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Forex - USD Steady as Fed Fund Futures Price in at Most, a 25bp Cut by Dec

DailyFX Fundamentals 01-15-07

By Kathy Lien, Chief Strategist of

- US Dollar (USD) Steady as Fed Fund Futures Price in at Most, a 25bp Cut by Dec
- Euro Rallies As Traders Look for a Rebound in the German ZEW Survey
- Canadian Dollar Strengthens Despite No Changes Expected from Bank of Canada

US Dollar

With the US markets closed for Martin Luther King Jr. Day, it not surprising to see currency trading grind to a halt after the London close. Even though there was no US economic data released today, it does not undermine the fact that this will be a busy data week. The main focus here in the US as well as globally is inflation. Both consumer and producer prices are due for release this week in addition to the Treasury International Capital flow report, the Empire State manufacturing index, the Philadelphia Fed index and the Beige Book report. On balance, the reports are expected to be positive for the dollar, but after such an extensive rally last week, the question is whether there are actually any actually buyers left in the market. According to both our speculative sentiment index and the Commitment of Traders report, there may be. Although both indicate that the market has turned long dollars, neither is anywhere near extreme levels. Since the beginning of the year, we have received a lot of US economic data that indicates that the entire market from analysts to traders have underestimated the resilience of the US economy. Over the past week, we have seen across the board revisions to fourth quarter GDP data with some analysts even projecting growth in excess of 3 percent thanks to a narrower trade deficit, stronger retail sales and a healthy labor market. The drop in oil prices has boosted GDP and encouraged traders to abandon any thoughts that the Federal Reserve will opt to lower rates in the first half of the year. This sentiment is reflected in the Fed Fund futures which went from pricing in a 70 percent chance of a first quarter rate cut at the beginning of last month to a nominal chance of a 25bp cut by the end of this year. We start the busy data week tomorrow with the Empire State manufacturing survey. Having not felt the drag that we saw in the Philly Fed index last month (it turned negative), the survey of manufacturing conditions in the NY region is expected to continue to drop in the month of January.


After extensive losses over the past two weeks, the Euro has started the third trading week of the year on firmer footing. Despite the price action, economic data released this morning was weaker than expected with industrial production growing by only 0.2 percent in the month of November. The market was looking for a monthly rise of 0.7 percent, but sluggish growth in France and Italy led only a minor growth of 0.2 percent for the region as a whole. Comments from ECB officials today have been mixed. ECB members Liebscher and Quaden were slightly hawkish, having said that rates are on the low side while Tumpel-Gugerell sided with the doves. Overall, this tells us that one more rate hike is still in the cards, otherwise the comments from ECB officials would be far more neutral. However the next rate hike which will probably be in March or April could also be the ECB’s last. That is the message that ECB President Trichet left us with last week and it is also the message that the Euro’s price action is reflecting. Looking ahead, we have the German ZEW survey due out tomorrow morning. The survey of analyst sentiment is expected to continue to rebound after hitting a 13 year low in the month of November. The trade data and IFO report suggest that the VAT tax has yet to become a worry for most German corporations. The recent weakness in the Euro and the drop in oil prices make the outlook for exports even more promising. This could help the Euro bounce as key US data does not come out until Wednesday.

British Pound

The market is still trading off of the surprise interest rate hike from the UK last week. This morning’s inflation data was mixed and not exactly delivering the major jump in inflation that everyone had expected after the cautionary words from the Bank of England last week. Monthly producer input prices and core output prices rose less than expected. However annualized growth for input prices and headline output prices were stronger. Overall the report was more positive for the British pound, but that was primarily due to the upward revisions in input prices for the month of November. The more import inflation numbers that we are watching for are tomorrow’s consumer price reports and Friday’s money supply reports. With the GBP/USD reaching a key technical resistance, if CPI fails to deliver strong numbers tomorrow, we could see a near term top in the currency pair as the market questions whether the BoE made the right decision. More likely than not however, the data should come out firmly and support the BoE’s latest rate hike.

Japanese Yen

Despite the possibility of an interest rate hike this week, the Japanese Yen continued to weaken against the majors. There were a lot of comments from Japanese officials last night and the collective message seems to be that they support a rate hike, but only for 25bp. Japan’s Economics Minster said that interest rates need to be adjusted gradually while the Chief Cabinet Secretary urged the BoJ to make an appropriate monetary policy decision. These comments along with the recent weakness in the Yen against both the US dollar and Euro suggests that the BoJ will raise rates on the 18th, but at the same time signal that this is a one off rate hike and that the economy will need time to absorb its impact. Back in July when they delivered their first rate hike, they moderated the market’s response to the move by ending their statement with the comment that “very low interest rates will probably be maintained for some time.”

Commodity Currencies (CAD, AUD, NZD)

The Australian, New Zealand and Canadian dollars are all stronger across the board thanks to firmer economic data and higher commodity prices. Australia reported an increase in investment lending as well as inflation, which offset the drop in home loans. Canada on the other hand reported a rebound in vehicle sales. Although both were encouraging, the primary driver of the move was the technical break in gold prices which sent the yellow metal to a fresh 2 week high. The Bank of Canada is set to convene on interest rates tomorrow, no changes are expected but the statement and the Monetary Policy Report update on Thursday will be examined closely for clues on how the central bank stands on inflation, economic growth and monetary policy going forward. New Zealand will also be releasing Q4 consumer prices. A further drop is expected as the kiwi continued to rise in Q4 while oil prices slide.


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