Carry Traders Bail Out of Yen Shorts Ahead of G7 (page 1 of 2)

DailyFX Fundamentals 02-05-07

US Dollar - The stronger than expected US service sector ISM report was not enough to change the prevailing themes in the currency market. Traders are focused on 4 things this week and these 4 things will continue to be the market's primary drivers. The first is the overall health of the US economy. US data was strong on Friday and today's service sector report continues to confirm that strength. However the Fed needs to see this growth continue over the next month or two before considering a rate hike and as result we need the same as well. Therefore even though there is no more meaningful data this week, the bias in the market is still for more dollar strength than weakness. The second is the G7 finance ministers meeting this weekend. Short yen traders are liquidating their positions ahead of the meeting which explains the dollar's underperformance against the Yen despite its out performance against the Euro and British pound. Although we do not think that the G7 will raise an official concern about the Yen's weakness, the fact that the yen dropped close to 400 pips in the less than 48 hours after the April 2006 G7 meeting is enough reason for some USD/JPY bulls to take profits here. The third focus is the ECB meeting on Thursday. Although no interest rate changes are expected to be made, traders expect the next ECB rate hike to be the last and are punishing the Euro as a result. Therefore ECB President Trichet's affirmation or denial of that will be a big driver of market activity. Finally, the fourth market mover this week is oil prices. It has so far received little notice in the currency market, but at $58.70 a barrel, the rebound may be significant enough for Fed officials to comment about it this week. Paulson, Bernanke, Moskow and Yellen are all scheduled to speak tomorrow so even though there is no data, keep an eye out for market moving comments.

Euro - Despite stronger service sector PMI, the Euro has dropped right back into its month long trading range. Germany, France and Italy all reported faster service sector activity, driving the regional index up from 56.8 to 57.9. However despite the growth, the market is still trading off of the Market News report released on Friday which speculated that the central bank will pause on rates after raising them in March. Economic data has been mixed and it may be too early to tell whether the ECB will put an end to their tightening cycle especially now that oil prices are higher. ECB member Draghi said this morning that growth rates remain robust and liquidity is abundant, signaling that more rate hikes are in store. We are expecting Eurozone retail sales tomorrow which are expected to print strongly after the sharp rise in German sales last week. However this continues to be data from December and we will have to wait another week before seeing data that may actually incorporate some of the impact of the value added tax increase. Furthermore, European government officials have been calling for the yen to stop falling against the Euro. On a small level, their wishes were answered as EUR/JPY fell close to 1 percent, earning it the title of the day's most market moving currency pair.

British Pound - The British pound was weighed down by a weaker service sector PMI figure. The index dipped to 59.2, falling from a nine and a half year high 60.6. Although not as bad as some had anticipated, about 0.8 points lower than the estimate, the survey results hold mixed notions for the upcoming Bank of England rate decision.