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Forex - US Dollar: Is a Bottom Near?

DailyFX Fundamentals 04-23-07

By Kathy Lien, Chief Strategist of

- US Dollar: Is a Bottom Near?
- Yen Skyrockets After First Upgrade to Debt Rating Since 1975
- Canada and New Zealand Not Expected to Raise Rates Next Week

US Dollar- Could the US dollar set a near term bottom this week? Quite possibly. Over the past two months, traders have ignored the upside surprises in US data to focus exclusively on the strength of UK, Canadian, Australian, and New Zealand data. This dynamic is based on the market’s overall belief that the Federal Reserve has their hands tied and their only possible response to stronger US data is to keep interest rates unchanged at 5.25 percent for a longer period of time. On the other hand, they believe that countries like the UK, Canada, Australia and New Zealand have more flexibility to lift interest rates if their economies continue to grow and if inflation remains a problem. Upside surprises in UK and Canadian inflation data last week put greed in the eyes of carry traders by spurring speculation that all four of these countries could raise interest rates within the next month. This week however could prove to be a reality check for these traders as they begin to realize that these central banks may not be in as much of a rush to raise rates as they expect. Australian producer prices have already surprised to the downside while the Reserve Bank of New Zealand and the Bank of Canada is expected keep interest rates unchanged this week. This should serve as a reminder to those anticipating higher yield that they will need to wait. The US dollar however could bounce if US data surprises to the upside. Consumer confidence and existing home sales are due for release tomorrow. The market is looking for both numbers to disappoint, but the recent strength of the stock market, increase in corporate profitability and the stability of the labor market could lead to stronger rather than softer numbers. We are also expecting the Beige Book report and Durable Goods later this week. Inflation pressures should keep the Federal Reserve hawkish while the weaker dollar could boost sales of Boeing aircrafts and other items made to last for more than 3 years. The data releases tomorrow will determine whether today’s dollar recovery continues.

Euro – After hitting a high of 1.3640 last week, the lack of any meaningful economic data has led to more profit taking in the EUR/USD. The initial French elections have delivered the results that the market had been anticipating, which is an eventual runoff between Sarkozy and Royal. The two candidates are neck to neck with Sarkozy holding a tiny lead over Royal. French voters can be notorious for changing voting habits between round one and round two, so either candidate still has the chance of becoming France’s next head of state. A win by Sarkozy would be short term bearish for the Euro, but long term bullish while a win by Royal would be the exact opposite. To read more about why this is the case, see our Special Election Report. Part of the Euro’s slide today can be attributed to the recovery in the dollar, but the other part is due to profit taking in EUR/JPY. The IFO survey of German business sentiment is due for release on Wednesday. Even though the ZEW survey reported stronger analyst sentiment, the recent strength of the Euro could prompt businesses to be less optimistic. Although some companies like Volkswagen have learned from their mistakes of under hedging foreign exchange risk in 2004, many companies did not. Paris-based L’Oreal recently reported that sales were up 7.9 percent in the first quarter, but the details of their earnings data indicate that the rapid rise of the Euro during the quarter actually produced a negative 4.1 percent impact on sales. We suspect that L’Oreal was not the only company to see their profit margins squeezed by currency fluctuations and the IFO report could reflect that.

British Pound – Demand for dollars and yen has pushed the value of the British pound lower despite evidence of stronger money supply growth. Inflation has been a persistent problem in the UK, with producer and consumer prices both surprising to the upside last week. It is very clear that the Bank of England needs to raise interest rates at least once, if not twice this year and this expectation should continue to keep the pound strong going into the May 10th monetary policy meeting. The BoE has a history of catching the market by surprise, which may explain why some traders are looking for a more aggressive 50bp rate hike next month. Although this is relatively unlikely, it should not be a complete surprise. Meanwhile, the economic calendar is relatively light this week with only the CBI industrial trends survey, GDP and Nationwide house prices due for release. This suggests that the value of the British pound could be dependent upon whether the dollar continues to rebound and whether carry trades continue to succumb to profit taking.

Japanese Yen – Expect the Japanese Yen to be a big focus of currency traders this week. The initial wave of yen buying that has caused a reversal in carry trades was sparked by S&P’s upgrade of Japan’s sovereign debt rating from AA- to AA for the first time since 1975. We are certain that the recent weakness in the Japanese Yen is a contributing factor to their rosier outlook on the banking sector and overall economic growth. Later this week, we have a tremendous amount of Japanese economic data due for release. It is only a matter of time before economic data begins to show the beneficiary impact of a weaker currency. This week’s data has the potential to reflect the turn. Meanwhile, keep an eye on the Dow. Over the past two months, we have seen carry trades move in lockstep with the stock market index. The Dow is struggling to break above the 13,000 psychological point of contention and that may be partially due to the profit taking that we are seeing in the currency market as both instruments are a reflection of the market’s demand for risk.

Commodity Dollars (AUD, NZD, CAD) – Australia’s disappointment in producer prices triggered a sell-off in both the Australian and New Zealand dollar. The strength of the Australian dollar has reduced inflationary pressures which will relieve some of the central bank’s urgency to raise rates. Consumer prices are due for release tonight and if that surprises to the downside as well, the near term top in the AUD/USD could be cementer. The disappointment could also prompt speculation that the Reserve Bank of New Zealand will be less hawkish Wednesday night after their rate decision. The Canadian dollar on the other hand continues to strengthen as oil prices gap higher in Monday trading. Expect leading indicators to come out strongly tomorrow, but this will not result in any rate changes by the central bank.


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