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Forex Research - US Dollar Could Recover Next Week


US Dollar Could Recover Next Week

Friday, 21 September 2007 21:10:15 GMT

Written by Kathy Lien, Chief Currency Strategist
• 2 Things Will Stop the Euro’s Rise
• Canadian Dollar Back at Parity

US Dollar Could Recover Next Week
One of the most emailed articles in the online edition of the NY Times today was a story titled Dollar Falls to a New Low against the Euro.  The fact that the weakness of the dollar has hit mainstream interest illustrates the significance that it has for not only currency traders, but also for anyone with international interests, including corporations, investors and travelers.  The main reason why the dollar has weakened so significantly over the past month is because the Federal Reserve has embarked on a brand new monetary policy cycle.  This week’s 50bp cut of the Fed Funds and Discount rate sent three messages to the market.  The first is that the Federal Reserve has adopted a new policy of being proactive and not just reactive; the second is that the outlook for the US economy could be worse than most people thought and the third is to expect more interest rate cuts in the months to come.  According to Fed Fund futures, interest rates are expected to be lowered by another 50bp before the end of the year followed by another 75bp of easing in 2008.  In the medium term, this will be extremely negative for the US dollar but in the week ahead, the dollar may get a chance to recover.  Although there are a number of US economic releases next week, none of these numbers are meaningful enough to shift the outlook for the US economy or change the Fed’s mind about the need to lower interest rates further.  Next week’s releases are divided into 3 divisions; housing, consumer and manufacturing.  The new and existing home sales data are expected to be weak, but that has pretty much been already discounted by the market.  The Chicago PMI and Durable Goods data should be mixed.  In the long run, the weak dollar will be a big boost for the manufacturing sector as a whole.  As for the consumer data which includes consumer confidence, personal spending and personal income, confidence is likely to fall, but the spread between spending and income could narrow.  There is also second quarter GDP, but that is a final number.  Overall, none of these reports are market moving enough to shift the overall trend in the financial markets.  The US dollar may use this opportunity to lick its wounds. 

2 Things Will Stop the Euro’s Rise
The all-time high in the Euro is now 1.4120.  As the currency continues to press higher, the burning question on everyone’s mind is, What Could Stop the Currency’s Rise?  From the US perspective, a series of very good US economic data could help the dollar recover, but that will take time because we need to see renewed strength in core sectors such as housing, consumer spending and the labor market.  In the immediate future, developments in Europe could also trigger a top in the Euro.  The two things that can stem the Euro’s rise are verbal intervention from ECB President Trichet and significantly weaker economic data.  In terms of data, we are already seeing signs of instability.  Service sector PMI in the Eurozone dropped from 58.0 to 54.0, the lowest level since August while manufacturing PMI fell from 54.3 to 53.2.  The German IFO report is due for release next week and we expect the recent problems in the US, credit market turmoil and rising Euro to take a big toll on business confidence.  If that is followed by weakness in German retail sales, we could see some traders take profit on the Euro.  In terms of the ECB, there are no signs of concern amongst the central bank.  In his speech today, ECB President Trichet simply touted the success of the Euro and reiterated the need for the central bank to be independent.  The reason why we are paying so close attention to ECB comments is because back in 2004, when the Euro hit a record high of 1.3667, the currency topped when Trichet called the move “brutal.”

Canadian Dollar Back at Parity
For a brief moment today, the Canadian dollar was stronger than the US dollar as USD/CAD fell to a 31 year low of 0.9937.  It has been a great week for not only the loonie, but also the Australian and New Zealand dollars, which have rallied for four days straight.   This strength is due to big moves in the commodity markets and overall US dollar weakness.  In the week ahead, the Canadian and New Zealand dollars could take on some action of their own with GDP figures expected from both countries.  Growth is predicted to have slowed in New Zealand and accelerated in Canada.  Watch out for industrial product and raw materials prices however since the strength of the Canadian dollar could bring down inflationary pressures.  Today, we had a big surprise in Canadian retail sales.  Yesterday’s jump in wholesale sales led everyone to believe that retail sales would be strong as well, but instead of rising, consumer spending actually dropped by 0.8 percent.  Interestingly enough, this only put a minor dent on the CAD’s rally. 

Japanese Yen Falls to One Month Low
The Japanese Yen fell to a one month low against all of the majors except for the British pound and US dollar.  The only piece of Japanese data released overnight was the all industry activity index which was right in line with expectations.  Carry trades have resumed their correlation with the Dow as the movements today reflect a minor return of risk appetite.  The bulk of Japanese data due out next week will be on Thursday, which is when we will receive labor market, consumer spending and inflation data.  Most of these numbers are expected to be weak and not likely to help the Japanese Yen recover its gains. 

Bank of England Forced Into Action
It has been a tough week for the Bank of England.  After standing aside when the credit turmoil unfolded in late July, the Bank of England has finally been forced into action.  Last week they bailed out Northern Rock and this week they infused more than $20 billion into the banking system.  Central Bank Governor King faced tough criticism for his late action, but he has defended himself by blaming legislation.  Despite the problems at Northern Rock, the UK economy remains relatively healthy in comparison to the US economy.  Retail sales and money supply were stronger than expected.  GDP, Housing and Consumer Confidence dominate the calendar next week.  No big surprises are expected there. 

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Written by Kathy Lien, Chief Currency Strategist of

 ©2007 Daily FX. All Rights Reserved




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