EUR/USD: Bulls and Bears Locked in a Tight Battle

DailyFX Fundamentals 07-17-08

By Kathy Lien, Chief Strategist of DailyFX.com

Oil at $130 pushing US Dollar and stocks higher

Oil prices have continued to fall, helping to lift the US dollar and stocks.

The reversed roles of oil and stocks, with the former falling and the latter rising comes as a big relief to traders around the world who may have feared for the worst - crude prices hitting $150 a barrel and the Dow falling below 10,500.

Lower oil prices act as a free tax cut for consumers and businesses who are currently crumbling under the weight of rising food and energy prices.

The answer to many of the Fed's problems would be oil at $100 a barrel. Since Monday, oil prices have fallen close to $18 or more than 12%, which is in line with the degree of prior corrections that we have seen in the commodity.

This has made investors cautiously hopeful that the stock market has bottomed and oil prices have topped.

Whether or not this is true remains to be seen. For the sake of the global economy, we hope that oil prices continue to ease, but we have seen similar recoveries over the past two years (oil charts) be nothing more than a hiccup.

As for the US dollar, it has strengthened significantly against the Japanese Yen and recovered impressively against the Euro and British pound.

Since the beginning of 2007, there has been a strong correlation between USD/JPY and the S&P500 Index, which explains why the currency pair has rallied more than 200 pips.

A strong dollar not only helps to lower oil prices but it also increases investor confidence. The Financial Times reported that the weakness of the dollar and the problems in the US capital markets are encouraging Sovereign Wealth funds to look at diversifying out of dollar denominated assets.

Economic data from the US was mixed. Housing starts, building permits and jobless claims were all better than expected but the Philadelphia Fed index failed to rebound.

The improved housing market numbers are somewhat distorted by a change in the NYC building code which has triggered a sharp rise in multi-family starts in the Northeast.

Claims on the other hand are unambiguously positive. There will no US data due for release tomorrow which means that oil and equities will continue to drive the price action of the US dollar.

EUR/USD: Bulls and Bears locked in a tight battle

EUR/USD bulls and bears are locked in a tight battle as hawkish comments from ECB officials prevent the currency pair from succumbing to the recovery in the US dollar.

ECB President Trichet said that even though the markets are still suffering from very severe turbulence, the central bank cannot afford to second round effects to get out of hand.

More specifically he said that the central bank is determined to bring inflation from 4% back down to 2%.

They are keeping a particularly close eye on the rise in unit labor costs and reminding household and businesses that they are guaranteeing price stability in the medium term.

ECB member Wellink went one step further in his comments this morning. He said that 'if you don't stop inflation before it rises further, it will take 10 years to get it under control.'

German producer prices and the Eurozone Trade Balance are due for release tomorrow and we expect the data to be Euro bullish.

Pound Sterling: Struggling to hold onto gains

The pound is struggling to hold onto its gains against the US dollar.

There was no UK economic data released today, but Bank of England Economist Dale warned that there are opposing risks to inflation.

Even though CPI is higher, he believed that slower growth would ease inflation in the coming months.

Sterling traders should now realize that the Bank of England does not have much choice when comes to inflation which is why they are banking on the hope that slower growth will drive down price pressures.

Earlier this week, UK labour market data was released and according to the report, unemployment rose by the largest amount in 16 years.

Don't forget that service, manufacturing and construction sector PMI all contracted in same month, which reflects the vulnerability of the UK economy.

Public sector finances, net borrowing and money supply data are due for release tomorrow - these are Tier 2 economic data which means that they will not be particularly market moving.

Australian, New Zealand and Canadian Dollars continue to fall

The Australian, New Zealand and Canadian dollars continued to fall as the US dollar rises and commodity prices decline.

The biggest loser was the New Zealand dollar which dropped 1.32% against the US dollar. This is expected given the overall weakness of the New Zealand economy.

The only reason why the Kiwi has been appreciating over the past few days is US dollar weakness.

Meanwhile the Bank of Canada released their monetary policy report. According to BoC Governor Dodge, inflation is expected to exceed the central bank's target but interest rates are appropriate.

His statement and bias is clearly neutral which means that for the time being, the central bank does not plan on altering interest rates.

Foreign purchases of Canadian securities surged in May as investments in Canadian bonds increased by the largest amount in 12 months.

On the calendar are the leading indicators and wholesale sales reports from Canada tomorrow and the import and export price indices from Australia this evening.

Japanese Yen Crosses continue to recover

The recovery in US equities has led to a continual recovery in the Japanese Yen crosses.

Even though leading indicators improved marginally in the month of May, Japan is still deep in the woods. China reported slower than expected GDP growth which means that their demand for Japanese goods could start falling.

This is a problem that could exacerbate following the August Olympics. Department store sales are due for release tomorrow. The recent drop in consumer confidence suggests that spending will be weak.