Euro On its Way to 1.50

DailyFX Fundamentals 11-20-07

By Kathy Lien, Chief Strategist of DailyFX.com

Expect More Dollar Weakness
The US dollar has fallen to new record lows against the Euro and Swiss Franc, leading many traders to wonder how much longer this weakness can continue. Unfortunately, we do not think an end will come anytime soon because the dollar's selloff is causing a stir in countries around the world who peg their currencies to the US dollar. China and Gulf Nations are complaining that their investments into US assets are falling in value and inflation is rising, which suggests that if the dollar does not stop weakening, and their losses reach a point that becomes intolerable, they may be forced to diversify their reserves and drop their dollar pegs. At best, they will threaten to do so which is the main driver behind today's dollar weakness. Yet the US government has not and probably will not do anything to stop the dollar from weakening. According to the latest FOMC minutes and Fed forecasts, the risks to growth are skewed to the downside. With oil prices hitting a new record high and US car loan defaults on the rise, this holiday shopping season could be a particularly difficult one. US retailers need a weak dollar to draw in tourism and foreign spending while larger corporations need a weak dollar to increase exports. Even though the October 31st FOMC minutes were hawkish because the decision to cut rates was a close call, the Fed reduced their growth and inflation forecasts for 2008 and increased their unemployment forecasts. Collectively these numbers are obviously bad for the US dollar and confirm that the Federal Reserve could very well be lowering interest rates again next month. Although there has been talk of an emergency rate cut by the Fed, this chance was slim from the very beginning. Housing market numbers released this morning were mixed. Starts increased by the biggest amount in 8 months but building permits fell to the lowest level in 14 years. This indicates that the housing market has not bottomed but the deterioration is clearly slowing. Jobless claims and leading indicators are the only meaningful US data due for release tomorrow.

Euro On its Way to 1.50
Over the past few weeks, we have consistently said that the EURUSD is headed to 1.50. Today, the currency pair made a decent move towards that target and we expect further strength in the weeks ahead. This Thanksgiving week has already proven to be as interesting and volatile as last year's even though it is traditionally a quiet trading week. Both German producer prices and the Swiss trade balance were hot last month, which was right in line with our expectations. Recent comments from ECB officials suggest that they are finally becoming worried abut the level of the exchange rate. Junker said today that the Eurogroup is keeping a very watchful eye on currency levels. There is no major Eurozone data due for release tomorrow which suggests that trading should be quiet unless the stock market is particularly volatile. Overall, we still think that the ECB will not cry uncle until the Euro reaches 1.50.

British Pound Rallying Ahead of Bank of England Minutes
The UK is one of the few countries releasing economic data that has the potential to move markets tomorrow. We are expecting the minutes from the latest monetary policy meeting which typically causes sharp volatility in the British pound. However the minutes tomorrow may be less exciting since Bank of England Governor King delivered the Quarterly Inflation Report last week. He was more worried about growth and less concerned about inflation leading some traders to believe that the central bank may cut interest rates in the first quarter. The minutes from the last meeting should contain a similar view but any risk would be to the upside. The British pound performed very well today thanks to a sharp rise in factory orders according to the CBI industrial trends survey. Money supply growth and mortgage approvals were softer and public sector net borrowing was narrower than expected.

Higher Commodity Prices Drive Australian, New Zealand and Canadian Dollars Higher
The Australian, New Zealand and Canadian dollars are sharply higher today. Even though the moves are respectable, they represent mere retracements within the recent downtrend. Commodity prices are sharply higher with oil hitting a new record high. This has offset the sharp downside surprise in Canadian consumer prices and helped to keep the Canadian dollar steady even though the latest economic data suggests that the BoC could consider lowering interest rates in the near future. This comes on the heels of comments from Bank of Canada Governor Dodge yesterday who said that the risks to global growth have increased and he will take this into account when they meet next month. For the first time in 2 years, Canadian prices are back below the central bank's target as the prices of gasoline and automobiles declined. Canadian retail sales are out tomorrow. We expect them to be strong given the sharp rise in wholesale sales.

Volatility in Stock Market Leads to Volatility in Carry Trades
The release of the FOMC minutes caused significant volatility in the equity markets. The Dow was down 100 points shortly after the release and then rallied up 100 points 20 minutes before the market close before finally settling up only 50 points. Unsurprisingly the relationship between equities and carry trades caused just as much volatility in currency pairs like GBPJPY which sold off to an intraday low of 226 only to rally to a high of 227.54 shortly thereafter. The Japanese trade balance and all industry activity index are due for release this evening. We are expecting strong numbers from both even though the Japanese government is growing increasingly worried about the housing market.