3 Reasons Why the Euro Weakened (page 1 of 2)

DailyFX Fundamentals 01-16-08

By Kathy Lien, Chief Strategist of DailyFX.com

US Dollar's Recovery Does Not Equal a Bottom

We are finally seeing cohesive price action in the currency markets as the US dollar recovered against every major currency. Stronger economic data has curbed expectations for a 75bp rate cut, leaving 50bp of easing the only realistic possibility. Unlike producer prices, consumer price growth was stronger than expected last month with the annualized pace of core prices rising from 2.3 to 2.4 percent. Industrial production was flat and net foreign demand for US securities increased $90.9 billion in November. Although both numbers represented a slowdown from the prior month, they soundly beat market expectations. Even the Beige book report contained silver linings. The various Fed districts acknowledged the weakness of holiday sales, but on balance, they all felt that economic activity has increased modestly and the labor market remains tight. With this in mind, it will certainly be interesting to see if Federal Reserve Chairman Ben Bernanke shifts his tone at tomorrow's Congressional testimony. The last time he spoke, Bernanke was decidedly bearish, triggering a sharp sell-off in the US dollar. In addition to the comments from the Fed Chairman, we are also expecting housing starts, building permits and the Philadelphia Fed manufacturing index. These are the most vulnerable sectors of the US economy which suggests a slim chance for dollar positive numbers. Although we still believe that the US needs a 75bp rate cut, Bernanke lacks the shock factor of some of his predecessors which means that 50bp is all that we will most likely get. However even if 50bp is under delivering, it is important to realize that this would take US rates down to 3.75 percent, which is 25bp less than the Eurozone's interest rates and 50bp less than Canadian rates. Therefore when the "cross" happens, we could actually see the EUR/USD rally and USD/CAD sell-off as funds that only hold interest bearing positions readjust their exposure.

3 Reasons Why the Euro Weakened

This morning, the Euro fell 200 against the US dollar pips in less than 2 hours and remained weak throughout the US trading session. The lack of breaking news at the time made it difficult to pinpoint one single factor that drove the currency pair lower. Instead, we attributed the move to a combination of developments. The most widely credited reason for the selloff was the dovish comments from ECB member Mersch. He said that the Euro's gains were dampening growth and he urged the ECB to be cautious given uncertainties and look through temporary inflation jumps. The biggest reason why his comments were so important is because Mersch is traditionally a hawk, which means that he has shifted his stance. Although this is a factor for the Euro's decline, we are not sure if his language was strong enough to warrant a 200 pip slide, especially since ECB member Weber reiterated his hawkish comments an hour before Mersch spoke. Strong US economic data is the second reason why the Euro dropped. The third is a fall in commodity prices, which could soften the blow to US consumer demand in the coming months and reduce the pressure on the ECB to raise interest rates. Tomorrow, we are expecting the ECB's monthly report and the Eurozone Trade Balance. None of these numbers should be particularly market moving.

Is the British Pound Making a Near Term Bottom?

Although the British pound ended the US trading session flat against the US dollar, the currency pair recovered strongly against the Euro, Japanese Yen and Swiss Franc.