Eurozone Economy Continues to Slow

DailyFX Fundamentals 7-18-08

By Kathy Lien, Chief Strategist of DailyFX.com

US Dollar: New week, same drivers

It has been a very volatile week for the US dollar, even though compared to the beginning of the week, the exchange rate for the EUR/USD and USD/JPY has remained virtually unchanged.

On Monday, the EUR/USD was trading at 1.5922 while USD/JPY was trading at 106.26, not far from current levels, but of course these rates masks what can only be likened to a rollercoaster ride in the financial markets.

There was a number of event risks and economic data released over the past week, yet the drivers of the financial market volatility can be boiled down to two things; the health of the financial sector and oil prices.

We have come a long way since traders first speculated about the possible demise of Fannie Mae and Freddie Mac.

The Federal Reserve and the Treasury have offered different solutions to avert more serious problems while Freddie Mac has announced plans to raise capital by selling as much as $10bn in new shares to investors.

Based upon the 600 point recovery in the Dow off of Tuesday's intraday low, for the time being traders believe that this could be enough.

JPMorgan and Citigroup have reported better than expected earnings even though Merrill Lynch disappointed; two out of three appears to keep the markets happy for the time being.

As for economic data, we learned that inflation remains hot but consumer spending is beginning to falter.

With the US economic calendar considerably lighter next week, the health of the financial sector, oil and the stock market will continue to set the tone for the FX markets.

Earnings season is in full swing. Bank of America will be releasing their earnings report on Monday and for the rest of the week there will be a number of regional banks reporting.

Leading indicators, durable goods, the final July UMich consumer confidence numbers, new and existing home sales are due for release along with the Federal Reserve's Beige Book report.

We will be keeping a particular close eye on the Beige Book report because it will serve as a temperature gage for how the US economy is really doing and how businesses and consumers may coping with the latest developments in the stock and commodity markets.

Eurozone economy continues to slow

The Euro is consolidating near its all time highs against the US dollar, even though we are reminded on a near daily basis about the risks to Eurozone growth.

Last night I was having dinner with a businessman from France and he described to me the sour mood in Europe.

He indicated that businesses are growing very pessimistic which confirms that Europeans are tightening their belts as they learn to deal with high prices.

This conversation comes at a perfect time because the marquee release on the Eurozone calendar next week is the German IFO report of business confidence.

Like the ZEW survey of analyst confidence, business confidence should have deteriorated materially over the past month.

Not only did the European Central Bank raise interest rates for the first time since June 2007, but exports, factory orders and industrial production have also plummeted which confirms that business activity has dropped significantly.

The only wrinkle to this outlook was the sharp rebound in German retail sales, but we think that this should be a mute point since higher energy prices was a big reason for the increase in spending.

Even though German producer prices grew by more than expected in June, the Eurozone trade deficit deteriorated materially in May, which came as a big surprise to the market.

Big week for the Pound

The pound has been at the whim of risk appetite and the US dollar for most of the week, but things will change in the coming week as the UK economic calendar is chock full of market moving data.

The country will be releasing their retail sales report for the month of June and the advance release of second quarter GDP.

After the big jump in May, we expect consumer spending to contract significantly - traders just need to be careful because the forecasts which are already low.

The Bank of England will also be releasing the minutes from their most recent monetary policy meeting. Although they left interest rates unchanged, it will be interesting to see if any of the monetary policy committee members leaned towards a rate change.

Australia, New Zealand and Canada look ahead to busy week

Like the British pound, the Australian, New Zealand and Canadian dollars will be in play next week with a ton of data due for release.

The Australian dollar has another chance at making a run for the 25 year high on producer prices Sunday night.

Inflationary pressures have been strong in countries around the world and Australia is no exception.

Canada on the other hand has retail sales and consumer prices due for release. Given the sharp rise in today's wholesale sales report, retail sales in May should be strong.

Consumer prices on the other hand could actually surprise to the downside given the slower growth in industrial product and raw material prices. Meanwhile there is a monetary policy decision in New Zealand.

Even though we do not expect the Reserve Bank to alter interest rates, RBNZ Governor Bollard could make cautionary comments that could hurt the kiwi.

Bank of Japan growing more concerned about growth

The Japanese Yen crosses are higher today thanks to the recent recovery in US stocks.

The Bank of Japan has finally acknowledged what we all have felt for some time, which is that the Japanese economy is in trouble.

According to the latest BoJ minutes, the downside risks to growth now supersede inflation worries. USD/JPY has had a very strong correlation with the S&P 500 over the past year and we expect this correlation to continue to drive the price action of the currency pair in the coming week.