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By Kathy Lien, Chief Strategist of DailyFX.com
US Dollar fights its way back
After hitting a record low against the Euro on Tuesday, the greenback is fighting its way back.
The fundamental factors that are driving the dollar higher today include falling oil prices, a rebounding stock market, intervention risk and hawkish FOMC minutes.
Although each of these factors has the power to turn the dollar around individually, the primary story is oil.
Since Tuesday, oil prices have fallen more than $10 a barrel, leaving many consumers and investors hoping that this is a top.
Lower oil prices is a big relief for US consumers and businesses, which is why the Dow rose more than 270 points today.
Meanwhile the dollar is also benefitting from speculation that the Federal Reserve could intervene to prop up the US dollar.
In his testimony this morning, Bernanke said that forex intervention should be done rarely and that USD intervention may be justified in disorderly times.
Since most of us would argue that current conditions can be described as 'disorderly,' Bernanke may be warning about possible plans for intervention, but we think that is unlikely.
According to the minutes from the June FOMC meeting, Fed officials were prepared to raise interest rates 'very soon.' They felt that growth risks diminished but inflation was on the rise.
However don't read too much into these minutes given that a lot has changed since June; Growth risks have increased significantly and inflationary pressures or at least inflation expectations are beginning to ease.
The same can be said of the Treasury International Capital flow numbers which indicated that even though foreign purchases of US securities fell last month, there is no sign that China or Japan has reduced their holdings of US dollars.
In fact, purchases of Fannie Mae and Freddie Mac's debt actually increased in May. We suspect that the data for June and July will look very different.
Finally, other pieces of US data were mixed. Consumer prices raced to the highest level since 1991 on an annualized basis, industrial production was strong but the NAHB housing market index fell to a record low.
Given current market conditions, traders should forget about a rate hike from the Fed this year.
Inflation is a problem, but the stability of the financial markets; growth and global investor confidence are even bigger problems. If oil prices fall back towards $120 a barrel, the Fed will remain on hold for the remainder of the year.
EUR/USD Risk Reversals signals further losses
Broad dollar strength has driven the EUR/USD lower.
Eurozone Consumer price figures were right in line with expectations, providing no real support for the currency.
Instead, a multitude of factors have contributed to the dollar's recovery (outlined in the US dollar section above), but the bottom line is that US dollar weakness was overdone.
Risk reversals in the EUR/USD hit an extreme level. The 25 delta three month risk reversals are at the highest level since June 2007.
Whenever risk reversals hits critical levels, it indicates that anyone who wants to be long Euros are already long and as a result, sentiment has hit an extreme.
The last time EUR/USD risk reversals were near these levels was in June and September 2007.
Kathy Lien, Chief Strategist, Daily FX
