Euro Struggles to Stay Above 1.48 (page 1 of 2)

DailyFX Fundamentals 01-11-08

By Kathy Lien, Chief Strategist of DailyFX.com

It's Judgment Time for the US Dollar as Market Prices in 44% Chance for 75bp Cut

The number one driver of the US dollar at the moment is interest rates, which is why we continue to focus on how many basis points the Federal Reserve will be shaving off the Fed funds rate at the end of the month. Throughout the past week, interest traders have been increasing their bets for a larger move which has led to widespread dollar weakness. Believe it or not Fed fund futures are now pricing in a close to fifty-fifty probability of a 75bp rate cut. Yesterday they were pricing in only a 50bp rate cut but today, Fed fund traders have gone crazy. As bearish as Federal Reserve Chairman Ben Bernanke may have been yesterday, there is zero chance that they will cut interest rates by 75bp at the end of this month. Although there has been one 75bp rate hike in the past 15 years, the last time that interest rates were reduced by more than 50bp at a single meeting was in 1984, after Paul Volcker had taken interest rates to a high of 20 percent to tame double digit inflation. By raising interest rates as aggressively as he did, Volcker managed to bring inflation down from its peak of 13.5 percent in 1981 to 3.2 percent by 1983. Are we coming off double digit interest rates or even high single digit interest rates for that matter? No. Is it confirmed that we are in a recession? No. If anything, the recent weakness of the US dollar contributes to inflation and the continual rally in gold prices indicates that higher inflation pressure is the bigger problem in the market at the moment. Therefore how could the Fed realistically lower rates by 75bp? A 50bp rate cut would already be overly generous. For the US dollar, Tuesday is judgment day. We are expecting retail sales and producer prices which will give us a glimpse into how desperately the US economy needs a larger rate cut. Although Bank of America's purchase of Countrywide Financial should have been very positive for US stocks, Merrill Lynch's $15 billion potential write down reminded traders that the worst of the subprime crisis is not behind us. If retail sales are weak and consumer price growth slow, it will be enough to convince the Federal Reserve to cut by half a point. In addition to those numbers, we are also expecting TIC, industrial production, Beige Book, housing starts and the Philly Fed survey, which means that it will definitely be a very volatile week in the currency market.

Euro Struggles to Stay Above 1.48

Will three times be the charm for the EUR/USD which has struggled to stay above 1.48 for the third time this month? Weak Eurozone economic data and an overall drop in risk appetite has forced the single currency to give back some of yesterday's spectacular gains. Despite the correction, we still expect the EUR/USD to hit 1.50, especially since today's price action does not reflect the sharp shift in interest rate expectations. German wholesale prices and industrial production was soft and Eurozone economic data will probably continue to weaken, but Euro strength or weakness depends largely on who is doing worse, the Eurozone or the US. ECB President Trichet remains committed to raising interest rates or least keeping them steady, which will remain positive for the Euro. Next week the only market moving releases that we are expecting from the Eurozone are the German ZEW survey of analyst sentiment and Eurozone consumer prices. These pieces of data will be taking a back seat to the heavily market moving US economic calendar.