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By Kathy Lien, Chief Strategist of DailyFX.com
US Dollar Could Recover Next Week
One of the most emailed articles in the online edition of the NY Times today was a story titled Dollar Falls to a New Low against the Euro. The fact that the weakness of the dollar has hit mainstream interest illustrates the significance that it has for not only currency traders, but also for anyone with international interests, including corporations, investors and travelers.
The main reason why the dollar has weakened so significantly over the past month is because the Federal Reserve has embarked on a brand new monetary policy cycle. This week's 50bp cut of the Fed Funds and Discount rate sent three messages to the market.
The first is that the Federal Reserve has adopted a new policy of being proactive and not just reactive; the second is that the outlook for the US economy could be worse than most people thought and the third is to expect more interest rate cuts in the months to come.
According to Fed Fund futures, interest rates are expected to be lowered by another 50bp before the end of the year followed by another 75bp of easing in 2008. In the medium term, this will be extremely negative for the US dollar but in the week ahead, the dollar may get a chance to recover.
Although there are a number of US economic releases next week, none of these numbers are meaningful enough to shift the outlook for the US economy or change the Fed's mind about the need to lower interest rates further. Next week's releases are divided into three divisions; housing, consumer and manufacturing.
The new and existing home sales data are expected to be weak, but that has pretty much been already discounted by the market. The Chicago PMI and Durable Goods data should be mixed. In the long run, the weak dollar will be a big boost for the manufacturing sector as a whole.
As for the consumer data which includes consumer confidence, personal spending and personal income, confidence is likely to fall, but the spread between spending and income could narrow. There is also second quarter GDP, but that is a final number.
Overall, none of these reports are market moving enough to shift the overall trend in the financial markets. The US dollar may use this opportunity to lick its wounds.
Things Will Stop the Euro's Rise
The all-time high in the euro is now 1.4120. As the currency continues to press higher, the burning question on everyone's mind is, What Could Stop the Currency's Rise?
From the US perspective, a series of very good US economic data could help the dollar recover, but that will take time because we need to see renewed strength in core sectors such as housing, consumer spending and the labour market. In the immediate future, developments in Europe could also trigger a top in the euro.
The two things that can stem the euro's rise are verbal intervention from European Central Bank (ECB) President Jean-Claude Trichet and significantly weaker economic data.
In terms of data, we are already seeing signs of instability. Service sector PMI in the Eurozone dropped from 58.0 to 54.0, the lowest level since August while manufacturing PMI fell from 54.3 to 53.2.
The German IFO report is due for release next week and we expect the recent problems in the US, credit market turmoil and rising euro to take a big toll on business confidence.
Kathy Lien, Chief Strategist, Daily FX
