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Thursday February 15, 2007 - 21:59:09 GMT -

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Forex - US Dollar – Weak Data But Not Weak Enough to Alter Fed Stance

FXCM -DailyFX Fundamentals 02-15-07

By Kathy Lien, Chief Strategist of

• US Dollar – Weak Data But Not Weak Enough to Alter Fed Stance
• Japanese Yen Extends Strength Following Robust GDP Report
• Canadian Dollar Hits 7 Week High Against the US Dollar

US Dollar - The takeaway message from yesterday’s testimony by Fed Chairman Ben Bernanke is that the central bank needs to see more data before deciding whether or not to raise interest rates. Today’s batch of economic data explains their hesitation as the disappointments outweigh the upside surprises. However aside from the Japanese Yen and Canadian dollar, the weakness in the US dollar was not that great because the disappointments are not compelling enough for the Federal Reserve to back away from their plan to raise interest rates again some time this year. The primarily sector that they are looking at, which is housing did exhibit strength with the NAHB home builder confidence index hitting the highest level since June. There were a lot of disappointments however the biggest one was the Treasury International Capital flow report. Foreigners were net sellers of US securities in the month of December, which caught every market watcher by surprise. With a consensus forecast of $70 billion, the worst that traders probably expected were purchases between $40-50 billion. Instead foreigners cut their net dollar holdings by $11 billion. Excluding short term flows, net long term flows increased by $15 billion, but that was the weakest since January 2002 and pales in comparison to the market’s $60 billion forecast. Even though the outflow is very dollar bearish, there is only so much weight traders should put on 1 month worth of data. Over the past few months, foreign inflows have been healthy. In addition, December tends to be an odd month because year end repatriation and position adjustments can alter the data. Much of the weakness has been attributed to the strong rise in emerging market debt which has attracted speculative capital out of US dollars. Caribbean-based investors, which are basically hedge funds, sold $15.1 billion while private investors boosted their foreign bond holdings by the largest amount ever. China, Japan and OPEC nations were all buyers. There is no excuse for the manufacturing sector however. Industrial production dropped by 0.5 percent in the month of January while the business outlook for the Philadelphia region posted a 0.6 reading in the month of January. This is a larger drop than traders were expecting and comes in stark contrast to the jump that we saw in the Empire State survey. The Philly Fed index has a far better correlation with the national ISM survey than the Empire State and on an ISM adjusted level, the Philly Fed actually dipped into contractionary territory. Other bad news today included the rise in jobless claims and drop in import prices. Looking ahead, we are left with producer prices, housing starts, building permits and the UMich consumer confidence survey tomorrow. Both the housing market data and inflation report could continue to deliver some interesting market activity.

Euro – The Euro ended the day slightly higher against the US dollar as unambiguously strong European reports and clearly hawkish comments from the European Central bank contrasts with the murky economic and monetary policy outlook for the US. The only piece of economic data released from the Eurozone today was new car registrations, which rebounded in January. The ECB monthly report was the day’s primary focus and as expected, the report indicated that the central bank needs to continue to exercise “strong vigilance” and act in a “firm and timely manner.” They still believe that the risk to the inflation outlook remains to the upside and that rates remain low. This was further confirmed by ECB members Quaden and Bini-Smaghi who both believe that monetary policy is “quite accommodative.” The ECB continues to tell us to expect interest rates to be increased in March and the price action of the Euro reflects that.

British Pound – The UK is beginning to run into problems, raising doubt to the recent comments from Bank of England Governor King. Retail sales fell 1.8 percent in the month of January, which was the biggest drop in four years while the RICS house price balance fell from 37 percent to 28 percent. The economy is showing signs of weakness and even though wage pressures could creep back higher as King warned yesterday, it may not be enough for the market to believe that the central bank will raise interest rates again in March. Consumer spending and housing has long been the two sectors of the economy that the BoE watches most closely and the drop retail sales is unarguably significant. This turn in the economy has sent the British pound tumbling against both the Euro and US dollar.

Japanese Yen – The Japanese Yen staged a major rally today after Japanese GDP jumped by 1.2 percent in the fourth quarter, driving the annualized rate of growth up from a downwardly revised 0.3 percent to 4.9 percent. A one-time growth in public capital formation was a big contributor to the accelerated activity, but consumer spending also added to the report. We all know that the primary focus of the Bank of Japan is consumer spending and inflation. Aside from the rebound in spending, the GDP deflator also improved from -0.7 percent to -0.5 percent. This could give the Bank of Japan the confidence to raise interest rates next week. The odds at this point are basically 50-50 and with no significant economic data left between now and then, further yen gains may be limited, especially against the US dollar.

Commodity Currencies (CAD, AUD, NZD) – The performance of the commodity currencies are mixed today with the Australian and Canadian dollars gaining against the US dollar while the New Zealand dollar remained unchanged. The Australian dollar has barely responded to the weaker house price index report and the warning from the Treasury’s Costello that the economy is facing a lot of risk. This price action indicates that the steering wheel is in the hands of the US dollar but that may not last if carry trade liquidation out of AUD/JPY continues. There is not much going on in the New Zealand dollar. The currency continues to hold steady after the firm retail sales report yesterday. The Canadian dollar on the other hand is trading at a fresh 7 week high against the US dollar. Improving Canadian data in the context of weaker US data continued to drive USD/CAD weakness. Germany’s Salzgitter has also announced plans to take over Canadian based Algoma for $1.6 billion. Oil prices started the day weaker, but the intraday reversal has helped to fuel the second round of USD/CAD liquidation.


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