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Tuesday October 16, 2007 - 21:50:06 GMT

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Forex Research - Dollar Sees New Life on Stock Market Losses


Tuesday, 16 October 2007 20:45:38 GMT

• Bank of Canada Leaves Rates Unchanged, Commodity Currencies Plummet
• Euro Falls Victim to Dollar Strength

Dollar Sees New Life on Stock Market Losses
The US dollar is stronger across the board as stock market losses override weaker economic data.  The rally in the US dollar has little to do with rate cut expectations because the probability of a cut at the end of this month has actually increased over the past 48 hours from 32 percent to 36 percent. Instead, the rally is a reflection of rising risk aversion as traders once again bail out of risky high yielding assets ahead of tomorrow’s consumer price report.  According to the Treasury International Capital report, net foreign capital outflows reached the highest level in 17 years.  Unsurprisingly, the credit crunch in the month of August sent foreigners rushing of US equities.  Industrial production was in line with expectations but the prior number was revised lower.  The housing market continues to struggle as builder confidence falls to another record low in October.  However, whether or not the Federal Reserve will cut interest rates at the end of the month is still up in the air.  The minutes from the emergency Fed meeting held in August at which the discount rate was cut by 50bp reveals that Fed members were split on the severity of credit crunch. Although these minutes are from the August meeting and not the September 18 meeting, it does suggest that the Federal Reserve may not be as dovish as everyone thinks.  Tomorrow’s consumer price report will play a major role in determining if the US is faced with stagflation.  Oil prices continue to be persistently high and as a result, we expect inflationary pressures to be evident in headline and core prices for many months to come.  With growth still steady, this will be one of the primary reasons why the Federal Reserve will deliver a treat instead of a trick to the markets on Halloween by opting to leave interest rates steady.   

Bank of Canada Leaves Rates Unchanged, Commodity Currencies Plummet
The Canadian, Australian and New Zealand dollars all suffered sharp losses today.  The Bank of Canada left interest rates unchanged at 4.5 percent.  Even though they felt that commodity prices were strong and that the Canadian economy is operating above their previously expected production potential, their monetary policy bias is still neutral with a slight tilt to the downside.  The Bank of Canada revised down their 2008 and 2009 growth forecasts because of the potential impact of a stronger Canadian dollar.  We have already seen manufacturing shipments fall sharply in the month of August. The Bank of Canada’s outlook on inflation is balanced because they felt that the capacity pressures brought on by a tight labor market should ease more rapidly. The central bank is expected to leave interest rates unchanged for the remainder of the year.  Wholesale trade is due for release tomorrow; this is generally a good leading indicator for retail sales.  There will be no Australian or New Zealand economic data to be release over the next 24 hours.

Euro Falls Victim to Dollar Strength
Since the beginning of the month, the Euro has been fluctuating within a 200 pip trading range.  Today, that range remains very much intact as rising risk aversion sent traders back into the US dollar.  ECB officials continue to be comfortable with the current level of the Euro and are leaning towards tighter monetary policy.  This morning, ECB member Constancio said that the money market is normalizing and the impact on the world economy should be minimal.  He also suggested that the EU would be able to deal with a stronger Euro.  The economic data released this morning was mixed with consumer price growth in Germany slowing but analyst sentiment remaining unchanged.  The market had expected analyst sentiment to deteriorate materially given the rise in the Euro, but instead, according to a statement released by the ZEW, “the almost unchanged economic expectations indicate that the most pressing downward corrections following the crisis on the financial markets seems to have come to an end.” Swiss retail sales were weaker than expected but as has been the recent trend in the currency markets, traders have completely ignored Swiss economic data.  EUR/CHF is weaker today on carry trade liquidation. 

Softer Consumer Prices Drive British Pound Lower
Softer consumer prices have driven the British pound lower against the US dollar and Euro.  The market had originally expected headline consumer prices to tick higher and core prices to remain unchanged, but instead both slowed materially.  This raises the question of what could have justified the hawkish comments from Bank of England Governor King last week.  Perhaps the BoE is concerned that the rise in commodity prices will have a lasting effect on the economy in the months to come.  The Bank of England will be releasing the minutes from their latest monetary policy meeting tomorrow. This should shed more light on why the central bank decided to not release another statement following their decision to leave interest rates unchanged.  Labor market numbers will also be released tomorrow. 

Dow Extends Losses Taking Carry Trades Down With It
The Dow continued to extend yesterday’s losses taking carry trades down with it.  NZDJPY and AUDJPY have dropped the most which clearly indicates that today’s liquidation represents a rise in risk aversion.  Most of the Yen crosses have hit support along with the Dow, if that is the case, then we could see a bounce.  The most important thing for Yen traders to do is to keep watching the price action of US equities. Tonight we have the tertiary activity index from Japan which is expected to improve, but like Swiss economic data, Japanese economic data is not expected to have much of an impact on the Japanese Yen.

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Written by Kathy Lien, Chief Currency Strategist for




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