Can the euro extend its gains

DailyFX Fundamentals 05-16-08

By Kathy Lien, Chief Strategist of DailyFX.com

Big moves in the currency market

For the better part of this past week, the Euro, Japanese Yen and British pound have been trapped within a tight trading range against the US dollar.

Even though the moves today in all three of these currency pairs have been relatively significant, especially in the EUR/USD, they pale in comparison to the moves in the Australian and New Zealand dollars.

The Australian dollar hit a new 24 year high on the back of rising gold prices and rumours that China could invest in Australian mining giant BHP Billiton while the New Zealand dollar rallied more than 1%.

It has turned out to be a very active day in the currency market with the dollar first rallying on the stronger housing market numbers and then giving back all of those gains following the disappointing consumer confidence report.

Building permits and housing starts both rebounded in the month of April and although the numbers do reflect some stability in the housing market, we caution against becoming too optimistic. The increase in housing starts came primarily from a surge in multi-family developments, which increased 36% in April after falling 35% in March.

Consumers however are still suffering; confidence for the month of May hit a 28 year low as rising gas prices and tight credit markets hurts their pocketbooks of.

The average price of gasoline across the nation hit a record high for the ninth day in a row according to auto group AAA. In the past month alone, prices at the pump have risen 11% and since a year ago, prices have risen 22%.

According to AAA, gas is the most expensive in Alaska followed by Connecticut, with the average price of gasoline both exceeding $4 a gallon. The US economy still faces many threats, but there could be some respite in the coming month as Saudi Arabia pledges to boost oil production in June.

After having cut interest rates by 325bp, the recent rise in oil prices will force the Federal Reserve to keep their focus on inflation.

Although the big moves have been concentrated primarily in the commodity currencies this past week, we expect the volatility to spillover to the other pairs.

There are a lot of key Eurozone, UK and Canadian numbers due for release next week. From the US, we are only expecting producer prices and existing home sales.

Can the euro extend its gains

The euro staged a very strong rally against the US dollar today after quietly selling off for the past three days.

The move was due almost entirely to the US numbers as the euro started to gain strength quickly following the University of Michigan Consumer Confidence report. Eurozone economic data was actually bearish for the currency with the trade surplus swinging into a deficit in March.

This provides evidence that the strong euro is finally weighing on the region's economy. Eeropean Central Bank (ECB) officials continue to express their conflicting concerns about inflation and growth.

Governing Council member Vito Constancio said that it is difficult to predict how bad the Eurozone economy will get while Liberscher indicated that 3% inflation is unacceptable.

Fundamentals will be heating up for the euro next week with German producer prices, the ZEW survey, IFO and PMI reports due for release. We actually expect most of the numbers except for the inflation reports to be euro negative.

With factory orders and industrial production turning negative, it would be a surprise if business sentiment managed to improve.

Meanwhile Switzerland reported a 9.7% rise in adjusted retail sales. Although the headline number is encouraging, it is distorting because the work day adjusted number actually dropped 2.5% yoy, meaning that Easter was the primary reason for the strength.

British pound: strength to be tested

The recent strength of the British pound will be tested next week by the busy economic calendar.

After hitting an intraday low of 1.9363 earlier this week, the currency has carved out a near term bottom against the US dollar. Like the rest of the world, the only reason why the central bank has stopped cutting rates is because of inflation.

Even though the labour market deteriorated for the fourth straight month, the British pound gained strength because both consumer and producer prices increased more than the market expected last month.

The minutes from the latest Bank of England meeting will be released next week. Although they left interest rates unchanged at 5%, the key will be their voting record.

At the prior meeting 6 members supported the 25bp rate cut, one member called for a 50bp rate cut while another called for no easing at all. We suspect that more members would have favoured the most recent pause.

In addition to the BoE minutes, we are also expecting UK retail sales and the second release of first quarter GDP.

Australian dollar hits 24 year high, Canadian Dollar in focus next week

The Australian dollar hit a 24 year high against the US dollar and a 1.5 year high against the New Zealand dollar. The currency's surprising strength came from the $20 surge in gold prices and rumours that China could invest as much as $22bn in a joint venture with an Australian fund to purchase a 9% stake in mining giant BHP Billiton.

China's thirst for commodities is no secret and acquisitions of commodity companies have been their preferred way of spending their $1.68 trillion of foreign exchange reserves. Next week, the Canadian dollar will be a big focus with consumer prices and retail sales due for release. There is no significant data from Australia or New Zealand.

US consumer confidence pushes USDJPY back below 105

For the past two trading days, USDJPY has been flirting with the 105 price level. The currency pair finally caved after the much weaker than expected consumer confidence report.

Risk appetite will dominate trading for the Yen in the coming week as we expect the Bank of Japan monetary policy and trade data to have little affect on the Japanese Yen.