Euro: Will We See 1.40 Before 1.4350? (page 1 of 2)

DailyFX Fundamentals 10-12-07

By Kathy Lien, Chief Strategist of DailyFX.com

- Will the Focus on Inflation and G7 Help the US Dollar Next Week?
- Euro: Will We See 1.40 Before 1.4350?
- British Pound: In for Some Action Next Week

Will the Focus on Inflation and G7 Help the US Dollar Next Week?

Today's reports on September retail sales and producer prices were the most anticipated numbers of the week but to our disappointment, the US dollar barely reacted. Even though these reports gave the Federal Reserve less reason to raise interest rates at the end of this month, overall strength contained underlying weakness. Consumer spending grew by the fastest pace in six months and sales excluding autos erased the prior month's drop. However even though inflation pressures are back with headline prices rising 1.1 percent after falling 1.4 percent in August, core prices grew less than expected. Also consumer confidence fell to a 14 month low in October, suggesting that consumer spending could weaken in the coming months. This may seem worrisome, but don't forget that since the last Fed meeting where they cut both the discount and Fed funds rate by 50bp, the credit and labor markets have stabilized, the stock market hit a new record high and consumers spending remains steady. So the pressure is off for the Federal Reserve to make another proactive move - we doubt that they want to create another bubble in the stock market. Going into next week, everyone will be talking about inflation and the upcoming G7 meeting. This speculation is likely to be positive for the US dollar because as we have seen today, inflation pressures do exist. Fed officials have recently indicated that headline inflation could have a longer lasting impact than they initially anticipated. Also, dollar weakness and Euro strength could be on the discussion table at next weekend's G7 meeting. Speculation will arise as to whether there will be official criticism of dollar weakness. Given that any changes to the language in the communiqué would require approval by the US and the UK (the US' ally) we don't think this outcome is likely. However unofficial comments around the G7 meeting have still triggered sharp market volatility and this possibility is exactly what the market may fear throughout the coming week. In addition to CPI and the G7, we are also expecting the Empire State and Philly Fed manufacturing survey, the Treasury International Capital flow report, industrial production and the Fed's Beige Book report. Bernanke will also be speaking on the Economic Outlook Monday evening in NY.

Euro: Will We See 1.40 Before 1.4350?

In a move that should have been bullish for the Euro today, the ECB drained liquidity from the money markets. Economic data was also firm with August industrial production quadrupling expectations while ECB member Stark continued to be optimistic about growth. Yet the Euro did not rally, leading many traders to wonder whether the EUR/USD will see 1.40 before 1.4350. Taking a step back, the monetary policy bias of the ECB and Federal Reserve are clear. One central bank remains staunchly hawkish and refuses to talk down its currency while the other is trying to time its next rate cut and is basking in the benefits of a weak currency. In the long term, this dynamic should be positive enough for the EUR/USD that we should see the currency pair hit fresh record highs. However in the week to come, there is a lot standing in the way of further Euro strength. From the US, we have CPI and the G7, both of which have a greater chance of being dollar positive than negative.