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By Kathy Lien, Chief Strategist of DailyFX.com
Euro Hits Record High
It has been an extremely active day in the currency markets with the US dollar falling to record lows against the euro and 30 year lows against the Canadian dollar.
For months, the currency market has been obsessed with 1.40 in the euro and 1.0 in USD/CAD. Now that these targets have been achieved, the question ahead of us is how much further can the euro rise.
In the currency markets, trends can last far longer than most traders expect and even though the risk of a top increases with each pip rise, there is no reason to believe that the EUR/USD will top out until the currency pair itself manifests weakness.
Fundamentally, the US dollar has been driven to a record low because of growing concerns about the US economy and the possibility of further interest rate cuts by the Federal Reserve. Although speculation of Saudi Arabia abandoning its dollar peg triggered the break of 1.40, the country's later denial of this possibility did not lead to similar relief rally in the US dollar.
Therefore this tells us that there is a lot more than speculation driving the dollar's weakness. We have often said that the expectation of where interest rates are headed is the number one driver of currency movements.
The latest bout of dollar weakness is a reflection of not only the larger rate cut delivered by the Federal Reserve earlier this week, but also the expectation of anywhere between 25bp to 50bp of further easing before the end of the year. Yet, the further the dollar falls, the greater the risk of a reversal.
A weakening currency will not only help to boost exports and revive the economy, but it will also induce inflationary pressures. So the question in front of us is what will get out of hand first, growth or inflation. All it takes for the euro to stop rising is a few pieces of stronger US economic data or any concern about euro strength by European Central Bank (ECB) President Jean-Claude Trichet.
Unfortunately we have yet to see a meaningful improvement in US data. Even though the Philly Fed index jumped from 0 to 10.9, it was offset by a larger than expected drop in leading indicators. Fed Chairman Ben Bernanke made no direct comments about the state of the economy or monetary policy.
He simply said that the rate cut was taken to stay ahead of the credit markets.
Meanwhile gold prices hit 28 year highs while oil prices hit a new record high of $83 a barrel.
Canadian Dollar Now Even With US Dollar Thanks to $83 Oil
At the beginning of the year, many people did not believe the Canadian dollar (CAD) could hit parity with the US dollar, but for the first time in over 30 years, $1 is worth CAD$1.
Although USD/CAD has rebounded since hitting an intraday low of 0.9993, the possibility of solid retail sales tomorrow could be all it takes to bring the currency pair back below parity. Canadian wholesale sales were released today and in the past, we have found wholesale sales to be an incredibly accurate leading indicator of retail sales.
Therefore the 2.0 per cent rise in wholesale sales suggests that we could see a sharp rise in retail sales tomorrow as well. Right now the market is expecting flat Canadian retail sales, so it will not take much for the number to surprise to the upside.
The Australian and New Zealand dollars also extended their gains on the back of higher gold prices despite mixed economic data.
Kathy Lien, Chief Strategist, Daily FX
