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By Kathy Lien, Chief Strategist of DailyFX.com
Dow drops 226 points, dollar tanks: bloodbath not likely to be over
The title of yesterday's Daily Fundamentals was "US dollar recovers: but the losses may not be over". Although that proved to be true, it was certainly to the dismay of any long dollar or US stock traders.
On Monday, US stocks failed to recuperate all of Friday's losses and today, the Dow has broken below Friday's low. The last time we had an attempt at a reversal losses in the Dow were in excess of 400 points. We are now less than 275 points away from the record high set last week, which means that there is a strong potential for further losses in the Dow.
Why is this so important for currency traders? Because the ebb and tides of the stock market is once again driving the direction of carry trades. Nothing new has unfolded over the past 24 hours, which suggests that the price action may be a reflection of the market's expectations for this week's housing market numbers.
Existing home sales is due for release tomorrow. Pimco fund manager Bill Gross warned that the problems in the sub-prime sector could lead to a high yield crisis, but he has long been a housing market bear. The dollar fell to the lowest level against the Japanese yen in two months.
In addition to the existing home sales figures, Standard and Poor's will also be holding a press conference at 10:30am EST on updated surveillance of Residential Mortgage Backed Securities and ratings actions of Collateralized Debt Obligations.
More downgrades will not be taken positively by the markets, especially if they follow a weak housing number.
Euro hits record highs despite evidence of euro driven economic weakness
The euro climbed to a new record high today at the onset of US trading, but the currency pair struggled to hold onto those gains amidst earlier data that revealed the first signs of euro driven economic weakness. The current account balance came in much weaker than expected, with the deficit rising to 8.6 billion from 4.0 billion the prior month.
Analysts were looking for an improvement since up until today's releases the Eurozone was relatively resilient in the face of a strong Euro. The manufacturing PMI index also deteriorated more than expected which suggests that Thursday's German business confidence IFO survey could fall more than analysts are currently predicting.
The Belgian manufacturing survey, which is frequently used as a leading indicator for the IFO dropped two points in July. Meanwhile we also heard one of the first euro critical comments from an ECB official. ECB board member Jürgen Stark warned earlier today that exporters were being hurt by the strong euro.
Is this the beginning of more warnings about currency strength from the central bank? Probably not. There are no more scheduled speeches by ECB officials this week and next week, they go off on their month long summer holidays.
Carry trades continue to sell off as risk aversion nears February levels
Carry trades sold off across the board today with the biggest losses seen in AUD/JPY and NZD/JPY. The only yen cross to remain immune to the liquidation was CAD/JPY which held steady thanks to stronger Canadian economic data.
According the VIX, which is the equity market's measure of volatility, risk aversion is nearing the levels that we saw back in February, when we had the 8.8 per cent slide in the Shanghai stock market followed by the three per cent sell-off in the Dow.
Kathy Lien, Chief Strategist, Daily FX
