Dollar Stalls Ahead of Service Sector ISM (page 1 of 2)

US Dollar
With no major economic data released today, profit taking and overall short covering was the main driver of the markets. The US dollar staged a modest rally against the Euro and British pound, but an earlier rally against the Japanese Yen and commodity currencies were unsustainable. The market has become very short dollars with the Commitment of Traders data indicating that short positions jumped by 14.6 billion, which is the largest rise that we have seen in a decade. The only piece of data that was released today was pending home sales, which reported a larger drop than the market was expecting. The housing market is really beginning to buckle and the economy is feeling its effects. Fed officials have remained relatively optimistic throughout and this is the message that they leave us with as we enter into the traditional "quiet period" before the December 12 FOMC meeting. It will be a busy week however as we look ahead to the service sector ISM report tomorrow and non-farm payrolls on Friday. The market may be holding out for the non-farm payrolls release before punishing the dollar once again. We will get a few "leading indicators" for payrolls starting tomorrow with the Challenger layoff report. We will also be keeping a close eye on the ADP employment survey as well as the Monster Employment index. With the housing market and manufacturing sector potentially going down the tubes, the labor market is the only part of the economy that is still offering some reason for optimism. In the last Federal Reserve Beige Book, most districts reported that there was a still sign of tightness in the labor market which leaves hope that NFP could print above 100,000. Before that however, we have service sector ISM. If we see slower growth in both the service and manufacturing sector, then the economy may really be in trouble.

Euro and Swiss Franc
The Eurozone reported softer producer price numbers this morning, which may have helped to push the EUR/USD lower. With a lagging economy, the French are starting to become uncomfortable with the level of the Euro. Trade Minister Lagarde said that the strong currency was penalizing French exports to Asia, which will become a more widespread concern should the currency rally even further. EU's Alumnia also said that they are watching the exchange rate and warned against "excess volatility." Whether they admit it or not, members of the Eurozone are becoming worried. We think that there is little chance that the ECB will remain hawkish. The ECB doesn't like surprises so with the EUR/USD trading not far from 1.34, a call for even higher interest rates after the December hike could push the currency up to 1.35 and even 1.36. With growth weakening and the Euro level reducing inflationary pressures, the urgency to raise rates is falling quickly. Therefore it may be far more reasonable for the market to expect the central bank President to tone down his comments and move the central bank's policy back to neutral.

British Pound
The British pound ended the day virtually unchanged against the US dollar despite another round of weaker economic data. Construction sector PMI dropped from 58.1 to 54.8 in the month of November. Although it can be argued that the index is still in expansionary levels, it does suggest that the enviable recovery in the UK housing market may be beginning to reach a top. Incoming retail sales data is also not looking very promising. If you recall, department store John Lewis reported weaker sales at the end of last week and this morning, retail company Footfall also reported a drop in shoppers last month.