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Tuesday July 3, 2007 - 20:56:19 GMT -

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Forex - Strong Euro Could Delay ECB Rate Hike

DailyFX Fundamentals 07-03-07

By Kathy Lien, Chief Strategist of

• Dollar Unfazed by Drop in Pending Home Sales and Hudson Employment Index
• Be Careful of Reserve Bank of New Zealand Intervention, Australia Rate Decision Should be Non-Event
• Strong Euro Could Delay ECB Rate Hike

Dollar Unfazed by Drop in Pending Home Sales and Hudson Employment Index

The US dollar has recovered from Monday’s sharp losses thanks to profit taking and position squaring ahead of the Independence Day holiday. Even though trading tomorrow should be quiet, traders should not become complacent, because we still have very important and market moving data scheduled for Thursday and Friday. The recent deterioration in the housing market makes job growth last month particularly important. Pending home sales dropped to the lowest level in 5 years during the month of May which suggests that existing home sales in June could continue to remain weak. Potential homebuyers are either facing difficulty getting mortgages or are simply holding out for lower prices, neither of which provide a promising outlook for the housing market. However the long held belief has been that as long as people in the US have jobs, they will prevent the housing market from collapsing by continuing to service their mortgages. The market expects job growth to slow in the month of June, but economists may be underestimating the potential decline. The Hudson employment index plunged 6 points last month to 101.2, the lowest level of job growth in 9 months. This follows a drop in the employment component of the manufacturing ISM report that was released on Monday. Service sector ISM and the ADP release will shed more light on how bad Friday’s non-farm payrolls number could be, but at this point the leading indicators for payrolls that we typically look at suggest that job growth could be weaker than most people are expecting.

Be Careful of Reserve Bank of New Zealand Intervention, Australia Rate Decision Should be Non-Event

Central banks love to intervene in the markets when liquidity is low because that is when they will get the most “bang for the buck.” For the Reserve Bank of New Zealand, this is particularly important because their war chest for intervention is estimated to be only USD$5.3 billion. Although the RBNZ is suspected of having intervened three times last month, the only time that they officially confirmed intervention was on June 11th. It is not a coincidence that the central bank chose to intervene when Australian markets were closed for the Queen’s Birthday. If they intervened on a holiday once, they can do it twice. Central bank Governor Bollard must be extremely frustrated that their intervention has done nothing to stem the New Zealand dollar’s rise. In fact, the New Zealand dollar rose to a fresh 25 year high against the US dollar this morning before ending the day slightly lower. For more on whether intervention is effective, see our Special Report. Tonight, we also have the Reserve Bank of Australia rate decision followed by the Australian trade balance. The announcement should be a non-event because the RBA is not expected to raise interest rates and when they do not, no statement is released. The recent strength of the Australian dollar is expected to push the trade balance lower in the month of May. A weak number would follow today’s sharp disappointment in retail sales.

Strong Euro Could Delay ECB Rate Hike

The rebound in the US dollar has led to a retracement in the Euro but this does not mean that the EUR/USD’s shot at a new record high is over. US traders will be missing out on two key economic releases due out from the Eurozone tomorrow morning. We are expecting service sector PMI and retail sales. Given the surprise improvement in the manufacturing PMI report, the market is forecasting similar strength in the service sector. Whether or not this will help the Euro rebound will be dependent upon how bad Eurozone retail sales was in the month of May. The sharp drop in sales in Germany that month has pushed expectations down to -0.5 percent. The marquee event this week is of course the ECB interest rate decision on Thursday. The recent rise in the Euro could reduce the central bank’s urgency to raise rates since a stronger currency automatically reduces inflationary pressures. Meanwhile the Swiss franc gave back nearly all of its gains after consumer prices fell short of expectations in the month of June. The annualized pace of growth increased from 0.5 percent to 0.6 percent instead of the market’s 0.7 percent forecast. This should be a just a bump in the road however since the Swiss National Bank is still expected to lift interest rates next quarter.

British Pound Should Hold Near 26 Year Highs Going into BoE Rate Decision

The British pound hit another 26 year high this morning on the back of a stronger than expected construction sector PMI report. In contrast to the US, the housing market in the UK has been extremely healthy. In fact the 60.1 print in the PMI index is the strongest in over 3 years. This indicates that not only are house prices accelerating, but the demand for residential buildings is increasing as well. Manufacturers do think that they are reaching a top however since the future business activity index dropped to the lowest level in a year. The value of the British pound should remain high going into Thursday’s interest rate decision. Before that we do have service sector PMI which is expected to improve slightly in the month of June. The market continues to be unfazed by the terrorist threats in London which is a testament to the currency’s resilience.

Profit Taking Hits the Yen Crosses

The Japanese Yen is stronger across the board today after comments from Bank of Japan member Nishimura. He hinted at the possibility of a rate hike by saying that “keeping rates low for a long time is not prudent.” We think that the market may have overreacted or the selling may be primarily due to profit taking because recent economic data indicates that the economy may not be ready for a rate hike. Besides that, there seems to be no real basis for the yen rally today. There is no major Japanese economic data for the remainder of the week, which means that the moves in the Yen crosses will primarily be dependent upon the demand for carry trades.


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