DailyFX Fundamentals 10-19-07 (page 1 of 2)

DailyFX Fundamentals 10-19-07

By Kathy Lien, Chief Strategist of DailyFX.com

- US Dollar: 90% Chance for October Rate Cut!
- G7 Meeting: Clearest Trend is Yen Strength
- Canadian Dollar Hits 33 Year High, RBNZ Rate Decision Next Week

US Dollar: 90% Chance for October Rate Cut!

The price action in the financial markets this week is a testament to how quickly expectations and sentiment can change. We started the week with nearly everyone in the market agreeing that the Federal Reserve will not cut interest rates at the end of the month and now implied Fed Fund futures are pricing in a 90 percent chance of an October cut. Taking a step back, aside from US consumer prices, the data released this week the US was mostly second tier, which means that they should not have been all that market moving. So what caused the dramatic change in interest rate expectations? Continued weakness in the housing market, disappointing earnings in the banking sector and a 550 point drop in the Dow (Monday to Friday). With HSBC downgraded, Bank of America reporting a 32 percent decline in earnings and Wachovia reporting a 10 percent drop, the 20th Anniversary Week of Black Monday 1987 has proven to be as brutal on a point basis as many of the October crashes that we have seen in the past. The rise in oil prices creates additional risk for an already vulnerable US economy and calls for a recession are returning. More immediately however, we need to turn our focus to today's G7 meeting. The communiqué should be released this evening. According to Dow Jones, the draft of the statement indicates that finance ministers will be calling for the Chinese Yuan to increase more quickly in value. The Euro, US dollar, Japanese Yen and the Dow will probably not be mentioned in the official statement. The biggest currency to be impacted will therefore be the Japanese Yen. Next week, we have more housing market data from the US as well as durable goods due for release. The market's primary focus will be on the following Wednesday's October 31st FOMC meeting but don't write off the potential for a continuation move in the equity and currency market if there are any additional surprises in the official G7 communiqué.

G7 Meeting: Clearest Trend is Yen Strength

The clearest outcome of the G7 meeting will be Yen strength. Not one of the Japanese Yen crosses have been able to escape the pressure of carry trade liquidation today since Yen is seen as the proxy for Asia, which includes China. The Chinese however are not very happy with shouldering the blame for US dollar weakness. Earlier this morning, an advisor to the People's Bank of China said that the Euro's gains are an indication of a dollar problem and they will become increasingly concerned if the dollar continues to devalue. Are they signaling potential diversification or liquidation of treasuries? The movements in equities continue to be a predominant driver of the Japanese Yen. If there is follow through selling in the Asian markets, carry trades could see further losses. Today's sell-off in the Dow is the strongest since early August. Next week, we are expecting the merchandise trade balance, consumer prices and industrial production. The weakness of the Japanese Yen should help to boost inflation, exports and overall manufacturing activity. However whether this will matter to Yen traders remain to be seen as more volatility in equities could easily overshadow surprises in economic data.

Canadian Dollar Hits 33 Year High, RBNZ Rate Decision Next Week

The Canadian Dollar continues to rise and today we have finally broken through another milestone to hit a 33 year high against the US dollar.