop in the Belgian index from 5.6 to 3.3 suggests that the business confidence will also slip in tomorrow’s report, but the drop may not be as dramatic as the 20 point drop that we saw in yesterday’s ZEW survey. The IFO index is generally not as volatile as the ZEW survey and it is coming off of very high levels. Aside from the IFO report, we are also expecting the final second quarter GDP figures from Germany along with import prices. Both are expected to be strong and could offset some of the Euro bearishness from a weak IFO report.

British Pound

The British pound is stronger against both the US dollar and the Euro following an improvement in the CBI manufacturing orders survey. The index increased from -11 to -8, which is the highest level since December 2004. The details of the report are not as encouraging with the expectations component slipping. The rise was primarily due to an increase in price expectations, which was further confirmed by a separate upgrade by RICS of their estimates for price growth. This suggests that the economy is beginning to improve slowly but the improvements have yet to be significant enough to compel the Bank of England to move interest rates. We expect the remainder of the UK data due out this weekend to give a similar signal.

Japanese Yen

The performance of the Japanese Yen was mixed today with the currency gaining strength against the US dollar, Euro and Swiss Franc but weakening against the British pound and Canadian dollar. This is not surprising since the yen crosses have behaved very differently in thin trading as economic data also comes in mixed. The trade surplus for the month of July fell by 0.2 percent while machine tool orders increased by a more than expected 2.2 percent. The biggest news that is impacting the Yen is Treasury Secretary Paulson’s plans to make multiple visits to China this year and next. Many traders believe that Paulson was brought on to convince China to make more meaningful changes to their exchange rate policy. China on the other hand continues to show reluctance. The country’s Minister of Commerce indicates that all they afford is a 3 percent per year climb in the value of the Yuan. Any further rise could put a serious dent in the export sector. Meanwhile the only piece of meaningful data from Japan this week will not come until Thursday night. Consumer prices are slated for release and they have the potential to shed more light on how soon we may see another interest rate hike from the Bank of Japan.

 

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