Euro Breaks Out, Headed Towards All Time Highs (page 1 of 2)

DailyFX Fundamentals 09-07-07

By Kathy Lien, Chief Strategist of DailyFX.com

US Dollar: Will the Fed be Proactive or Reactive?

Volatility has rocked the financial markets after the shockingly weak non-farm payrolls report. Economists were looking for companies to add 100k jobs last month, but they ended up firing more people than they hired.

The Federal Reserve can no longer pretend that the subprime and credit crisis is not having an impact on the overall economy. It is and in a very serious way.

At the end of trading today, Countrywide Financial announced job cuts of up to 12,000. The only choice that they have at this point is between cutting interest rates by 25 or 50bp. After today's non-farm payrolls number, the interest rate curve is pricing in 75bp of easing.

There are even rumours about the possibility of an emergency intermeeting cut. The chance of this is low since the FOMC meeting is only seven trading days away. The bigger question will be whether the Fed chooses to be proactive or reactive.

If they really want to do more than put a band aid on the problems that the US economy currently faces, they will need to surprise the markets with a half point cut, but based upon the measures that we have seen from Bernanke so far, it is more likely that the Fed to play it safe with by cutting interest rates 25bp.

The weak non-farm payrolls number has sent stocks, carry trades and the Dow tumbling. The dollar has been completely stripped of its safe haven status as job losses point to weak spending in the months to come as well as the risk for a recession.

Retail sales are the most important release on the economic calendar next week. After today's payrolls number, everyone will be looking for consumer spending to confirm that the economy is continuing on a downward spiral but we actually don't think that retail sales in August will be that bad.

The last time job growth was negative was in August 2003. That month retail sales jumped 1.6 per cent but in September and October, spending fell -0.8 per cent and -0.5 per cent respectively. Therefore it may be another month before we see a meaningful contraction in spending.

Carry Trades: Expect More Losses

None of the Japanese yen crosses have been spared from today's massive and widespread exodus out of carry trades. With the exception of CHFJPY, every other yen cross lost a minimum of 200 pips.

Risk aversion is back and we expect it to be here to stay. Unless the Fed steps in with an intermeeting rate cut, the Dow will want to test the 13,000 level by the end of next week. As currencies and equities continue to move together, this should have a negative impact on the Yen crosses as well.

When Asian traders return to the markets on Sunday night, we expect them to react the same way as US and European traders. Further losses in the Dow will also make it a difficult night for carry trades. Risk or no risk is still the big driver of the markets and based upon today's movements, it seems that no one wants to take on any risk.

Japan will be releasing second quarter GDP along with industrial production CGPI, current account and consumer confidence next week. These reports will probably matter little to the overall market as they focus on figuring out how much worse the US economy can get.

Euro Heads Towards Record Highs

The euro has finally broken out on the back of sharply weaker US economic data.