Is the Euro the Dollar and Yen's Puppet? (page 1 of 2)

DailyFX Fundamentals 01-17-08

By Kathy Lien, Chief Strategist of DailyFX.com


Manufacturing Sector Slips into Recession, Is it Time for a 75bp Rate Cut?

In yesterday's Daily Fundamentals, we warned that even though the US dollar recovered and we had a few pieces of stronger economic data, it is premature to assume that the sell-off has come to an end. Following the shockingly weak Philly Fed manufacturing survey, talk of a recession in the US economy is back in force and with lots of fundamental backing behind it. The manufacturing index fell to the lowest level in over 6 years which basically means that the manufacturing sector is already in a recession. Taken together with the Financial Times report that California and Florida are in or on the brink of a recession and we can understand why stocks fell over 300 points today. Housing starts dropped to the lowest level in 17 years while building permits posted their biggest drop in 33 years. The dollar is weaker against all of the major currencies with the exception of the commodity currencies and rate cut expectations have increased once again. Believe it or not the futures market is now pricing in a 58 percent chance of 75bp of easing at the end of the month up from 40 percent yesterday. In his Congressional Testimony, Bernanke repeated his prior warning that the Fed is "ready to take substantive additional action." Up until today, this meant 50bp of easing because we expect the Federal Reserve to deliver exactly what the market prices in, nothing more, nothing less. Now that rate cut expectations are favoring 75bp of easing, we will be watching to see if those expectations grow. The financial markets have been extremely volatile and Fed fund futures are no different. We do believe that the US economy needs a 75bp rate cut, it is just a matter of whether Bernanke will risk a jump in inflationary pressures to support growth. If the Bush Administration announces a stimulus package, that too could lower rate cut expectations as tax cuts and additional spending reduces the need for more aggressive easing. Leading indicators and the University of Michigan consumer confidence reports are due for release tomorrow; both numbers are expected to be dollar negative.

Is the Euro the Dollar and Yen's Puppet?

The Euro ended the day unchanged against the US dollar as EUR/JPY selling grappled the markets. The Eurozone trade balance was narrower than expected due to a slowdown in import and export growth. There is no doubt that the Eurozone economy is becoming less immune to the slowdown in the US or globally for that matter, but the problems across the pond (in the US) is still more severe. Also, despite ECB member Mersch's shift from hawkish to dovish yesterday, other members of the ECB remain hawkish. Today Liebscher said that the primary task for the central bank is to avert second-round inflation. Although their stubbornly hawkish stance should keep the Euro from falling severely, there are consequences. Airbus warned that orders for their aircrafts could fall 50 percent this year and even though they did not directly cite the Euro, we are sure that the currency's strength and the global slowdown are the primary reasons for the company's dire forecasts. We doubt that Airbus is the only company suffering from a strong currency and slower export demand. Meanwhile, the Swiss Franc is weaker across the board as the Swiss Investor Confidence index falls for the third month in a row.

British Pound Bounces, But Still Struggling to Sustain Gains

The British pound strengthened against every major currency with the exception of the Japanese Yen.