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Forex - Euro Falls Victim to Dollar Strength

DailyFX Fundamentals 05-16-07

By Kathy Lien, Chief Strategist of

- Dollar Hits 3 Month High Against Yen: What’s Behind the Move?
- Japanese Yen: BoJ Meeting and GDP Data Raises the Stakes for a Possible Turn
- Australian, New Zealand and Canadian dollars Break down as Commodity Prices Turn

Dollar Hits 3 Month High Against Japanese Yen: What’s Behind the Move?

The US dollar performed extraordinarily well today, with no currency escaping its strength. The press is crediting the move to the stronger housing starts, but with the rally coming 2.5 hours after the data release, this remains questionable. Instead, what is probably not a coincidence is the fact that the Dow Jones Industrial Average began to erase all of its earlier gains around the same time that the dollar started moving higher. Currency pairs like EUR/JPY, AUD/JPY and NZD/JPY also began breaking down within minutes of the dollar’s move. The strength of the dollar has been so prevalent that USD/JPY is moving in a completely opposite direction as the other yen crosses. A warning of possible interest rate hikes by a Japanese minister was the trigger for Euro and Aussie selling, which probably filtered into the majors since the Bank of Japan is set to announce their monetary policy decision this evening (more in Japanese Yen commentary). The housing starts number is strong, especially considering that the market was looking for unambiguously bearish housing numbers. Yet the 2.5 percent rise in housing starts, does not offset the fact that building permits saw the slowest pace of growth in 10 years. Housing starts are the number of residential projects that have begun construction while building permits are the number of applications filed for new construction. Therefore building permits represent a far better reflection of where the housing market is headed going forward. In a growing market, permits should be higher than housing starts, but in this case, it is not. Even though the dollar has rallied strongly today, the housing market may not be out of the woods. It is far too early to tell since both building permits and yesterday’s NAHB index of builder confidence sank to decade lows. The one unambiguously positive piece of dollar news was industrial production, which increased by 0.7 percent last month. As we have said often, the weakness of the US dollar has been extremely beneficial for the manufacturing sector. We expect this to continue with tomorrow’s Philadelphia Fed index.

Euro Falls Victim to Dollar Strength

Despite the fact that officials from the European Central Bank continued to stress their hawkishness, the Euro erased all of its gains and then some. The move did not come until the US session as the upside surprises to Eurozone data kept the Euro hovering around 1.36 until the open of the US session. The data indicated that French wage growth accelerated in the first quarter along with non-farm payrolls. Eurozone CPI remained unchanged at 1.9 percent, which was slightly stronger than market expectations. The ECB is set to release their monthly report tomorrow and we expect the details to contain the same hawkish tone. Growth and inflation data give us no reason to question whether the ECB will follow through with their plans to raise interest rates next month.

British Pound: Softer Inflation Continues to Weigh on the Pound

The British pound began to weaken at the onset of the European trading session and continued to sell-off throughout the trading day. Even though UK unemployment fell to the lowest level since 2005, average earnings growth slowed from 4.6 percent to 4.5 percent. Inflation is clearly falling with earnings being the third piece of inflation data that has surprised to the downside. Since inflation was the primary reason for the central bank’s rate hike last month, the fall in inflation seriously questions whether they will raise rates again next month. The fact that the Bank of England Quarterly inflation report failed to contain any urgency for a rate hike also added to the overall bearishness. The BoE signaled that if inflation moves back to 2 percent, they may need to raise interest again by 25bp. The recent move in the GBP/USD reflects a currency that is working off excess speculation. It is clear that the central bank is watching inflation, so pound traders need to do the same if they want to figure out where the currency is headed next.

Japanese Yen: BoJ Meeting and GDP Data Raises the Stakes for a Possible Turn

The Japanese Yen is rallying going into tonight’s interest rate decision and GDP release. The comments from the Japanese minister today about possible interest rate hikes come at a very peculiar time. Even though we do not expect a move from the central bank, tonight we could see a significant upgrade to their level of hawkishness. The recent record current account surplus reported by Japan puts pressure on Japanese officials to do something about the currency’s weakness. USD/JPY is not trading far from the February levels, which was the last time the central bank raised interest rates. Weakness continues to be very pronounced against the other currencies with EUR/JPY hitting another record high before reversing intraday. We also expect Japanese GDP to surprise to the upside given the stimulative impact of yen weakness. This means that we could be at the cusp of a few hundred pip turn in the yen crosses.

Australian, New Zealand and Canadian dollars Break down as Commodity Prices Turn

The Australian, New Zealand and Canadian dollars are weaker across the board, as are commodity prices. In fact, the AUD/USD and NZD/USD are the day’s worst performing currency pairs. Even though Australian employment hit 32 year lows last month, last night’s wage growth numbers confirms that the central bank will be in no rush to raise interest rates. If you recall both producer and consumer prices surprised to the downside earlier this month. Like the UK, the strength of the local currency is helping to reduce inflationary pressures. We see the same in New Zealand as producer prices fell for the second quarter in a row on both an input and output basis. In addition, inputs, which are most sensitive to currency valuations, fell by the largest amount in at least 30 years. Therefore like the rest of the world, the strength of the Canadian dollar should also lower inflationary pressures in Canada. Consumer prices are due for release tomorrow and we are looking forward to weaker numbers. In addition to CPI, wholesale sales is also due for release. We usually use this number as a leading indicator for retail sales, which is due on Friday.


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