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Tuesday April 3, 2007 - 21:23:27 GMT -

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Forex - Greater Appetite for Risk Drives U.S. Dollar and U.S. Stocks Higher

FXCM - DailyFX Fundamentals 04-03-07

By Kathy Lien, Chief Strategist of

- Greater Appetite for Risk Drives U.S. Dollar and U.S. Stocks Higher
- Strong Rise in Construction Sector PMI Helps British Pound Outperform Euro
- Turn in Commodity Prices Leads to Turn in Canadian, Australian and New Zealand dollars

US Dollar – The combination of thin trading conditions, stronger economic data and subsiding tensions in the Middle East were enough to drive the dollar higher on what was otherwise a quiet trading day. After yesterday’s hawkish comments from Federal Reserve President Poole, traders came back into the markets looking for a reason to buy dollars. The Fed President made it clear that the economy would need to weaken far more significantly before he would be willing to support an interest rate cut, giving carry traders the green light to reinitiate their positions. Oil prices are also lower as signs of Iran’s willingness to find a diplomatic solution to the capture of the UK soldiers emerge. Iran’s Chief Nuclear Negotiator said earlier today that the two governments have already begun talks and if they “continue this path, they can change the situation logically…in such a way that the issue is resolved.” This has helped to fuel a greater appetite for risk as it eliminates the risk of another war being started in the oil rich Middle East. As for data, the only economic report released today was pending home sales. In contrast to the drop in new home sales, pending home sales actually increased by 0.7 percent, suggesting that the problems in the sub-prime sector have yet to spillover into the broader housing market. Looking ahead, there is enough important data tomorrow to challenge the market’s dollar bullish sentiment. This includes the service sector ISM report, ADP Employment survey and factory orders. The market’s focus will be on jobs. Yesterday’s manufacturing sector ISM report revealed a contraction in employment. If the service sector also sees slower employment growth, analysts may rush to revise their March non-farm payroll estimates. The forecast is currently calling for 133k jobs to have been added to the US economy last month. This is a lofty estimate that has more scope for downside than upside risk.

Euro – Late afternoon strength in the dollar pushed the Euro lower today. The lack of any meaningful economic data kept the EUR/USD range bound for most of the European trading session. The only economic release we had on the calendar was Eurozone producer prices which rose by 0.3 percent, right in line with expectations. After hitting a one year high last week, the EUR/USD did not have enough momentum to extend the rise. With February data trickling in, we have finally begun to see the Value Added Tax increase hit the German economy. The big upside surprises that we saw in January are now beginning to fade, but even so, the impact has not been as deep as many analysts may have predicted. For that reason, the European Central Bank still has justification to raise interest rates again this year. ECB member Liebscher indicated today that rates are still on the accommodative side. Looking ahead, we are expecting Eurozone service sector PMI and retail sales tomorrow. The market is still looking for faster growth, but in all likelihood, we could see weaker growth in the service PMI report just as we did in the manufacturing sector report earlier this week. Over in Switzerland, consumer prices grew by 0.1 percent in the month of March. This was right in line with expectations, but represented a slower pace of growth when compared to the prior month. The outlook for Switzerland remains positive. In their Spring Economic Outlook, the KoF raised their GDP forecasts from 2.1 to 2.4 percent for this year which paves the way for another rate hike by the Swiss National Bank.

British Pound –The British pound has outperformed the Euro thanks to a stronger than expected construction sector PMI report. Rising from 57.3 to 58.9, the three month average of the PMI report hit a 3 year high, indicating that the housing market is still chugging along in a stable and healthy way. The Bank of England begins their 2 day monetary policy meeting tomorrow. Even though some recent reports have been encouraging, the central bank is not likely to surprise the market with another rate hike. With the geopolitical situation in Iran still keeping some Britons nervous, the BoE may not want to rock the boat at such a precarious time by raising rates. Furthermore, at the last meeting, eight members voted to keep interest rates unchanged while one member, Blanchflower, voted for an interest rate cut, which means that the scales were tipped towards a dovish bias. At this point, the UK economy has not accelerated enough to convince the majority of the members to favor another rate hike.

Japanese Yen – The weakness of the Japanese Yen has put carry trades back in play. A strong rally in both the Asian and U.S. stock markets have helped to boost global risk appetite, which has come at the expense of the Yen, the financial market’s long favored vehicle for funding. The only piece of economic data released overnight was the monetary base, which was higher than expected. The G7 meeting is next week and traders are beginning to talk about whether the Yen will be a topic of discussion. Canadian Finance Minister Flaherty started the speculation when he said that the G7 may discuss the currency at the upcoming meeting. Japanese Finance Minister Omi refuted that by saying there was only a slim chance that the value of currency would be discussed. No data is scheduled for release tonight, so expect traders to continue to key off the movements in the Nikkei.

Commodity Dollars (AUD, NZD, CAD) – As a group, the commodity currencies are all weaker across the board despite the demand for high yielding currencies. The prior rally in commodity prices is now exhausting which has led to similar price action in the commodity currencies. The turn in crude prices has sent the Canadian dollar lower while the prospects for a sharp drop in building permits tomorrow also weighs on the currency. Meanwhile the Australian trade deficit increased far less than expected thanks to a sharp rise in exports. The Reserve Bank of Australian is set to announce their interest rate decision today and there is 60 percent chance that they will raise rates. Even if they do not, the strength of recent data suggests that they will keep the door open for a rate hike in the months to come. The New Zealand economic calendar is very light this week, indicating that the kiwi will most likely be tracking the Aussie for the time being.


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