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Thursday September 21, 2006 - 21:43:39 GMT

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Forex - Dollar Breaks Lower as Negative US Reports Signals Slowdown Ahead

FXCM - DailyFX Fundamentals 09-21-06

By Kathy Lien, Chief Strategist of

• Dollar Breaks Lower as Negative US Reports Signals Slowdown Ahead
• Currency Volatilities Fall to Record Lows
• Long List of Reasons for Yen’s Rise

US Dollar
The US dollar is much weaker today against its counterparts. Having just returned from giving seminars in Asia, I am surprised to see the positive take on yesterday’s FOMC statement. Even though the Federal Reserve repeated that inflation risks remain, they probably only did so to temper the more bearish change that they made to the statement which was to say that they no longer see the slowdown in the housing market as gradual. Any hopes that the Fed will resume its rate hikes this year is probably wishful thinking. Their true inflation concerns should be relatively moderate because in the third paragraph of their statement, they said that “inflation pressures seem likely to moderate over time” thanks to “reduced impetus from energy prices” and the effects of their past interest rate hikes. Oil prices have fallen significantly over the past few weeks driving gasoline prices lower as well, which should keep inflationary pressures well contained. Economic data has been lackluster at best. We did see a strong retail sales report last week, but every other piece of data released in recent weeks was either in line or worst than expected. There is actually further evidence of slowing in the housing market. However it took today’s reports to remind traders of the tough times to come in the US economy. Both leading indicators and the Philadelphia Fed survey of manufacturing conditions came in negative, signaling slower growth ahead. For the second month in a row, leading indicators fell by 0.2 percent in the month of August while the Philly Fed survey came in negative for the first time in over three years. Even though the outlook for the US economy is grim, the sharp fall in energy prices should keep consumers happy for the time being. Prices at the pump have already fallen and we may even see discounts pop up in other industries if oil prices continue to remain low. Therefore any dollar weakness could be capped by the prior lows of 1.2945 against the Euro and 115.50 against the Japanese Yen, especially since there is no US economic data scheduled for release tomorrow.

The Euro has finally broken higher after remaining trapped in a relatively tight 1.2650 to 1.2750 trading range for the past two weeks. The current account data was weaker than expected, but the rally in the Euro was primarily due to dollar weakness rather than Euro strength since the single currency lost value against the Japanese Yen, British pound and the Canadian dollar. This is not surprising since it was only two days ago that the German ZEW survey fell to the lowest level in eight years. However even though the report came in weak, it will not prevent the European Central Bank from raising interest rates again in October. At that time, the direction of their monetary policy should come in stark contrast to that of Federal Reserve, which will benefit of the Euro. With dollar losses limited by the fall in oil and Euro gains helped by the central bank’s interest rate hikes, there is no immediate catalyst for the currency pair to break beyond the 1.2630 to 1.2940 trading range that the EUR/USD has been fluctuating in for the past two months. One month volatilities for Euro options have fallen to record lows of 6.85 percent which is typically the volatility that we see in a currency pair like USD/CAD. In fact, volatilities have dropped across the board. The only major currency with volatility still in the double digits is the New Zealand dollar. Tomorrow’s economic data from the Eurozone include French consumer spending and Eurozone industrial orders, neither of which have the power to cause any sharp reactions in the EUR/USD. Traders will have to wait until next week for any excitement.

British Pound
Like the Euro, the British pound has skyrocketed on broad dollar weakness. However unlike the Euro, the pound has a good reason to. While economic data in the Eurozone surprised to the downside, the data reported by the UK was stronger than expected. The CBI Industrial trends survey increased from -8 to -5. Analysts were calling for a smaller improvement, but an increase in the outlook for export orders and output expectations drove the index to its highest level since December 2004. The UK economy continues to remain stable which is coming to the benefit of the British pound against both the Euro and the US dollar. Tomorrow’s car production report has little significance, but next week’s heavy economic data should show signs of more improvements. The outlook for the pound appears promising, but the 1.9120 level will be a tough one to breach for the British pound against the Us dollar.

Japanese Yen
The Japanese Yen is stronger across the board today with gains seen against all of the major currency pairs. The Yen is rising for a long list of reasons. First, as mentioned in the special report written by Boris Schlossberg yesterday, the yen is benefiting from margin call liquidation. With so much capital gains as well carry interest profits booked in yen crosses, they are the easiest targets for profit taking by hedge funds in trouble. Much of the rise in oil has been driven by speculative interest as has the practice of shorting the yen to fund carry trades. At a time when investors will be critiquing the health of their hedge fund investments, we suspect that many funds will be looking to dress up their balance sheets as they rush to reassure investors that they are not in the same trouble as Amaranth. Cashing in on profits could continue to come to the benefit of the yen. Meanwhile the new military rule in Thailand continues to remain peaceful which is a sigh of relief for the Asian region as a whole. Oil prices also continue to remain low while the market speculates on the possibility of a near term revaluation move by China. Even though recent data has mostly been weak, we expect that the lower value of the yen against the Euro and the US dollar in the months of August and September will help turn things around in the months to come.


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