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Forex - Euro: German IFO to Give the Market Clues on Policy Actions beyond June

DailyFX Fundamentals 05-23-07

By Kathy Lien, Chief Strategist of

• Dollar: Dow Struggles to Stay Positive, What Does this Mean for the Dollar?
• Euro: German IFO to Give the Market Clues on Policy Actions beyond June
• British Pound: Strong Gains after BoE Contemplates 25 or 50

Dollar: Dow Struggles to Stay Positive, What Does this Mean for the Dollar?
Another record intraday high in US stocks today means another day of solid gains for carry trades. The strong correlation between the two instruments explains why the dollar continues to rise against the Japanese Yen but has weakened against other major currencies. The relationship between the Dow and carry trades goes both ways so we caution that the stock market’s inability to hold its highs over the past few days could spell trouble for not only US stocks, but also carry trades in the days or weeks ahead. Today, the Dow was up as much as 70 points before reversing intraday gains to end the day down 14 points. Carry trades have retraced as well, but having rallied significantly throughout the European and US trading sessions, the moves lower were not significant enough to send those pairs into negative territory. However should the stock market finally buckle by selling off 100 points or more then carry traders should seriously watch out. What could trigger a more significant move lower in the Dow? Perhaps tomorrow’s durable goods and new home sales reports. The weak dollar has continued to fuel demand for Boeing aircrafts, but orders for big ticket items excluding transportation could suffer, especially when it comes to electronics and furniture. Builder sentiment has hit decade lows which could be reflective of how new homes have been selling. Disappointments in both could lead to more dollar weakness, which has been expressed against every currency except for the Yen. However neither durable goods nor any of the housing market reports will probably change the Federal Reserve’s mind about leaving interest rates unchanged. Only a big up tick in jobless claims, falling gasoline prices or an end to the stock market rally will give them enough flexibility or reason to be proactive rather than reactive to the deteriorating conditions of the housing market.

Euro: German IFO to Give the Market Clues on Policy Actions beyond June
Positive economic data continues to fuel gains in the Euro. Italian retail sales doubled expectations by rising 0.5 percent in March, bringing the annualized pace of growth up from 0.4 percent to 2.6 percent. The strength of the Italian consumer is reflective of the broadness of the European recovery especially as Eurozone industrial orders came close to tripling expectations with a monthly growth rate of 2.7 percent. Yet even though European data has been consistently surprising to the upside, the Euro has struggled to rally. Why? Because a lot of the good news has already been priced into the market and traders fully expect a 25bp rate hike to 4.00 percent next month and what they are now looking for are clues on policy actions beyond June. Unfortunately, the two latest pieces of data are for the month of March, which is too backward looking to give any clear indication of whether interest rates will hit 4.25 percent this year. Tomorrow’s German IFO survey is different as it is forward looking rather than backward looking and unlike the German ZEW survey of analyst sentiment, the IFO survey has been a far better indicator of how the economy is faring. Therefore, the data release tomorrow will be much more market moving for the Euro than the releases that we have seen thus far. Meanwhile the only carry trade currency pair to not rally was EUR/CHF. Continual complaints from the Swiss National bank suggest that they may be getting serious about preventing any further weakness in the currency.

British Pound: Strong Gains after BoE Contemplates 25 or 50
The British pound is the story of the day as hawkish minutes from the latest monetary policy meeting spurs across the board gains in the currency pair. Given the recent weakness in UK economic data, the market had anticipated tepid comments from the central bank. The general belief was that the Bank of England did not want to do anything that would take the country’s exchange rate beyond 2.0. However instead of contemplating a 25bp hike versus no hike, the central bank actually debated 25 versus 50. Even though the members voted unanimously in favor of a quarter point hike, the fact that they were considering more versus less was enough to bring some bulls back into the market. More specifically, the BoE said that there is a “high probability of another rise later in the year.” The last part of this statement suggests that June may be too early to expect another move, especially given the recent pieces of economic data. Therefore even though we could see further pound strength, the rally could be limited.

Japanese Yen: Carry Trade Demand and Weak Data Sends Yen Tumbling
The Japanese Yen weakened significantly on the weight of carry trade demand and soft economic data. Activity in Japan continues to be lackluster with the all industry index falling by the largest amount in 3 years. Disappointments all around in economic data has made it difficult for the Yen to rally. Tonight however, we could have our first surprise with a weak yen expected to help drive stronger exports. Meanwhile the US government remains very critical of China despite their latest moves. Paulson warned today that the country is getting impatient with the weakness of the Yuan and as a result, the Chinese will likely hear “strong views” from Congress. He urged for faster Yuan appreciation, but issued no major threats, which led to little reaction in the Yen.

Commodity Currencies Rebound Despite Mixed Data
The Australian, New Zealand and Canadian dollars are moving in unison once again, with each of these currencies up strongly against the dollar. This can most likely attributed to dollar weakness than commodity currency strength since economic data out of the region wasn’t incredibly impressive. Skilled vacancies in Australia dropped by 1.1 percent in the month of April, which was less than the -2.2 percent drop reported the prior month. Westpac leading indicators increased by a modest 0.2 percent in March, compared to a 0.9 percent in the month of February which suggests that tonight’s Conference board numbers could also be softer than expected. Meanwhile both New Zealand Q2 inflation expectations and Canadian leading indicators remained unchanged. Looking ahead, the New Zealand trade balance is due for release and we expect the strength of the Kiwi to take a big bite out of exports.


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