Euro Rallies on Strong Data and Hawkish Comments (page 1 of 2)

DailyFX Fundamentals 12-10-07

By Kathy Lien, Chief Strategist of DailyFX.com



4 Scenarios for the Fed, but Only 2 Outcomes for the US Dollar

Traders across the markets are holding their breath for the last Federal Reserve interest decision of the year. In our opinion, there are four possible scenarios for tomorrow's rate decision but only two outcomes for the US dollar. The most likely option is for the Fed to cut interest rates by 25bp and to issue a dovish statement reflecting concerns about growth. Even though this would leave the door open for further easing in 2008, it may not be entirely dollar bearish because it disappoints the minority in the market looking for a larger 50bp rate cut. The second scenario is also a 25bp cut, but one that is followed by a 50bp discount rate cut. This would be more dollar bearish than the first scenario, but not enough to take the EURUSD back towards 1.50. The third scenario is for a quarter point cut to be accompanied with neutral or hawkish comments, most likely related to inflation. The chance of this is relatively low, but if it is the one that the Fed elects, it would be the most dollar bullish scenario. The final possibility is a half point cut which would be the most bearish for the US dollar. At the beginning of last week, there was a decent chance of that happening with probability of a 25 versus 50bp rate cut was close to fifty-fifty. However now with less than twenty four hours to go before the interest rate decision, those probabilities have plunged to 72-28, with the higher percentage in favor of the more conservative move. In our opinion, the Fed will most likely disappoint the market by under delivering. Even though food prices remain high, oil prices have tapered off which means that the Fed may have slightly more flexibility in lowering interest rates.

Euro Rallies on Strong Data and Hawkish Comments

The Euro extended its rally for the third consecutive trading day following strong economic data and hawkish comments from ECB officials. For those people who have been criticizing the Euro for hurting the Eurozone economy, their complaints continue to be refuted by economic evidence. In the month of October, exports actually hit a record high in Germany and if you recall, that was the month that the Euro broke above 1.45 for the very first time. Following the recent rise in manufacturing PMI, industrial production and factory orders, the boost in exports is not too much of a surprise. Instead, what is more surprising is the soft growth of imports. Domestic demand is beginning to wane and that could be a cause for concern. Tomorrow we are expecting the German ZEW survey, which is expect to drop to a new 15 year low but analysts have been notoriously pessimistic and as a result, have incorrectly forecasted Eurozone growth for the past few months. For this reason, we actually believe that the ZEW survey could surprise to the upside as analysts finally recognize the stability of recent Eurozone data. Furthermore, the Euro is also benefitting from ECB officials repeating the hawkish comments made by Central Bank President Trichet last week. Both Liikanen and Stark warned of upside inflation risks next year, which tells us that this week's consumer price data could be particularly firm.

Fastest PPI Growth in 16 Years Drives British Pound Higher

Last week, the Bank of England cut interest rates for the first time in 2 years, which should have been bearish for the British pound, but wasn't.