Euro Rebounds on Dollar Weakness, Shrugging Off Softer Economic Data

DailyFX Fundamentals 07-30-07

By Kathy Lien, Chief Strategist of DailyFX.com

US Dollar: Has risk appetite returned?

Today's rebound in the financial markets has everyone hoping that we have hit a bottom. Stocks, carry trades and bond yields are all up sharply, but given the strong selling that we saw last week, a recovery is hardly surprising.

There was no US economic data released today but stronger earnings from Tyson Foods and Verizon helped to draw back some optimism. Even the VIX (Exchange Volatility Index), the measure of volatility in the stock market, has retraced, but this does not mean that risk appetite has returned.

The new record high in the Shanghai stock index suggests that even though global investors are nervous, they are not nervous enough to dump their Asian exposure. Although it may be tempting to hope that August should bring us a calmer market, it is not time to become complacent. Another major announcement of losses could easily send the Dow and high yielding currency pairs tumbling once again.

The market has shrugged off news that American Home Mortgage, which commands 2.5 per cent of the mortgage market, has to delay its quarterly dividend because of major write-downs. AHM specialises in prime and near prime loans, which means that bad loans are extending beyond subprime lenders.

Tomorrow we will get a better look at how consumers are bearing the pain. Personal income and personal spending are due for release along with the PCE deflator, Chicago PMI and consumer confidence. A sharp drop in confidence as well as a widening gap between spending and income will resurrect talk of an end of the year interest rate cut.

Bloomberg Fedwatcher John Berry claims that it will take more than a few days of market volatility to change the Fed's stance, but there is a great deal of economic data this week could affect the Fed's bias. This includes manufacturing ISM, service sector ISM and non-farm payrolls.

Euro rebounds on dollar weakness, shrugging off softer economic data

The euro rebounded today despite weaker economic data. Both French producer prices and retail PMI for July deteriorated, providing further evidence that the strength of the euro is finally weighing on the economy.

That does not seem to matter however as speculators talk about the possibility of a surprise press conference by the European Central Bank(ECB) this week. It is expected to leave interest rates unchanged, but if the market is pricing in a good chance of a September rate hike.

If the ECB plans on delivering one then, it will have to find an opportunity to reintroduce the words "strong vigilance". Now that the EUR/USD is close to 200 pips off its highs, the economy may be able to handle another rate hike. However we still think that a surprise press conference is unlikely given the recent comments by ECB officials.

Last week, ECB member Jürgen Stark said the strong euro was hurting exporters while Guy Quaden indicated that the central bank was against abrupt and excessive currency moves. Looking ahead we are expecting German retail sales, unemployment and Eurozone confidence. Switzerland on the other hand will be reporting its UBS consumption index which is barometer of consumer spending.

British pound unchanged despite stronger mortgage data

The British pound is unchanged for the day despite stronger housing market and mortgage approvals data. The lack of reaction in the currency may be due to the fact that the rise in approvals was related to the planned introduction of home information packs (HIPS) on August 1 for home with four bedrooms or more.

These HIPS contain legal documentation with title information and an Energy Performance Certificate, detailing the energy efficiency of the home. Sellers of homes that fall under the rules, which eventually will spread to all homes, are now obligated to supply this information to buyers rather than buyers obtaining the information themselves.

The cost to the seller is several hundred pounds and the effort is substantial. Overall, the housing market is still performing well despite a recent decline in prices. We will get more insight on how that has affected consumer confidence tomorrow with the release of the GfK survey. The CBI industrial trends survey is also due for release

Yen weakens after Japan's LDP loses majority

The Japanese yen was dealt a double blow with a LDP defeat and a rebound in equities. Prime Minister Shinzo Abe is fighting to save his job after the LDP party lost its upper house majority. This means that any policies and reforms that Abe wants to pass in the future will probably be met with stiff resistance.

The impact on the currency should be only short term however as long as Abe is not forced to resign. The longer term driver of carry trades will be the global growth outlook and with liquidity conditions.

Unfortunately August is never a good month for liquidity because of summer holidays. It is earnings season in the US right now, so keep watching the corporate calendar for more good or bad news.

After tonight's Japanese economic releases, there is nothing of consequence for the remainder of the week. We are expecting Japanese overall household spending, labour cash earnings, PMI, personal income and the jobless rate.

Usually spending and earnings is the most important because they represent the weakest part of the Japanese economy. Retail trade last week was particularly weak. The lack of recovery in both is one of the primary reasons why the Bank of Japan has not been able to raise interest rates.

Mixed data leads to mixed performance in commodity currencies

High yielding currencies like the Australian and New Zealand dollars licked their wounds today. Economic data released overnight was mixed with home sales in Australia decreasing but business confidence increasing. New Zealand saw a drop in money supply growth but an increase in building permits.

Even Canada was faced with mixed reports; industrial product prices fell last month while raw material prices increased. Even though more data is due for release from Australia and New Zealand tonight we do not expect much more clarity until Wednesday when we get the Australian trade balance and retail sales figures.

Canada has GDP due for release tomorrow. Strong retail sales and trade balance figures suggests that growth in May could have been strong.