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By Kathy Lien, Chief Strategist of DailyFX.com
US Dollar: End of Quarter flows
When the European markets opened for trading this morning, the greenback came under the same brutal selling pressure that we saw throughout the previous trading week.
The US dollar even fell to a new 25 year low against the Australian dollar, but quarter end flows quickly hit the markets, helping the dollar recover all of its earlier losses.
Today is the end of the second quarter and also the end to the first half of the year. Although 2008 has been marked by dollar weakness, the dollar's performance in the second quarter has been mixed.
It is virtually unchanged against the Euro, down more than 5% against the Australian dollar and up more than 5% against the Japanese Yen.
Interestingly enough, the Yen and not the dollar has been the worst performing currency this quarter.
The Japanese Yen has fallen against every major G-10 currency.
It is going to be a very active week for the currency market. The ECB interest rate decision and the non-farm payrolls report collide to create the perfect storm for the US dollar.
What ECB President Trichet says about future rate hikes should be more important than the non-farm payrolls report, unless of course job losses are more than 100k.
Chicago PMI was slightly stronger than the market expected, but still in contractionary territory. This suggests that the national ISM manufacturing index, which is due for release tomorrow, should continue to trend lower.
The Philly Fed, Empire State and Richmond Fed manufacturing indices have all fallen sharply, painting a grim outlook for the US manufacturing sector. T
he rise in energy prices is now offsetting any stimulative effects from a weaker dollar. Going forward, we expect more US companies to struggle with the difficulties of containing costs as oil prices climbed to an intraday high of 143.67 a barrel.
Euro: Alternatives for the ECB
A 25bp interest rate hike by the European Central Bank on Thursday has been completely priced into the market, but there are increasing signs that the central bank may have to raise interest rates beyond July.
The estimate for Eurozone consumer prices for the month June is 4%, double the ECB's 2% inflation target. This spike in inflation complicates the central bank's task on Tuesday.
Up until now the ECB has openly hinted that a rate hike in July will one-off, but with inflation pressures continuing to increase, can they really increase interest rates by only 25bp this year? Probably not.
We believe that Trichet is mulling over two additional alternatives for Thursday. He could proactively clamp down on inflation by raising interest rates 50bp or he can raise interest rates by 25bp and leave the door open for another rate hike this year.
Closing the door completely could be a mistake especially if oil prices continue to rise. German retail sales and employment numbers are due for release tomorrow.
Given the sharp drop in the retail PMI index, consumer spending in Germany should remain weak. Swiss PMI is also due for release. The dovish comments from the Swiss National Bank suggest tepid manufacturing activity.
Pound Sterling: Consumer confidence hits record low
The British pound lost ground against the US dollar as economic data confirmed further softening in the UK economy.
Kathy Lien, Chief Strategist, Daily FX
