Is the Dollar Tumbling Because of the Dow? (page 1 of 2)

DailyFX Fundamentals 06-06-07

By Kathy Lien, Chief Strategist of DailyFX.com

New Zealand Dollar Hits 25 Yr Highs After Interest Rates are Raised to 9 Year High - More To Come?

The NZD/USD hit a fresh 25 year high after the Reserve Bank of New Zealand surprised the market by raising rates to 8 percent, which is a 9 year high. This very dynamic is what will keep carry trades alive and well even if the Dow is falling. Although RBNZ Governor Bollard finds the exchange rate unjustifiably high, the 60 percent surge in dairy prices has forced him to fight inflation as aggressively as he can. According to Bollard, domestic spending and overall growth is strong enough to weather 8 percent interest rates. Even though he refuses to comment on future rate decisions, the futures curve is pricing in one more 25bp hike by the end of the year with a slim chance of two. The AUD/USD is also performing well, having hit a fresh 16 year high after strong GDP numbers. Employment data will be the key whether this strength can continue. Despite weaker IVEY PMI and building permits, Canadian dollar bulls refuse to give up.

Is the Dollar Tumbling Because of the Dow?

The Dow Jones Industrial Average tumbled over 100 points today, bringing the US dollar down with it. The most significantly weakness has been seen against the Japanese Yen, Australian and Canadian dollars but the fact that the US dollar has held steady against the Euro and British pound indicates that this is not a dollar story. True economics is back in play as the price action of each currency pair reflects the country's own outlook for interest rates. Take the AUD/USD for example. It is the best performing pair of the day because the market now believes that the Reserve Bank of Australian will raise rates this year. The EUR/USD on the other hand is weaker because the comments from ECB President Trichet today suggests that the central bank will be hold at least until September. Unit labor costs and productivity were the only pieces of data on the US calendar today and these final quarterly releases are never major market movers. Therefore even though productivity slowed in the first quarter while unit labor costs increased, the US dollar did not budge. Instead, everyone has their eyes on the US stock market which dropped after Morgan Stanley issued a triple sell warning. This was the first time since the tech bubble burst that all three of their key warning indicators which follow P/E ratios, growth, inflation and risk appetite call for a correction. In fact, their model is predicting a 14 percent drop over the next six months. We have said often that carry trades will die with the Dow dies. Now that it is beginning to, we are seeing the currency component unfold as well. Therefore should the weakness in stocks continue, we expect to see a further sell-off in USD/JPY. The hawkish comments from Federal Reserve Presidents Lacker and Pianalto suggest that central bankers are happy with the correction. Wholesale inventories and wholesale sales are the only US releases on the docket tomorrow so we do not expect any major price action in the US dollar. Continue to watch the Dow for direction.

ECB Comments Put a Lid on Euro Rally

The European Central Bank raised interest rates by 25bp today, bringing their target rate up to 4.00 percent. This move was widely expected, which explains why the Euro did not react to the rate announcement. Instead, the volatility came when ECB President Trichet began to speak.