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Forex - Euro: Chance for Neutral Comments from Trichet after June Rate Hike?

DailyFX Fundamentals 06-04-07

By Kathy Lien, Chief Strategist

• US Dollar: Empty Rally in the Dow will keep Federal Reserve on Hold
• Euro: Chance for Neutral Comments from Trichet after June Rate Hike?
• Strong Gains Continued to be Seen in the Australian, New Zealand and Canadian Dollars

US Dollar: Empty Rally in the Dow will keep Federal Reserve on Hold

To the relief of carry and stock traders around the world, what could have been a very painful trading day ended up being a good one. With the Shanghai stock index down 8 percent overnight, traders knew that there was a strong risk of a sharp move lower in both the yen crosses and the Dow. In fact, carry trades began to sell-off even before the US stock market opened, but when the stock market refused to fall, the fear that we would have another 3.3 percent down day in the Dow quickly abated. Carry traders jumped right back into the markets as they realized that the lifespan of their trades would be extended for at least one more day. Although we believe that carry and stock traders are simply buying time before the inevitable decline, the resilience of the stock market is nothing short of impressive. Earning season is over so it will be interesting to see what is left to fuel the rally in US stocks. It is not a stretch to say that the equity market is aiming for the moon with little fundamental backing. GDP growth of 0.6 percent is hardly reflective of a growing economy. This type of empty rally is exactly what will keep the Federal Reserve on hold for the remainder of the year. If they even hinted that they are considering a rate cut, we could easily see 14,000 in the Dow. Factory orders fell short of expectations in the month of April, but were revised sharply higher in March. Service sector ISM is due for release tomorrow along with speeches by Bernanke and Paulson. Although both of these are very important, the currency market will continue to take its cue from the stock market. The upcoming ECB interest rate decision on Wednesday should keep the EUR/USD range bound. The dollar is weaker across the board today but that weakness is less reflective of a more bearish outlook on the US economy, but rather the voracious demand for currencies of countries that may still raise interest rates again this year. At best, the Federal Reserve will only keep interest rates unchanged.

Euro: Chance for More Neutral Comments from Trichet after June Rate Hike?

With the much awaited European Central Bank interest rate decision just around the corner, the market placed greater than normal weight on the PPI release this morning. Producer prices increased 0.4 percent in April, bringing the annualized pace of growth down to 2.4 from 2.8 percent. Eurozone Retail sales and service sector PMI could fuel more gains the EUR/USD ahead of the interest rate decision. Comments from ECB officials continue to be hawkish. President Trichet said this morning that growth prospects are still very encouraging. ECB member Wellink added that low inflation is “no reason for complacency.” This essentially guarantees a rate hike on Wednesday and may raise the number of traders expecting hawkish comments in the accompanying press conference. However it is important to understand that after the ECB raises rates, unless they plan on following up with another hike the very next month, the central bank usually neutralizes its statement to some degree. Typically this involves dropping the words strongly vigilant, which would be perceived as a more dovish move. Even though economic growth has been strong, is not strong enough to warrant back to back rate hikes. The last time they delivered two consecutive hikes was back in September and October 2000. The only reason why they were so aggressive was because the EUR/USD hit a record low and the central bank was desperately trying to drum up demand for the currency pair.

British Pound: Acquisition Flows Drives Strong Gains in the British Pound

The British pound is up strongly today thanks to a wave of acquisition news and rumors that Syria could abandon its dollar peg and as a result, shift a large portion of its reserves into the British pound. Strong M&A flow has been a major driver of pound strength for the past year and it seems that even at an exchange rate of 2.00, UK companies are in strong demand. Although UK construction sector PMI for the month of May dropped to 58 from 59.8, a 3.5 year high, the index still remains at relatively high levels. BRC retail sales are on the docket tomorrow. Consumer spending is always an important indicator. It is expected to remain strong in the month of May.

Japanese Yen Crosses See Intraday Reversal

The intraday reversal in the Dow has led to an intraday reversal in carry trades. CHF/JPY and GBP/JPY ended the day in positive territory while EUR/JPY, AUD/JPY and CAD/JPY are basically unchanged. USD/JPY remained weak, but that was mostly due to broad based dollar weakness. Overnight data from Japan was strong with capital spending printing at 13.6 percent compared to the market’s 10.1 percent forecast. It is clear that this is where the increases corporate profitability is going. Employees have unfortunately been skipped over as corporations recycle their profits into capital spending. This is the primary problem preventing the Bank of Japan from raising interest rates. As long as wage growth is tepid, consumer spending will be weak.

Strong Gains Continued to be Seen in the Australian, New Zealand and Canadian Dollars

The commodity currencies continued to perform extraordinary well today as the Canadian dollar hit another fresh multi-decade high against the US dollar. Like the UK, more acquisition news is fueling the move in the Canadian dollar. GE Real Estate is said to have bought assets from Canada’s Dundee REIT for C$2.4 billion. There is no Canadian data until Wednesday which means that there is little standing in the way of further USD/CAD weakness. The Australian and New Zealand dollars are also up strongly thanks to solid Australian economic data. Company operating profit is up a whopping 7.6 percent in the first quarter while ANZ job advertisements were up 10 percent in the month of May. This suggests that GDP and employment, which are due out later this week, could also be firm. Before that, we have service sector PMI, building approvals and the current account due for release. With the AUD/USD trading not far from its May high, tonight’s data could trigger some profit taking before the more important RBA rate decision and GDP releases scheduled for Tuesday.


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