Dollar Weakens as Softer Beige Book Keeps a Fed Pause on the Table (page 1 of 2)

US Dollar

Rarely is the Beige Book report as market moving as it was today. At a time when traders are scrambling to figure out whether the Federal Reserve has enough evidence to raise interest rates again in August, the clarity of the Beige Book was exactly what dollar bears needed to hear.

The problem with yesterday's reports was that existing homes sales is too backward looking while the Confidence indicator conflicted with recent retail sales reports. The Beige Book report is more reliable because it explains the current state of the economy and the risks that it faces.

Analysts have been worried about consumer spending and housing and today's Beige Book report confirmed those fears. According to the Fed districts, there have been continued weakness in retail sales and except for "only scattered exceptions" activity in the housing market is also slowing.

Inflation pressures or increases in the prices of final goods and services have also remained modest. However even though the report is clearly more supportive of a pause than a hike, do not be mistaken, the report indicates that economy is still growing and that there has been significant activity in commercial real estate sales and industrial sector activity. Whether today's dollar weakness can be sustained will be dependent upon tomorrow's durable goods and new home sales reports.

Stronger demand for aircrafts and the replacement of older equipment for newer energy efficient equipment is expected to boost sales but given the recent trend of the economy and the weakness seen in the previous month, the rebound could fail to meet expectations. In addition new home sales will also be important because it is a more current reading than existing home sales and a better reflection of the state of speculator driven housing market bubble.

Many builders have already reported a decline in sales and increase in inventories, which are expected to be reflected in tomorrow's report. Over the past two days, traders have accentuated the negative and minimized the positive when it comes to US data - we expect the same reaction tomorrow.

Euro

The German ZEW and Belgian manufacturing survey correctly forecasted today's drop in German business confidence. The IFO report eased off 15 year highs to fall from 106.8 to 105.6 in the month of July. Although the drop was more than expected, it still remains at an extremely strong level, especially since the last time the index was above 105.6 was in 1991.

The expectations component also fell less than expected to 102.6 from 104.2. Overall, this is a good start to the third quarter for the German economy and continues to support the case for another interest rate hike from the European Central Bank on August 3rd. Beyond that, we will need to be more reactive to the comments from ECB officials. The upcoming hike in the VAT tax from 16 to 19 percent along with high oil prices could pose a risk to further economic growth.

Yet, for the time being, as we continue to see economic data that has been impacted by the World Cup, traders may push off this fear unless Trichet reintroduces it at the press conference following the monetary policy meeting. Both the French employment report and the German confidence report are expected to be strong tomorrow and would aid in any EUR/USD extension move off of weaker US economic data.

British Pound

The British pound continued to climb higher today despite the fact that the CBI's industrial orders survey improved less than expected.