Euro: Watch for a Break of 1.37 (page 1 of 2)

DailyFX Fundamentals 08-29-07

By Kathy Lien, Chief Strategist of DailyFX.com

Carry trades and Dow rally despite bad data

Carry trades rebounded strongly as the Dow came close to erasing all of Tuesday's losses. The only piece of economic data released from the US was mortgage applications which dropped for the second week in a row.

Any news from the financial sector only provided more cause for concern. UK hedge fund Cheyne Financial may be forced to liquidate up to $6bn in assets due to losses in the commercial paper market while Basis Yield Alpha Fund filed for bankruptcy.

Everyone is also beginning to shift their focus to this quarter's earning releases. Moody's and Standard and Poor's both warned that banks could suffer double-digit losses due to falling revenue and big write offs.

So why has the Dow rallied so much today? There are only two real explanations. The first is that the market expects tomorrow's second quarter GDP report to be revised up sharply. Although a valid reason, the backward looking GDP report does not reflect the recent turmoil that we have had in the financial markets.

The second explanation is Fed Chairman Ben Bernanke's comment that there is no need to lift portfolio caps on Fannie Mae and Freddie Mac. This could suggest that the Fed has other ways to boost growth and may not need to resort to raising portfolio limits on GSEs.

The lower volume in the market is also contributing to the unusual swings in the currency and stocks markets and because of this, it is not time to become complacent. The problems are increasing as risks continue to grow, but traders are simply ignoring them.

Judgment day will come after the Labor Day holiday in the US. The slide in the dollar today indicates that risk appetite is returning, but for the time being, the downtrend in most of the high yielding currency pairs remains intact.

The rallies that we have seen so far should only be perceived as a rebound within an overall downtrend.

Euro: Watch for a break of 1.37

Even though the euro started the week on a softer footing, it has now recovered close all of those losses. German and French unemployment numbers are expected to be strong tomorrow even though retail PMI across the region should be weak.

German consumer confidence has already deteriorated for September. However these economic releases will most likely be only secondary triggers for moves in the euro. Instead, all eyes will be on US data, the credit markets and any comments from European Central Bank (ECB) officials.

So far, the central bank has kept us guessing on what to expect in September. Meanwhile the Swiss KoF leading indicators report deteriorated from 2.09 down to 2.06 in August. Swiss economic data has been on a downtrend, which suggests that the central bank will leave interest rates unchanged next month.

British pound: A puppet of the risk appetite

There was no economic data released from the UK today and the only news out the country was a bad one since Cheyne Financial is a UK based hedge fund. Yet, the British pound rose strongly against the euro, US dollar and Japanese yen which means that the currency was nothing more than a puppet of global market risk appetite.

Tomorrow may be a bit different however with Nationwide house prices, consumer credit, mortgage lending, money supply and the CBI distributive trades survey all due for release.