US Dollar Breaks Down as Consumers Buckle (page 1 of 2)

US Dollar - With a heavy economic calendar today, we had said the country that doled out the biggest disappointments would be the day's biggest loser. Even though the outlook portion of the German ZEW survey hit a 13 year low and GDP fell short of expectations, headline US producer prices matched the biggest monthly drop on record while core prices fell by the largest amount in 13 years.

Retail sales also disappointed significantly with major revisions made to the September data. The double dose of negative readings in the US raises the question of whether the US Federal Reserve is being overly aggressive with monetary policy by keeping interest rates at a 5 year high for too long. Federal Reserve Presidents remain persistently hawkish by warning about the upside inflation risks despite the sharp drop in producer prices.

This trend suggests that we could see a more hawkish tone in tomorrow's FOMC minutes. However the more aggressive they are in the face of weaker economic data, the greater the possibility of a Fed induced recession. The housing market is already seeing major signs of weakness and it is also affecting other housing related sectors. In today's retail sales report, furniture sales fell for 2 months in a row along with building materials.

Today's data indicates that the US consumer is buckling which could push the Fed over the cliff especially with exceptionally weak inflation numbers. If they are forced to cut interest rates to stimulate the economy later on, it would not be a one off reduction but instead will be the beginning of a brand new easing cycle. For the time being, traders could be holding off major dollar short positions until Thursday, when we see the release of consumer prices, which tends to be the more important inflation indicator. If there is also a sharp slide in CPI, then we have major problems as the market will completely discount the validity of any further hawkish comments by the Federal Reserve.

Euro and Swiss Franc - Even though weak US data has pushed the Euro higher, a quick look at the charts will reveal that the currency has actually had a very tough time rallying. For the past 3 trading days, the EUR/USD reversed most if not all of its earlier gains. It seems that someone has a vested interest in making sure that the Euro's rally does not become overextended and we would not be surprised if it involved European governments.

As an export dependent region, a strong Euro is damaging to the economy, especially if the ECB plans on raising interest rates again in December. Both serve to tighten the already fragile economy, which saw a drop in third quarter GDP from 0.7 to 0.6 percent. The Economic Sentiment component of the German ZEW survey also dropped from -24.5 to -28.5, a 13 year low. Even though analysts were more optimistic about current conditions, the prospect of another rate hike and a VAT tax increase next year has the group siding with slower rather than stronger growth.

The real catalyst however for the intraday reversal in the EUR/USD were comments from French Prime Minister Villepin who called for collaboration on dealing with the Euro's strength as it poses a risk for all export dependent industries. Although the market reacted on these comments, we doubt that it really has that much punch since the ECB are the ones that control monetary policy and Garganas was on the wires again this morning, stressing the central bank's need to exercise strong vigilance. Individual European governments always kick and scream when the Euro is strong, but only comments by ECB President Trichet actually manages to cause a major reversal in the EUR/USD.