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Tuesday December 5, 2006 - 23:06:48 GMT -

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Forex - The EUR/USD Has More Room to Rise

DailyFX Fundamentals 12-05-06

By Kathy Lien, Chief Strategist of

• The EUR/USD Has More Room to Rise
• Canada and Australia Leave Rates Unchanged
• Japanese Yen Jumps After Hawkish Comments from BoJ Officials

US Dollar
The stronger service sector ISM report has helped the US dollar recover against all nearly all of the majors. In contrast to the manufacturing sector report, a number of the components within the service sector accelerated in the month of November. Prices paid jumped from 51.9 to 55.6 while employment rose from 51.0 to 51.6. Given that the service sector represents seventy percent of the economy, its stability is comforting at a time when everyone is talking about the possibility of recession. The outlook for the payrolls report on Friday also remains encouraging after the Challenger layoff report printed a strong 22.7 percent drop in the month of November. With no major releases until payrolls, the US dollar really needs a strong NFP print to cement a bottom. If we do not see that strength, the EUR/USD would have the green light to aim for its previous all-time highs. Even though the EUR/USD and GBP/USD moves thus far may seem very large to us, compared to prior breaks out of low volatility environments, we have only captured half of the previous moves. Back in 2002 and 2004, the EUR/USD broke out of similarly low volatility environments and in both cases, the moves exceeded 1000 pips. So far, the currency pair has only rallied approximately 500 pips which mean that the market could turn far more dollar bearish than it has already. If the EUR/USD stages a similar move this year as it did in 2002 and 2004 that would put the price at approximately 1.38, which is above its prior all-time high of 1.3665.

Euro and Swiss Franc
The Euro hit a fresh year to date high against the US dollar after the surprise strength in service sector PMI and retail sales. The service sector strength was primarily concentrated in Germany as the expansion in France slowed last month, but this first improvement since June supports the central bank’s plans to raise interest rates. At this point, the market’s primary focus is Thursday’s ECB rate decision. We’ve got some retail sales figures tomorrow, which is usually important but any meaningful reaction will probably be held off until Thursday. The market expects the ECB to raise interest rates from 3.25 percent to 3.5 percent. Comments from central bank President Trichet will be the key focus of the market as traders look for direction on future rate decisions. With the Euro hovering at 1.33, it is unlikely Trichet will do anything to talk up or talk down the Euro. As an export dependent economy, the ECB does not want to see the Euro strengthen too much, but at the same time, the recent move in the currency has done wonders to lower inflationary pressures. Meanwhile the Swiss franc strengthened against both the Euro and US dollar despite the lack of any economic data.

British Pound
The sterling failed to gain from a strong PMI survey that showed that UK services sector grew at the strongest pace in nearly three years. The sterling traded far from last week's 14-year high against the dollar reaching an intraday low of 1.9667, when a better than expected US ISM report surprised many traders and showed that the U.S. service sector grew at its fastest pace since May. Services activity in the UK rose from 59.3 in October to a better than expected 59.8 in November and the index components for incoming, outstanding business and employment were all relatively strong. Earlier in the day, the BRC Sales Monitor showed a worst than expected gain of 0.5% on a month over month basis which encouraged investors to take profits on the sterling. Retail Sales are a key driving force in the progress of the U.K. economy but the data is often very volatile and trends can be hard to make out.

Japanese Yen
The Japanese Yen staged a very strong rally against all of the majors after BoJ policy member Mizuno said that softer consumer spending numbers would not dissuade the central bank from raising interest rates. Today’s price action tells us that traders are looking for any reason to exit out of short yen carry trades even though his words probably hold very little weight on overall policy. The big wigs, Fukui and Abe talked about an interest rate hike at their regular meeting, but reached little conclusion. The economy is slowly improving, but even if they did deliver a rate hike, it would not be until mid next year. The yen is also bouncing on news that China plans on launching Yuan currency option contracts. This move is aimed at helping China’s commercial banks manage exchange rate risk better and is a promising step towards financial liberalization. As a proxy for Asia, the Yen has rallied on the report.

Commodity Currencies (CAD, AUD, NZD)
Both the Bank of Canada and Reserve Bank of Australia left interest rates unchanged today which has pressured their respective currencies. The BoC statement remained virtually unchanged, which is not surprising given the recent weakness in Canadian economic data. The IVEY PMI report is due for release tomorrow and even though the consensus forecast is for an improvement, the greater possibility is for a contraction. We have already seen manufacturing conditions slow globally, so there is no reason why conditions in Canada should be any different. Meanwhile Australia does not release a statement when they rates unchanged, but their own recent deterioration in economic data will keep rates from moving anytime soon as well. The third quarter current account deficit narrowed to AUD12 billion, which was not as good as the market was anticipating. Service sector PMI dropped from 52.0 to 48.5, with new orders and employment dropping. The Reserve Bank of New Zealand will be announcing its own rate decision tomorrow and like the BoC and RBA, no changes are expected.


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