Euro Makes New Record High Despite Sharp Drop in Business Confidence (page 1 of 2)

DailyFX Fundamentals 09-25-07

By Kathy Lien, Chief Strategist of DailyFX.com

US Dollar Hits an All Time Low; It Only Gets Worse

The US dollar fell to a new all time low of 1.4154 against the euro on the back of continued deterioration in the US economy.

Traders and investors are selling dollars as the outlook for consumer spending becomes bleaker with each passing day. Consumer confidence dropped to a two year low in the month of September while sales of existing homes fell to a five year low.

We are actually surprised that there wasn't an even larger drop given the deterioration in the labour markets, tight credit conditions and rising energy prices. October is the month when sub-prime adjustable rate mortgage resets will hit a peak of $50bn. This is the largest amount on record and suggests that the cycle of major sub-prime related losses at hedge funds and banks could begin once again.

Generally, the increase in mortgage payments will lead to an increase in foreclosures, so now may not be the time to be complacent about taking risk. The drop in confidence and home sales only reinforces the need for the Federal Reserve to continue lowering interest rates.

We expect another 50bp of easing by Christmas followed by another 50bp before the middle of next year. The next Non-Farm payrolls report is not expected to be pretty either. On top of the layoffs that have already been announced in the financial sector, workers at General Motors held their first nationwide strike in 25 years.

Some 73,000 workers have been displaced and 30,000 are expected to be pushed off the job. If this is not resolved soon, it will have a meaningful impact on non-farm payrolls which will naturally dovetail into further weakness for the US economy. The question now is will a recession happen; we are discussing this on the DailyFX Forum.

Meanwhile the only piece of good news was the Richmond manufacturing index which jumped from seven to 14 in September, the highest level since April 2006. The manufacturing sector is expected to be one of the biggest beneficiaries of dollar weakness which is why tomorrow's durable goods may not be as bad as analysts are currently predicting.

Euro Makes New Record High Despite Sharp Drop in Business Confidence

The euro made a new record high today despite larger than expected drops in German business confidence and import prices. Economic data out of Europe continues to get worse and if the euro does not stop rising, the European Central Bank (ECB) will be forced to verbally intervene in the currency.

Don't forget that the euro topped out in late 2004 after ECB President Jean-Claude Trichet called the moves brutal and he may have to do so again as German business fell to a 19 month low in September. This is a result of deteriorating credit conditions, a strengthening currency and tight monetary policy.

As an export dependent nation, the Eurozone has a lot to lose if the euro continues to rise. The only major benefit of a strengthening currency is lower inflationary pressures. We are already seeing the initial impact with import prices falling for the first time in nearly 2.5 years.

Less inflationary pressure means less pressure on the ECB to raise interest rates. If we see a material slowdown in economic data, softer inflation may actually give the central bank the flexibility it needs to begin talking about lowering interest rates. This of course is a few months off at the earliest, but it is a factor that is certainly worth watching.