Euro: More reasons to be hawkish (page 1 of 2)

DailyFX Fundamentals 07-01-08

By Kathy Lien, Chief Strategist of DailyFX.com

Big reversals lift the US Dollar

The US dollar has been driven higher by big reversals in the stock market and in the manufacturing sector.

The Dow Jones Industrial Average was down as much as 160 points intraday before it reversed sharply to end the day in positive territory.

Part of this strength was due to stronger than expected sales by General Motors.

The big fear in the markets today was that Toyota would overtake GM in sales to the US, but a month end sale and zero percent financing helped the automobile giant hold onto its title.

On a day when the manufacturing ISM report blew past the market's expectations, this was not only positive for stocks, but also for the US dollar.

Regional indexes all pointed to a very weak nationwide manufacturing report, but for the first time in five months, activity the manufacturing sector increased thanks to a rise in inventories and prices paid.

The inflation component of the report actually hit a 34 year high due to higher commodity prices.

Although we remain skeptical about how well the US economy is doing, today's economic data certainly increases the likelihood of a third quarter rate hike by the Federal Reserve and that is what matters most to currency traders.

Oil prices continue to remain stubbornly high with $150 a barrel within arm's reach. Gas prices could hit $5 a gallon by the end of the summer, which would make the Federal Reserve's job even more difficult.

This is why we only expect a limited decline in the US dollar against the Japanese Yen because for USD/JPY, the direction of interest rates is clearly in the dollar's favour.

For other currency pairs such as the EUR/USD, the outlook for the 'interest rate spread' is not as clear, but that may change with the ECB meeting and US non-farm payrolls report on Thursday.

Tomorrow we are looking forward to the leading indicators for non-farm payrolls such as the Challenger layoffs report and the ADP Employment report.

Euro: More reasons to be hawkish

The Euro remains firm ahead of the ECB meeting on Thursday.

Yesterday, the June consumer price index estimate came in at 4% double the central bank's 2% inflation target.

Today, Germany reported strong consumer spending and the lowest unemployment rate in 14 years.

Manufacturing sector PMI for the Eurozone was also revised higher in the month of June due to stronger activity in France and Germany.

The combination of higher inflationary pressures and better than expected economic data could force the ECB to backtrack on their warnings and actually prepare the market up for more than one rate hike in the third quarter.

Up until now the ECB has openly hinted that a rate hike in July will one-off, but given the recent reports, two rate hikes from the ECB this year is more than realistic.

Eurozone producer prices are due for release tomorrow and given the rise in wholesale sales and import prices, we expect the PPI number to be hot.

A 50bp rate hike by the ECB on Thursday may not be out of the question. Meanwhile Swiss PMI numbers hit a three year low while the prices paid or inflation component of the report jumped to a 1.5 year high.

Pound Sterling fails to hold 2.0

For the first time in two months, the British pound hit 2.0 against the US dollar.