New Zealand Dollar Hits 25 Year High as Strong Data Signals More Rate Hikes (page 1 of 2)

DailyFX Fundamentals 06-28-07

By Kathy Lien, Chief Strategist of DailyFX.com

Fed Meeting Over: What Next For the US Dollar?

The Federal Reserve monetary policy meeting is now behind us and with no major changes to inflation outlook and growth assessment, the impact on the currency market has been limited.

The dollar is slightly higher across the board, but no new daily highs or lows have been achieved after the rate announcement. The rally in the dollar represents the market's relief that that the Fed did not address the problems in the sub-prime sector. In fact, the Fed kept their comments on the housing market virtually unchanged.

As for inflation, even though they acknowledged the fact that core price growth improved, they weren't entirely convinced that the battle has been won. Instead, they still felt that inflationary pressures will refuse to fall.

With oil prices hitting an intraday high of $70.52, the Fed has good reason to be worried. It should not be long before we see the national average of gasoline prices move back above $3 a gallon. The Federal Reserve really had no choice other than to keep the tone of the statement unchanged in order to tame the stock market bubble.

For a comparison between the last two FOMC statements, see our Instant Insight. Although traders will be watching tomorrow's PCE deflator for evidence of growing inflationary pressures, the more important releases will be personal income and personal spending.

Should the gap between spending and income widen, then the US economy could seriously be in trouble, especially since the market is looking for the gap to narrow significantly. Beyond that, non-farm payrolls and service sector activity next week will provide traders with better clues on how the US economy is doing. For the time being, there is nothing to threaten the immediate trend of the US dollar.

Carry Trades Rebound as Profit Taking Comes to an End, Party Not Over Yet

Two days ago, we argued that the sell-off in carry trades represented profit taking rather than liquidation. Today, the strength of the rebound in the Yen crosses, particularly AUD/JPY, NZD/JPY and CAD/JPY confirm that it will take more than a mere correction to put an end to the carry trade.

At the first sign of trouble, traders piled right back into their Yen short positions. Japanese industrial production dropped 0.4 percent in the month of May, the third consecutive monthly decline in manufacturing activity.

Analysts were looking for very strong growth; expectations were for industrial production to rise by 0.9 percent, bringing the annualised pace of growth up from 2.2 percent to 4.8 percent. Although retail sales and the corporate service price index reported earlier this week were strong, the drop in industrial production may prevent the Bank of Japan from raising interest rates in July or August.

Before rushing to judgment, it is important to wait for tonight's Japanese economic releases. We are expecting CPI, overall household spending, the jobless rate, and manufacturing PMI. Whether Japan sees inflation or deflation will determine where the Yen is headed next.

New Zealand Dollar Hits 25 Year High as Strong Data Signals More Rate Hikes

The Australian, New Zealand and Canadian dollars were the strongest currencies of the day thanks the combination of higher commodity prices and the resurgence in demand for carry trades.

New Zealand economic data also surprised to the upside with the first quarter current account balance narrower than expected, consumer confidence accelerating and building prices rising strongly.