Reserve Bank of Australia and Bank of Canada Both Expected to Remain Hawkish (page 1 of 2)

DailyFX Fundamentals 09-04-07

By Kathy Lien, Chief Strategist of DailyFX.com

US Dollar: Will Fed chairman Ben Bernanke Bow to Political Pressure?

The Dow is up 91 points on the first day of trading in September and in the third quarter. Although this has helped to lift carry trades, the US dollar's rally against the euro and British pound as well as the mixed performance of bond yields suggests that the financial markets have not turned suddenly optimistic.

US economic data was weak with both manufacturing ISM and construction spending falling short of expectations. Activity in the manufacturing sector was the slowest in four months while construction spending was the lowest in seven months.

Even though vehicle sales were stronger than expected the Dow is higher today for no other reason than the fact that the market expects the Federal Reserve to cut interest rates later this month. A 25bp rate cut has been fully priced in and there is a 58 per cent chance of a half point cut.

Although the markets have been calling for the Federal Reserve to lower interest rates for months now, this would still be the first time in over a year that the Federal Reserve has actually altered their lending rate. Another reason why the rally in carry trades may not continue is because September tends to be a difficult month for the Dow.

Over the past 50 years, the Dow has had an average return of -1.35 per cent from the beginning to the end of the month. If the relationship between carry trades and the Dow continue to hold, then that would mean a difficult month for carry trades as well.

The Challenger layoffs report and ADP employment survey are due for release tomorrow along with the Beige Book report. For those who are not convinced that the Fed will lower interest rates, and there are a decent amount of people who still don't, the labour market reports this week could be the deciding factor.

Congress has returned from Summer Recess and we expect a lot of finger pointing over the next few months. They will be looking for someone to blame the subprime and credit debacle on as well as pressuring the Federal Reserve for solutions.

The fact that Senator Dodd and not the Fed Chairman was the first to tell the markets last month that the Federal Reserve has pledged to use "all tools available" to avert a housing and credit crisis suggest that Bernanke will act in a way that will please the consensus later this month.

For the time being however, the Federal Reserve will probably remain on the fence until more economic data is released.

Reserve Bank of Australia and Bank of Canada Both Expected to Remain Hawkish

The Reserve Bank of Australia (RBA) and Bank of Canada (BoC) will be the first central banks to announce their interest rate decisions this week. For the RBA, the announcement will be easy since there is zero chance that they will be changing their interest rate and when they fail to do so, no statement is released.

This will make the RBA announcement a nonevent even though the central bank could still raise rates before the end of the year. The Australian dollar is the only major currency to have strengthened against the dollar today and that was because second quarter GDP increased 0.9 per cent, bringing the annualised pace of growth to 4.3 per cent, the fastest in three years.

The Bank of Canada on the other hand has a much more difficult job.