Euro headed lower? (page 1 of 2)

DailyFX Fundamentals 07-08-09

By Kathy Lien, Chief Strategist of DailyFX.com

What Bernanke could be hinting about interest rates

The sharp drop in oil prices has helped to strengthen the US dollar.

Pending home sales dropped more than expected, but it has failed to put a dent in the greenback which continues to follow equities higher.

The dollar is becoming a safe haven bet as the Federal Reserve reminds us that they will be the lender of last resort.

With stocks falling close to a two year low on Monday, Fed President Ben Bernanke attempted to stabilize the stock market and the US dollar by saying that they are thinking about 'extending the duration' of their emergency lending facilities to investment banks.

Is Bernanke trying to tell us something about interest rates? Perhaps, because to extend the availability of emergency lending facilities means that there could still be liquidity problems in the financial markets.

Keeping the lifeline open to banks and raising borrowing costs at the same time would actually be counterproductive, especially if they expect the banks to tap into the lifeline.

Bernanke is hinting to us that raising interest rates this year, even by 25bp is not a done deal. Oil prices have fallen to $136 a barrel and if crude continues to drop, the Fed's decision about interest rates will be an easy one.

Bernanke and his colleagues are becoming extremely sensitive to market prices which could be very dangerous but for the time being its working. Both the stock market and the US dollar have recovered.

However oil prices are really dictating Fed policy at the moment. Hawkish comments from Fed President Lacker suggest that some Fed officials are still nervous about inflationary pressures and stand ready to act if necessary.

Fed fund futures are currently pricing in a 45% chance that interest rates will be increased in September, down from a 65% chance a week ago.

As for the October meeting, there is only a 53% chance that rates will be increased; the odds for December are about the same. If the duration of the emergency lending facility is actually increased, then a rate hike by the Federal Reserve in 2008 becomes highly unlikely.

The G8 Summit comes to an end tomorrow, no comment about currencies are expected to be made.

Euro headed lower?

The Euro came under further selling pressure on the combination of broad dollar strength and moderate comments from ECB officials.

ECB member Tumpel-Gugerell said this morning that Trichet's 'no bias' is shared by the entire Governing Council. In other words, no one in the monetary policy committee is committed to another rate hike, especially not with oil prices falling as much as they did today.

The final figures for first quarter GDP are due for release along with the German trade and current account balances. Given the sharp drop in industrial production and the decline in export orders, the trade surplus may have shrank by more than expected in the month of May.

Another negative surprise could send the EUR/USD below 1.56, which would open up the door for a move down to 1.55.

Sellers not letting up on the Pound Sterling

Traders continue to push the British pound lower against the US dollar.

Since last Wednesday, the currency pair has fallen close to 300 pips. Despite modest rebound in house prices in May according to DCLG, business confidence continues to suffer.