Euro: Rate Hike, Rate Hike, Rate Hike (page 1 of 2)

DailyFX Fundamentals 11-05-07

Bu Kathy Lien, Chief Strategist of DailyFX.com

Has the US Dollar Hit a Bottom?

The most commonly asked question in the currency market these days is "When Will the US dollar Reach a Bottom?" Every time we have any sort of mild dollar rally like the one we had today, everyone wonders whether this will be the end of dollar weakness. Over the past week, we had relatively positive US economic data suggesting that a bottom may be likely; GDP growth was the strongest since 2006, non-farm payrolls doubled its forecast and contrary to market expectations, service sector activity accelerated according to the non-manufacturing ISM report. However many people remain worried that the US economy still faces problems. The financial sector is in disarray with banks reporting much larger than expected write downs last quarter and CEO's leaving left and right. Jim Rogers and Bill Gross have both warned that the subprime crisis is far from over and the threat of higher gasoline prices and winter heating costs leave recession a realistic possibility. Yet, recent comments from Federal Reserve officials suggest that even if this is the case, they may not continue lowering interest rates. Fed Governor Mishkin said today that should the latest interest rate cut by the Federal Reserve prove unnecessary, it "could be removed." Mishkin voted in favor of lowering rates last month, Hoenig was the one who dissented. His comments today reveal more on why the Fed decided to lower rates because according to Mishkin, the "potential costs of inaction outweighed the benefits." It is becoming increasingly clear that getting the Fed to consent to another interest rate cut will be like pulling teeth. However traders are expecting a rate cut. Fed fund futures are now pricing in a close to 100 percent chance that US interest rates will be 4.25 percent by the end of the year. The situation that we have now is one where traders and investors think that the Federal Reserve needs to continue cutting interest rates but the Fed does not want to do that; therefore whichever party manages to convince the other by December 11th will decide whether the US dollar has bottomed.

Euro: Rate Hike, Rate Hike, Rate Hike

The financial markets are finally waking up to the possibility of an interest rate hike by the European Central Bank. Although a rate hike has not been priced in for this week's monetary policy meeting, there is a growing possibility that ECB President Trichet could notch up his degree of hawkishness by bringing back the words "strong vigilance." We have been talking about this scenario for weeks and relating the ECB decision to the recent decision by the central bank of Sweden to increase interest rates. Inflation has become a major problem with the annualized pace of consumer price growth jumping to 2.6 percent, well above the ECB's 2 percent inflation forecast. If the Reserve Bank of Australia raises interest rates tomorrow night, it will be further evidence that major central banks are not afraid to increase interest rates in the current market environment. There was no Eurozone economic data released this morning, but service sector PMI, PPI and retail sales are due for release tomorrow. We are expecting stronger inflation numbers, decent retail sales and stable service activity.

USD/CAD Sinks to New Record Low

The Canadian and New Zealand dollars were the only currency pairs to rally against the US dollar today. The fact that commodity prices were slightly lower and there was no Canadian data released indicates that the move in USD/CAD is driven by momentum, flow and speculation that tomorrow's building permits and IVEY PMI will be strong.