Euro Benefits from Deteriorating US Economic Outlook (page 1 of 2)

DailyFX Fundamentals 08-03-07

By Kathy Lien, Chief Strategist of DailyFX.com

Weak payrolls and ISM could force the Fed to drop its inflation bias next week

Bad news begets bad news which begets even more bad news. This is why both the US dollar and the Dow are lower in Friday trading.

This morning, we had much weaker than expected non-farm payrolls. Despite a sharp rise in consumer confidence and a drop in average weekly jobless claims, US corporations only added 92,000 jobs onto their payrolls, which was the weakest level since February 2007 and the third weakest in two years.

This brought the unemployment rate up to 4.6 per cent, the highest since September 2006 (for more details see our NFP Instant Insight). The divergence between jobless claims and non-farm payrolls indicates that even though companies are not firing, they are also not hiring.

With hedge funds and mortgage lenders blowing up left and right, August could be ugly for the labour market. American Home Financial announced that it will be cutting staff numbers from 7,000 to 750, a loss of 6,250 jobs. We are sure that it is not the only company to be downsizing.

In addition to American Home Financial's announcement and the bad non-farm payrolls number, Standard and Poor's also cut its outlook on Bear Stearns to negative while Wells Fargo raised its mortgage rates on 30 year jumbo loans from 6 7/8 per cent to eight per cent.

The last piece of US data released today was service sector ISM which dropped from 60.7 to 55.8. The fall in bond yields yesterday was an accurate sign that we have yet to see the worst. Will there be respite next week? Possibly - the economic calendar is very light and the only piece of US data with any market moving potential is the Federal Reserve's monetary policy decision.

Rates are expected to be left unchanged, but as usual, the market will be focusing on the accompanying statement. Will the recent movements in the stock market and endless troubles in the US economy force the central bank to drop its hawkish inflation bias? The potential exists, but based upon the latest Fed rhetoric, it is not ready to do so.

Euro benefits from deteriorating US economic outlook

Yesterday, European Central Bank (ECB) President Jean-Claude Trichet signaled to the markets that despite the recent slowdown in European growth, it still has full intentions of raising interest rates next month. This of course is bullish for the euro and helped to take the currency higher against the US dollar.

However the breakout in the euro today was more a reflection of the deteriorating conditions in the US economy than the more promising outlook in the Eurozone. We are currently in an environment where the Federal Reserve may have no choice but to slowly downgrade its degree of hawkishness while the ECB is expected to deliver one and possibly even two rate hikes by the end of the year.

Although service sector ISM in the Eurozone was stronger than expected in July, retail sales for the region were weaker. Like the US, the economic calendar is relatively light.

German factory orders, industrial production, the trade and current account balances are the only pieces of data that are potentially market moving and even then, they are second tier data. All of these reports reflect aspects of the Eurozone economy that may be affected by the strength of the euro.

Therefore a downside surprise is far more likely than an upside one.