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Forex - British Pound Sees Big Moves on Talk of 50bp Rate Hike this Thursday

DailyFX Fundamentals 05-07-07

By Kathy Lien, Chief Strategist of

• US Dollar: Gas Prices Hit Record High Days before Fed Meeting
• British Pound Sees Big Moves on Talk of 50bp Rate Hike this Thursday
• Canadian Dollar Hits 11 Month High as Building Permits Grow by Fastest Pace Ever

US Dollar: Gas Prices Hit Record High Days before Fed Meeting

The US dollar is visibly weaker today, but trading has remained exceptionally quiet with the EUR/USD trapped within a 35 pip trading range for the past 24 hours. Even though Japanese traders are back in the market, London traders are out on holiday. Therefore the activity will not begin to pick up until tomorrow, when currency traders begin to lay on pre FOMC trades. The only piece of US data released today was consumer credit, which increased by a much stronger than expected $13.5 billion from $3.0 billion. The focus of the market this week is central bank meetings starting with the Federal Reserve meeting on Wednesday. The dollar is treading water going into meeting since it is unclear whether or not the Federal Reserve will adopt a less hawkish tone. They face a very difficult decision with average gasoline prices hitting a record high at a time when economic growth is beginning to falter. Non-farm payrolls on Friday were weak. First quarter GDP was the slowest in the 4 years while the housing market is beginning to give way. The tug of war between inflation and growth gives the Fed little room to alter the FOMC statement. Even though we think that recent data warrants more cautionary comments on growth, the Fed will most likely wait for a few more weeks of data to ensure that the deterioration in growth is continuing before changing the tune of their statement. Team Bernanke has often put inflation ahead of growth and for the time being, we do not expect this to change. There is no doubt that the central bank will keep interest rates unchanged at 5.25 percent. If the statement does remain unchanged, expect the US dollar to recover. In the off chance that they acknowledge the weakness in growth, we could see the EUR/USD target 1.3700.

Euro Extends Gains as Strong German Factory Orders Forecast Stronger Industrial Production

The Euro’s strength today can be credited to multiple factors. First and foremost, Japanese traders finally had a chance to react to the softer US labor market number from last Friday. Secondly we had stronger German factory orders to compound the Euro bullishness. Even though a number of economic releases are beginning to show the country’s vulnerability to the strength of the currency, just as many pieces of data have shown the country’s resilience. Today’s German factory orders were a perfect example. For the time being, the manufacturing sector is holding up well and the numbers indicate that the sector is continuing to boom. This suggests that we could see a stronger German industrial production number tomorrow as well. Finally, Sarkozy won the French elections with a 53 versus 47 percent victory over Royal. The election results led to a mild Euro rally. As long as there are no major surprises from the Federal Reserve, the Euro should remain above 1.3550 going into the ECB interest rate decision as traders look forward to further rate hikes in June. Meanwhile the Swiss unemployment rate fell from 3.0 to 2.9 percent. The market was looking for a larger improvement, but nonetheless the jobless rate has moved to a 12 month low, reflecting a healthy labor market.

British Pound Sees Big Moves on Talk of 50bp Rate Hike this Thursday

The British pound is the day’s biggest market mover, but you would never be able to tell that from just looking at the price action of the GBP/USD. Instead, the pound’s strength is the most significant against the Euro, Swiss Franc and Japanese Yen. With the UK markets closed, there is little news behind the move. Instead, much of the rally has been credited to speculation that the Bank of England could surprise on Thursday with a 50bp hike. The last time they ever raised interest rates by anything more than 25bp was back in February 1995, over 12 years ago. They have lowered rates by more than 25bp in two instances over the past 10 years; once in 2001 and once in 1998. The majority of traders in the market are only expecting a 25bp hike, but when it comes to the Bank of England, you never know what could happen as they have a track record of catching the market completely off guard.

Yen Crosses Could Break if US Brands China or Japan as Currency Manipulators

Even though Japanese traders are back in the market, we have seen little cohesive price action in the Yen crosses. AUD/JPY and GBP/JPY are up today, but currency pairs like EUR/JPY, USD/JPY and NZD/JPY are down. Aside from the rally in GBP/JPY, the movements in the yen crosses have been limited as the Dow Jones Industrial Average trades up for the 24th trading session out of the past 27. The carry currencies are all holding steady with most of the pairs still consolidating in triangle formations, which indicates that a major breakout is imminent. Coincidently, there are a number of factors brewing that could trigger a breakout. The US House of Representatives’ Trade subcommittee will be hosting a hearing on currency manipulation. China and Japan are the most prominent potential violators which mean that any critical comments about excessive undervaluation of the Yuan or Yen could lead to strength in either currency. Like the Dow, the Shanghai stock index has also hit a record high. China may opt to pacify the situation by engineering speculation of potential moves to cool the rally. If you recall, the last time we had similar speculation, the Chinese stock market dropped 9 percent, triggering a wave of selling in the yen crosses and in the Dow.

Canadian Dollar Hits 11 Month High as Building Permits Grow by Fastest Pace Ever

The Australian, New Zealand and Canadian dollar are all up strongly today despite mixed economic data. Australia’s AIG construction index dropped from 51.1 to 47.9 but business conditions increased from 10 to 13. New Zealand data was clearly less bullish with wages increasing by a less than expected 0.6 percent. This led to the underperformance of the New Zealand dollar against the Australian dollar. Canada on the other hand reported the fastest pace of building permit growth ever. Originally predicted to rise by a modest 2 percent, building permits ended up surging by 27 percent which sent the Canadian dollar to an 11 month high. Looking ahead we have Australian retail sales tonight. Spending is expected to be softer, which would be in line with the slower growth we have seen as of late.

DailyFX Research Team
Forex Capital Markets LLC
32 Old Slip, 10th Floor
New York, NY 10004
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FXCM, L.L.C.® assumes no responsibility for errors, inaccuracies or omissions in these materials. FXCM, L.L.C.® does not warrant the accuracy or completeness of the information, text, graphics, links or other items contained within these materials. FXCM, L.L.C.® shall not be liable for any special, indirect, incidental, or consequential damages, including without limitation losses, lost revenues, or lost profits that may result from these materials. Opinions and estimates constitute our judgment and are subject to change without notice. Past performance is not indicative of future results


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