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Tuesday January 2, 2007 - 21:23:07 GMT -

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Forex - US Dollar Sells Off on First Trading Day of 2007

FXCM - DailyFX Fundamentals 01-02-06

By Kathy Lien, Chief Strategist of

• US Dollar Sells Off on First Trading Day of 2007
• Euro Traders Not Worried About VAT Tax Increase Yet
• Yen Crosses Hit New Highs

US Dollar
2007 has started with a bang even though the US equity markets were closed for the National Mourning Day. After at least a week of compressed volatility, we have finally seen a breakout in the currency market as the US dollar came under severe selling pressure. Traders are telling the market that they do not want to be long dollars ahead of the busy data week. There was originally a lot of important data due for release today, but that is now pushed out to Wednesday. Tomorrow we are expecting not only the manufacturing ISM survey, but also one of the “leading indicators” for December payrolls, which is the ADP Employment index. ISM and payrolls are this shortened trading week’s most important economic releases. The ADP report is projected to forecast a smaller payroll gain in December than in November. The size of the surprise, if any could set the tone for trading until we see the actual payrolls report on Friday. We would need to see very strong payroll growth to reverse the hold that dollar bears have on the market right now. The ISM report could help as traders are forecasting for a rebound in the month of December. The strong Chicago PMI print last week suggests that we could actually see the index rebound, especially since the ISM adjusted Philly Fed index increased in the month December despite the drop in the headline index. Traders will also be paying very close attention to the prices paid component since inflation is still the Federal Reserve’s top priority. Growth in the prices paid component could drive talk of hawkish FOMC minutes later in the afternoon. With so much data due for release, tomorrow should not be a boring trading day one way or the other.

The Euro is up strongly today despite weaker economic data. The Eurozone manufacturing PMI index dropped from 56.6 to 56.5. Even though Germany and France saw improved activity, weaker performance in France dragged the overall index lower. On the most fundamental level, the fact that the US ISM index has a possibility of remaining in contractionary territory while the Eurozone PMI index remains solidly in expansionary territory explains the reason why the market was able to shrug off the report. In addition, there was more speculation of central bank buying for reserve diversification purposes along with hawkish comments from yet another ECB member this morning. This time Liikanen warned about the second round effects of higher oil prices. The biggest uncertainty in the Eurozone is Germany’s value added tax increase which went into effect yesterday. The VAT tax rose from 16 percent to 19 percent and was originally expected to have a huge drag on the economy. However the most recent IFO report suggests that businesses are not worried yet. Interviews with a bunch of German retailers suggests that even though the VAT tax will have a meaningful impact on the economy, that may not be until February or March when January discounting comes to an end. German unemployment is due for release tomorrow. Another improvement is expected, which should have kept retail sales healthy last month.

British Pound
Like the Euro, the British pound also rallied strongly on the first trading day of the year. Manufacturing PMI fell for the third month in a row even though the market was projecting for an improvement. The index fell from a downwardly revised 52.5 to 51.9, the lowest level since last March. Despite the drop, the Bank of England is still on track to raise interest rates again early next year. We will be watching tomorrow’s money supply data for more direction. Faster acceleration in money supply growth could push the central bank to move faster with interest rates. There will also be a number of housing market reports tomorrow. The sector has shown impressive strength throughout the second half of 2006 and the data is expected to continue reflect that. With a booming housing and stock market, there is little chance that consumer confidence will not tick higher.

Japanese Yen
The Japanese Yen has weakened significantly against all of the majors except for the US and Canadian dollars. The weakness was so pronounced that it drove EUR/JPY to a fresh record high, AUD/JPY to a fresh 8 year high, GBP/JPY to a fresh 7 year high and NZD/JPY to a fresh 1 year high. With the Japanese markets closed until Thursday, there was no economic data released overnight. The biggest question on the minds of yen traders is still when the next Bank of Japan interest rate hike will be. Yomiuri newspaper reported on Monday that the central bank could raise rates as early as this month. They have a monetary policy meeting scheduled for January 17 to 19. The JiJi News Agency repeated their prior call for the BoJ to discuss the possibility of a half point hike. BoJ member Muto’s comments this morning that rates will be increased gradually are probably the most accurate projection of what to expect. We think that the BoJ will raise rates by a quarter of a point and then pause for 3 or 4 months before changing rates again.

Commodity Currencies (CAD, AUD, NZD)
The Commodity Currencies were all stronger against the US Dollar today. The biggest mover was the AUD/USD which hit a 21 month high. Aside from dollar bearishness and continued demand for carry trades, there is nothing behind the move. The futures market closed early today with gold and oil prices ending slightly higher. The only Australian and New Zealand data due for release this week will be on Wednesday night. Canada has no data out tomorrow but there are a number of key releases on Thursday and Friday to watch.


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