Euro: Record Oil Prices Will Keep the ECB Hawkish

DailyFX Fundamentals 04-15-08

By Kathy Lien, Chief Strategist of DailyFX.com

Proof of Why the US Government Wants a Weaker Dollar

The US dollar has recovered on the heels of stronger economic data. The Empire State manufacturing survey jumped almost 23 points in March while foreign purchases of US securities increased more than expected in February. Although some economists argue that one month of stronger manufacturing data does not equal a recovery, the market is nonetheless pleased to see the weaker US dollar finally lead to some positives for the US economy. In addition to the Empire State manufacturing survey, the strong earnings from Johnson and Johnson is one of day's biggest stories. Interestingly enough even though sales have increased in all 3 of its units, if not for the weakness of the US dollar, drug sales would have actually declined. Revenues increased 7.7 percent in the first quarter with currency moves contributing a whopping 5.1 percent to growth. With earning season upon us, the dollar's weakness could help to boost revenue for many multinational corporations. The companies that will benefit the most are the ones that are heavily reliant on international sales because exports will be boosted by the weakness of the greenback. Johnson and Johnson is not the only company to have benefitted from exchange rate fluctuations. Last month, Nike Inc said that strong overseas sales and beneficial currency rates pushed its profits up 30 percent. Earlier this year, IBM reported an 8 percent increase in sales in 2007 but acknowledged that the increase would have been only 4 percent if exchange rates were excluded. Meanwhile producer prices grew 1.1 percent last month. With oil and food prices skyrocketing, strong inflationary pressures are not much of a surprise. Although the growth in core prices was more tepid, with companies like Kimberly Clark raising the price of Huggies Diapers and Cottonelle products, it will only be a matter of time before core prices rise as well. Consumer prices are due for release tomorrow along with housing starts and industrial production; we expect these reports to be dollar positive.

Euro: Record Oil Prices Will Keep the ECB Hawkish

For the first time in 3 months, analysts grew more pessimistic on the outlook for the Eurozone economy. We warned yesterday that even though the consensus forecast pointed to an improvement in analyst sentiment, this is a group that is notoriously pessimistic and cringes at any sign of a deterioration in the Eurozone economy. In recent weeks, we have had mixed economic data which makes it no surprise that analyst sentiment has turned. However, the correlation between the ZEW and the more important German IFO report on business confidence is mediocre and for that reason, we only put limited weight on the data. Instead, we are paying more attention to ECB comments as well as the ramifications of record oil prices. ECB members Trichet and Stark reminded us today that anchoring inflation expectations is of the essence. With oil prices hitting an intraday high of $113.99 a barrel, inflation has become an even greater problem for the ECB. As a result, don't expect Trichet to loosen his belt anytime soon. Tomorrow's Eurozone CPI could keep the EUR/USD near its all time high.

Double Dose of Bad News Sends British Pound to a New Record Low

Stronger producer prices drove the British pound higher yesterday, but the lack of meaningful follow through into consumer prices and continual drop in house prices drove the pound to a one month low against the US dollar and to a new record low against the Euro. The CPI numbers today indicate that producers are finding it difficult to pass on higher costs to consumers which mean that they are taking a hit to profits. This trend cannot last forever before corporate profitability starts to seriously suffer or producers begin to raise prices. The UK economy is still in trouble, especially after house prices as measured by the Royal Institute of Chartered Surveyors (RICS) fell by the fastest pace in 30 years. At this rate, it is very likely that the UK could be following in the US' footsteps. In the meantime, employment numbers could help the GBP tomorrow. The improvement in the employment components of the manufacturing and service sector PMI reports suggest that there may have actually been job growth last month.

Higher Commodity Prices Failed to Lift the Canadian, Australian and New Zealand Dollars

Both commodity prices and the stock market have closed today, but that has failed to translate into strength for the Canadian, Australian and New Zealand dollars. This may be partially due to weaker New Zealand consumer prices and moderately dovish minutes from the latest Reserve Bank of Australia monetary policy meeting. Although prices are rising globally, it appears the strength of the NZD in the first quarter has appeared to offset much of that rise. The RBA believes that moderating demand should help to lower inflationary pressures which mean that they have no plans to alter interest rates in response to the latest inflationary pressures. The relationship between oil prices and the Canadian dollar has been weak as of late and for that reason, the CAD actually weakened despite record oil prices.

Japan Encourages Foreign Investment

The Japanese Yen crosses are mixed today which is hardly a surprise with little Japanese economic data on the calendar and risk appetite generally unchanged. The Nikkei Net reported that Japan has scrapped taxes on investment returns for all foreign fund or corporations seeking to invest in Japan. Countries like the US or Eurozone have been exempt from the up to 40 percent tax, but this new rule will make it more attractive for investors in oil rich countries like the Middle East to look at Japan as an investment destination.