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By Kathy Lien, Chief Strategist of DailyFX.com
The Path to a Stronger Dollar is through a Weaker One
New records will either be made or lost this week because not only do we have a very busy economic calendar, but Federal Reserve Chairman Ben Bernanke will also be delivering his semi-annual testimony on the economy and monetary policy.
The weakness of the US dollar and continual rise in oil prices will keep the Federal Reserve hawkish as they bank their hopes for a second half recovery on the movements of the US currency. We have already seen the benefits that a weak dollar can instill on the economy. Just last week, the US reported that exports rose to a record high in May and it could not have done so without a weaker dollar.
Since the beginning of last year, the trade weighted dollar has fallen 7.7 per cent and is now testing lows last seen in the end of 2004. The jump in the Empire state manufacturing survey confirms that the weak dollar continues to benefit the manufacturing sector.
After hitting a one year high last month, analysts were looking for a sharp retracement, but activity continued to accelerate with the manufacturing index edging up to its highest level since June 2006. Tomorrow, the action begins with producer prices, followed by the Treasury International Capital flow report, Industrial Production and the NAHB housing market index.
Net foreign securities purchases and industrial production are expected to remain strong, but the expectations for producer prices are low despite the jump in import prices. With the rally in the EUR/USD becoming exhausted, any upside surprise could drive a much needed recovery in the US dollar. The FX markets are cyclical, so the path to a stronger dollar will be through a weaker one.
British Pound: The Currency to Watch This Week
The British pound is in play this week. Having hit another 26 year high today, the GBP/USD is now less than 150 pips away from the psychologically important 2.05 level. With so much economic data on the calendar, we will either see a top or a move towards 2.10 over the next four trading days.
Tomorrow's report on consumer price growth will be the first piece of key economic data to come out. The combination of a drop in producer prices and a strong currency suggests that consumer price growth will slow as well. However even though the recent strength of the British pound is expected to push inflation lower, UK economic data has a habit of catching everyone by surprise.
Traders will be using the CPI number to forecast whether Wednesday's release of the Bank of England minutes from the meeting held earlier this month will be pound positive or negative. The minutes have become extremely market moving - if you recall, the turn that we saw in the middle of June was triggered by surprisingly hawkish MPC minutes.
A near unanimous decision to raise rates would accelerate further gains, while more than two dissenting votes would probably be construed as dovish, which would mark a top in the currency pair.
Carry Trades hit by a Wave of Profit Taking
With no major US data released today and the Japanese markets closed for a holiday, carry trades have succumbed to profit taking. Aside from NZD/JPY, most of the Yen crosses are either flat or slightly lower.
The fact that they did not continue to rise after a large earthquake hit North West and Central Japan is a testament to the currency market's continual appetite for risk.
Kathy Lien, Chief Strategist, Daily FX
