Euro Slips as Action Speaks Louder than Words

DailyFX Fundamentals 12-19-07

By Kathy Lien, Chief Strategist of DailyFX.com

US Dollar Makes a Comeback

As 2007 draws to a close, the US dollar is making a nice comeback. Since December 1st, when 'The Panic about the Dollar' was the headline on the front page of the Economist, the mighty buck has increased 600 pips against the British pound, 400 pips against the Euro and 300 pips against the Japanese Yen. What has changed? Has the curse of the magazine cover marked the bottom in the US dollar yet again? Some may argue that it has but the real driver is a shift in risk appetite. Stocks have given back their month to date gains and the big events over the past few weeks have all centered around the additional measures that central banks have taken to boost confidence in the financial markets. The end of the year has brought with it more announcements of subprime related losses which have done nothing but give investors better reasons to book profits and to delay any additional risk taking until the New Year. Today was no different. Even though S&P downgraded a bunch of US bond insurers and Morgan Stanley warned of challenging times ahead, the dollar was bought anyway as risk aversion continues to seep through the market. The results of the Term Auction Facility also came in. A 3 to 1 bid-to-cover ratio was neither good nor bad for the markets. So far, we are seeing a drop in LIBOR rates, which is the desired reaction of central banks. The only question is - Will it last? If it doesn't, the monetary helicopters will need to dump more liquidity into the markets. There was no US economic data released today but GDP, leading indicators and Philly Fed is due for release tomorrow. The GDP numbers are final figures; no revisions are expected which means that they should not be market moving. If there is a revision however, it will probably be to the downside. The Empire State manufacturing survey was particularly horrid which suggests that the Philly Fed could be as well. Whether this matters to the US dollar on the other hand is a different story.

Euro Slips as Action Speaks Louder than Words

For the people who are trading the Euro, action speaks a lot louder than words. ECB President Trichet reminded everyone that the central bank remains worried about inflation and that there is no room to cut interest rates. However their action, being the $500 billion loan that they extended to the market earlier this week indicates that they also have no room to raise interest rates. The high level of LIBOR rates has been their primary cause for concern. To raise rates anytime soon could erase all their recent efforts to drive down LIBOR rates. Furthermore, Eurozone economic data is beginning to soften. The German IFO survey, which is a measure of business confidence dropped to a 2 year low in the month of November. Producer prices were hot but inflationary pressures have already been priced into the Euro. Swiss National Bank President Roth was on the wires today talking up the chance for a rate hike. He said that the franc is undervalued and could push inflation higher, which would trigger another interest rate hike. The Swiss trade balance and producer prices are due for release tomorrow. We expect both of these numbers to be positive for the franc.

British Pound Hits 3 Month Lows

The British pound was the day's biggest market mover as bad news leads to more bad news in the UK. Yesterday, we had softer than expected consumer prices, which negated the big rise in producer prices. Today, the Bank of England minutes revealed a 9 to 0 vote in favor of the first rate cut in 2 years. The move was described as 'pre-emptive,' but judging from the price action of the British pound, the market did not care. The minutes were more dovish than they were anticipating and the likelihood of another rate cut next year has increased. Weak economic data also continues to pour out of the UK. The CBI industrial trends balance, which measures retail sales, fell to 8 from 13 in the month of December. The expectations component fell to -5 from 11, which was the first negative reading in over a year. Third quarter GDP is due for release tomorrow but these are final figures which means that they should not be that market moving. For the time being, both fundamentals and technicals suggest that the British pound should remain one of the weakest currencies in the foreign exchange market.

No Rate Hike Expected from Bank of Japan

The Bank of Japan will be announcing their interest rate decision tonight. Even though the Yen has strengthened against every major currency except for the US and Canadian dollars, expectations for a rate hike is not one of the reasons why the Yen has rallied. With recent economic data still reflecting a weak economy, the Bank of Japan does not have any room to raise rates especially at a time when central banks around the world are pumping liquidity into the financial system. Also, Prime Minister Fukuda's approval ratings are down 33 percent, which means the government will not support a rate hike. Therefore even if the BoJ is hawkish, the market may not believe them.

Australian and New Zealand Dollars Slip, But Canadian Dollar Gains Ground

Dollar strength has forced the Australian and New Zealand dollars lower as the turn in the equity markets leads to another a wave of carry trade liquidation. The New Zealand current account deficit for Q3, which was released shortly before the US session close hit the highest level in 2 years. GDP is due for release tomorrow; bearish numbers are expected as well. The Canadian dollar on the other hand was the only commodity currency to rise against the US dollar thanks to stronger economic data and higher oil prices. Wholesale sales doubled expectations, suggesting that retail sales due on Friday could also be firm.