Fate of EUR/USD Will Depend On Who Delivers the Bigger Surprises (page 1 of 2)

DailyFX Fundamentals 03-28-08

By Kathy Lien, Chief Strategist of DailyFX.com

US Dollar Could Fall to a New Record Low

We have seen some big moves in the currency market this past week, but these fluctuations should pale in comparison to the action that we expect to see next week. Not only are there a lot of economic data due for release from countries around the world, but Federal Reserve Chairman Ben Bernanke will also be testifying before the Joint Economic Committee. His comments as well as the ADP Employment report could set the tone for trading ahead of Friday's non-farm payrolls report. We continue to call for further job losses in the US economy as Wall Street and Main Street announce more layoffs. With liquidity still a problem, we don't expect any optimistic comments from Bernanke. For these reasons, the US dollar could fall to a new record low against the Euro in the coming week. The bearish outlook for the US economy is confirmed by the latest US economic numbers. Consumer confidence as measured by the University of Michigan fell to a 16 year low. Even though personal income ticked higher, spending was the weakest in 17 months. Regardless of whether the Federal Reserve admits it, 85 percent of the people surveyed by the University of Michigan already feel that the US economy is in a recession. They have cut back spending and are focusing on repaying debts and rebuilding their savings. Such a dramatic shift in sentiment will be difficult for the Federal Reserve to fix especially since banks and mortgage lenders have been counteracting the Federal Reserve's efforts by tightening lending standards. Commodity prices are also skyrocketing with rice prices yesterday jumping 30 percent in one day. Inflation will come back to haunt the Federal Reserve, but with consumers retrenching and the housing market weakening, the outlook for growth is so bleak that the Fed may have no choice but to focus on fixing the more immediate problems. Although we think that the Federal Reserve will need to bring interest rates down to 1.50 percent, cutting interest rates alone will not do the trick.

Fate of EUR/USD Will Depend On Who Delivers the Bigger Surprises

The Euro has staged a dramatic recovery against the US dollar this past week and now it is trading approximately 100 pips away from its record highs. If economic data was the only thing that mattered, the EUR/USD stands a very good chance of breaking 1.60. German retail sales, unemployment and Eurozone PPI are the only major releases on the EZ economic calendar, which means that Bernanke's comments and non-farm payrolls will probably drive the price action of the EUR/USD. However there is one potential European risk and that could turn the EUR/USD around, which is a major writedown by a German bank. This morning, Guenther Beckstein, the prime minister of Bavaria said that their state owned Bayern Landesbank will be announcing writedowns of EUR4bn, more than double their initial EUR1.9bn forecast. Although this number is small, it comes on the heels of a potentially huge loss for German banks. According to Spiegel, which is a leading German newspaper, local banks could "hemorrhage 70 billion Euros." They are even speculating that Germany's third largest bank, WestLB could require a 2 billion liquidity injection. Whether this happens remains to be seen, but whoever delivers the bigger surprises - the US or the Eurozone will determine the fate of the Euro.

British Pound Extends Loses

The British pound extended its losses today, hitting an intraday low of 1.9883.