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Tuesday September 26, 2006 - 21:56:18 GMT

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Forex - New Home Sales Poses a Risk to Further Dollar Strength

DailyFX Fundamentals 09-26-06

By Kathy Lien, Chief Strategist of

• New Home Sales Poses a Risk to Further Dollar Strength
• Kiwi Melts Down on Comments from Cullen
• Japan Welcomes a New Prime Minister

US Dollar
What a difference a month makes as the optimism of US consumers rebounded significantly in the September after hitting a nine month low in August. The jump from an upwardly revised 100.2 to 104.5 was the largest that we have seen since February. Not only were consumers more confident about current conditions, but they were also more optimistic about future economic conditions. We called for dollar strength yesterday with a test of 1.2685 against the Euro on the back of a strong confidence report and that was exactly what we saw today. Gains were limited because the report was not influential enough to cause the Federal Reserve to resurrect its tightening campaign. The main reason why consumers were happier was because they are paying less at the pump. Since the beginning of August, crude oil price have fallen 23 percent as the national average of gasoline prices dropped over 65 cents. Despite the downturn in the housing market, persistent spending by the US consumer is continuing to drive economic growth. As a leading indicator for retail sales, today's confidence report signals that next month's retail sales report could be as strong as last month's. However, even though this is positive for the dollar, any additional gains beyond 1.2625 against the Euro will be a tough battle. The EUR/USD has been range bound since the beginning of August and we still do not have a significant enough catalyst to take the dollar beyond its recent range highs. In addition, we will likely see some of the dollar bullishness dented after tomorrow’s reports. We are expecting durable goods and new home sales. Even if durable goods comes out decent, new home sales will probably fall for the fourth consecutive month. All indicators from the housing market are expected to confirm the deflation of the housing bubble. However like the gains in the dollar today have been limited, we continue to expect weakness tomorrow to be capped. Unfortunately, range trading will continue to be the dominant theme for the dollar and will remain so until we see some a clear reason for the market to expect that the Federal Reserve will veer away keeping interest rates on hold for the remainder of the year.

The Euro is weaker today because even though the headline of the German IFO business survey was stronger than expected. Unfortunately the business expectations index fell from 101.4 to 98.9. As we said yesterday, domestic spending in Germany has been lackluster at best while the evaporation of the World Cup effect will take away any residual stimulus. Tomorrow’s economic reports will do little to help the Euro with the risks to the Gfk Consumer Confidence report, Italian business confidence report and Italian retail sales report all tilted to the downside. Eurozone M3 should tell us that inflationary pressures are easing, which combined with the drop in the IFO will add to the reasons why the European Central bank may soon announce a more conservative plan for interest rates. Any Euro strength will likely come from dollar weakness. Meanwhile the European Union approved Bulgaria and Romania as potential members of the European Union on January 1, 2007. This is on top of the 10 countries that joined in May 2004 and would bring the total number of EU members to 27. The actual economic implication of this news is minimal because the EU has set high benchmarks for Romania and Brussels to meet that could take years to achieve before they are allowed to join. Furthermore, once they join, they would comprise less than 1 percent of the total EU GDP and approximately 6 percent of its total population.

British Pound
The divergent performance of the British pound against the Euro and the US dollar today confirms that European and US data were the primary drivers of the fluctuations in the GBP/USD and EUR/GBP. The weaker German IFO led to a fall in the Euro against the pound while stronger US consumer confidence led to rally in the dollar against the pound. The hawkish comments by Bank of England monetary policy member Gieve were tempered today as he clarified that even though he favored another rate hike to bring inflation back to their target, he acknowledged that the outlook for the economy was uncertain. Second quarter business investment was revised downward from 1.7 percent to 1.6 percent, which suggests we could also see a downward revision in tomorrow’s third release of second quarter GDP. If the number is revised lower, we could the GBP/USD continue to top out.

Japanese Yen
Yesterday, the market was all about Yen strength, but today, the theme is Yen weakness. We now have a new official Prime Minister of Japan and as expected it is Shinzo Abe. Abe has promised to speed up reforms and has appointed a tax expert as his finance minister who shows his commitment to reduce the country’s burgeoning budget deficit and to cut their public debt. The hope is that the relatively youthful cabinet will help to revive the Japanese economy. Abe has already expressed a strong interest to improve the relations between China and Japan. During Koizumi’s 5.5 year term, he did not hold one summit with China. We expect this to change under Abe’s leadership.

New Zealand Dollar
The strong currency is finally catching up to the New Zealand dollar as the kiwi melts down. We had horrid trade numbers last night, the second in a row. Finance Minister Cullen was on the wires late afternoon squashing rate hike expectations. Expressing his sharp distaste for the rise in the kiwi, Cullen said that the up move was primarily driven by speculative hedge funds and warned that investors should not rule out a drop to 40 cents. Though that’s a bit far fetched his comments that rates could remain unchanged until 2008 are not.


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