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Forex - Dollar Stalls Ahead of Service Sector ISM

FXCM - DAILYFX Fundamentals 12-04-06

By Kathy Lien, Chief Strategist of

• Dollar Stalls Ahead of Service Sector ISM
• Canada and Australia Expected to Leave Interest Rates Unchanged
• EUR/JPY Hit Intraday Record High

US Dollar
With no major economic data released today, profit taking and overall short covering was the main driver of the markets. The US dollar staged a modest rally against the Euro and British pound, but an earlier rally against the Japanese Yen and commodity currencies were unsustainable. The market has become very short dollars with the Commitment of Traders data indicating that short positions jumped by 14.6 billion, which is the largest rise that we have seen in a decade. The only piece of data that was released today was pending home sales, which reported a larger drop than the market was expecting. The housing market is really beginning to buckle and the economy is feeling its effects. Fed officials have remained relatively optimistic throughout and this is the message that they leave us with as we enter into the traditional “quiet period” before the December 12 FOMC meeting. It will be a busy week however as we look ahead to the service sector ISM report tomorrow and non-farm payrolls on Friday. The market may be holding out for the non-farm payrolls release before punishing the dollar once again. We will get a few “leading indicators” for payrolls starting tomorrow with the Challenger layoff report. We will also be keeping a close eye on the ADP employment survey as well as the Monster Employment index. With the housing market and manufacturing sector potentially going down the tubes, the labor market is the only part of the economy that is still offering some reason for optimism. In the last Federal Reserve Beige Book, most districts reported that there was a still sign of tightness in the labor market which leaves hope that NFP could print above 100,000. Before that however, we have service sector ISM. If we see slower growth in both the service and manufacturing sector, then the economy may really be in trouble.

Euro and Swiss Franc
The Eurozone reported softer producer price numbers this morning, which may have helped to push the EUR/USD lower. With a lagging economy, the French are starting to become uncomfortable with the level of the Euro. Trade Minister Lagarde said that the strong currency was penalizing French exports to Asia, which will become a more widespread concern should the currency rally even further. EU’s Alumnia also said that they are watching the exchange rate and warned against “excess volatility.” Whether they admit it or not, members of the Eurozone are becoming worried. We think that there is little chance that the ECB will remain hawkish. The ECB doesn’t like surprises so with the EUR/USD trading not far from 1.34, a call for even higher interest rates after the December hike could push the currency up to 1.35 and even 1.36. With growth weakening and the Euro level reducing inflationary pressures, the urgency to raise rates is falling quickly. Therefore it may be far more reasonable for the market to expect the central bank President to tone down his comments and move the central bank’s policy back to neutral.

British Pound
The British pound ended the day virtually unchanged against the US dollar despite another round of weaker economic data. Construction sector PMI dropped from 58.1 to 54.8 in the month of November. Although it can be argued that the index is still in expansionary levels, it does suggest that the enviable recovery in the UK housing market may be beginning to reach a top. Incoming retail sales data is also not looking very promising. If you recall, department store John Lewis reported weaker sales at the end of last week and this morning, retail company Footfall also reported a drop in shoppers last month. This suggests that the BRC retail sales number that is due tomorrow runs a greater chance of coming out weak than strong. However, US service sector ISM will be the market’s true mover since traders have been in the habit of shrugging off weak UK data. There was a minimal reaction to last week’s drop in the CBI distributive trades survey and Gfk consumer confidence.

Japanese Yen
After selling off in the Tokyo trading session to a new record low against the Euro, the Japanese Yen quietly recovered its losses in the European and US trading sessions. Japanese economic data has been mixed recently with the latest batch leaning to the negative instead of the positive. Total cash earnings were flat in October, which was weaker than expected while third quarter corporate expenditures also grew less than expected. The Ministry of Finance’s lack of concern for the value of the EUR/JPY is being taken as a green light for further gains in the currency. The longer the yen remains weak against the Euro, the more stimulus it provides for the export dependent economy. We can only rely on comments from the ECB to deliver a top in the currency pair. Thursday’s ECB monetary policy meeting may be a perfect opportunity for the central bank to do so.

Commodity Currencies (CAD, AUD, NZD)
The commodity currencies were all stronger against the US dollar today despite slightly weaker oil prices and neutral gold prices. With no economic data on the calendar, the Canadian dollar firmed as the country’s stock market hit a new record high. The Bank of Canada is scheduled to make a decision on interest rates tomorrow but no changes are expected. The central bank should also remain neutral on policy given the surprise drop in GDP and overall trend of weaker economic data. The Reserve Bank of Australia will also be announcing interest rates tomorrow evening or Wednesday Australian time. No changes are expected from the RBA either especially after last night’s weaker building approvals and company profits.


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