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Wednesday January 10, 2007 - 23:02:00 GMT
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Forex - Euro (EUR) Traders Insecure Ahead of ECB Rate Decision

FXCM - DailyFX Fundamentals 01-10-07

By Kathy Lien, Chief Strategist of www.dailyfx.com

- Euro (EUR) Traders Insecure Ahead of ECB Rate Decision
- US Dollar (USD) Rallies After Stronger Trade Balance
- Canadian Dollar (CAD) Rises Despite 19 Month Low in Oil Prices

US Dollar

The US dollar has rallied 400 pips against the Euro in a little more than a week with the latest jump being driven by the smaller than expected trade deficit. As we pointed out yesterday, the four percent drop in the trade weighted dollar during the month of November has helped to deliver the third straight monthly improvement in the deficit by boosting exports and restraining imports. The low level of oil prices has also kept the value of crude imports virtually unchanged. Former Federal Reserve Chairman Alan Greenspan has often said that one of the few ways to fix the trade deficit is for the US dollar to weaken. Now that it has weakened, we have seen its impact on trade and its potential contribution to growth. As long as the trade balance does not deteriorate much in the month of December, we could see 3 percent GDP growth in the fourth quarter. The market is very bullish dollars now after having recovered nearly all of its end of November gains, but we will need to see a strong retail sales report on Friday before the EURUSD can retreat back into its Summer of 2006 trading range. Comments from Federal Reserve officials this afternoon were mixed, but the takeaway message from Moskow and Fisher is that inflation is still a concern and for the time being, there is a next to zero chance that the Federal Reserve will be cutting interest rates in the near future. There is no significant data due for release tomorrow but more Federal Reserve Presidents will be giving speeches. The day’s key focus will the European Central Bank meeting in the morning and then depending on how Trichet sways, the market could settle down after the London close and tread water before the US retail sales figure on Friday.

Euro

The long awaited European Central Bank interest rate decision is tomorrow morning and the Euro is weak going into it, which means that should there be any upside surprises, the EUR/USD has plenty of room to rise. The main question the market is contemplating at the moment is not how much the ECB will move but whether ECB President Trichet will stick to his hawkish stance since no rate changes are expected. Recent economic data suggests that even though growth in the Eurozone economy is improving, the improvements have been limited to certain sectors. The drop in oil prices has also been helping to lower inflationary pressures but at the same time, recent Euro weakness is keeping it from falling too far. Trichet surprised the market in December by remaining extremely vigilant and to date, we have not heard any differently from other ECB officials. The ECB is not a central bank that likes surprises which means that if they were to change their stance, they would have most likely let the market know by now. Therefore it is quite clear why the market is so insecure going into this rate decision. Insecurity only means one thing in the currency market and that is, volatility. Meanwhile the Eurozone data released this morning was softer than expected. Both French industrial production and the French trade balance deteriorated in the month of November while the German wholesale price index remained flat in December.

British Pound

After two days of holding onto its gains, the British pound finally succumbed to dollar strength. The currency buckled when consumer confidence and the trade deficit both came out weaker than expected. Confidence dropped from 89 to 83 while the trade deficit hit a 6 month low. The drop in confidence is actually quite surprising given the potential strength of retail sales this holiday season. Many individual retail chains have reported very sharp increases in spending over the past few weeks while the BRC reported an acceleration in prices. Both of these developments are still relatively positive for the British pound and should keep the central bank hawkish for the time being. Even though the trade data was poor, most of the deterioration was related to the strength of the sterling and should not impact the economy much since the UK is dependent on export. Looking ahead, we have industrial production and leading indicators due for release tomorrow morning. Although the manufacturing sector contracted in October, a nice rebound is expected for the month of November. The Bank of England also has a scheduled interest rate announcement, but no changes are expected.

Japanese Yen

The Japanese Yen rebounded today against every major currency expect for the US and Canadian dollars. Speculation about interest rate direction continues to drive currency movements, but for the time being, the outlook remains very cloudy. The war of words last night was between the head of research at the Bank of Japan (Hayakawa) and ex-BoJ official Nakahara. Hayakawa was relatively optimistic about growth, but Nakahara said that it may be premature to raise interest rates this month. Either way, we believe that even if the BoJ raises rates, it may not necessarily be positive for the Yen.

Commodity Currencies (CAD, AUD, NZD)

Once again, the Australian and New Zealand dollars are moving in lockstep while the Canadian dollar performs differently. Interestingly enough, the CAD is the only currency that is stronger against the US dollar. In the face of falling oil prices, this movement is primarily due to expectations for a rebound after crude hit 19 month lows. As prices continue to drop, the risk for major complaints from OPEC is growing. Canada also reported some firmer data which includes an uptick in house prices, building permits and a stronger trade surplus. Australia on the other hand reported mixed data, which included a weaker trade surplus, stronger consumer confidence and job vacancies. This suggests that tonight’s employment data could be slightly firmer as well.

 

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