Euro Propelled Higher by IFO

The game of seesaw continued in the currency markets as EUR/USD reversed all of its losses from yesterday after the release of better than expected results from the IFO survey. IFO registered a slight decline for the month of July printing at 105 versus 105.6 for the month of June.

The reading however, beat consensus estimates of 104.8 and dealing desk rumors of a possibility of am even lower print of 104. Overall the survey indicated that the decline in German business demand while acknowledged by the respondents was not nearly as severe as market had feared and was therefore unlikely to create an immediate slowdown in EZ economic growth.

One interesting side note to tonight's IFO data was the more substantial decline in expectations from the construction sector which contrasted sharply with German GDP results. In tonight's German GDP report released prior to the IFO data, construction investment was responsible for the bulk of GDP gains while consumption actually contacted by -0.4%.

Retail demand remains the critical missing link to a sustained economic growth in the Euro-zone. Up until now, the EZ consumer has been stubbornly absent from the recovery story, but tonight's IFO data which showed that the retailing climate has improved slightly should offer hope to euro bulls of pick up in demand.

Overall, tonight's IFO results put to rest, for the time being, any worries that ECB may be forced halt its rate hike campaign for fears of snuffing out the recovery. Barring any rapid deterioration in fundamentals the ECB should be on track to raise rates by another 25bp in its October 5th meeting.

In Japan the news was not nearly as supportive of yen. USD/JPY has remained essentially unchanged at 116.45 from yesterday's New York close as Corporate Service Price inflation printed slightly below expectations printing at -0.1% versus 0.0% projected.

Although the year over year data remains negative as the last vestiges of deflation continue to circulate through the system, the trend in Japanese price levels points upward and it appears to be a simply a matter of time before this index turns positive. In the meantime, tomorrow all eyes in the FX market will be trained on the Japanese inflation data expected to increase 0.5% on a year over year basis.

The inflation gauges remain the single most important fundamental drivers to the near term direction of USD/JPY as they will exert the most influence on BOJ rate policy decisions going forward. The yen has continued to suffer due to the hesitancy of BOJ to raise rate beyond the initial 25bp hike in July, as result of which EUR/JPY has reached record highs coming to within a whisker of the 150 level.

If tomorrow's inflation data shows little upside pressures, allowing BOJ to remain passive for while longer, the 150 level may indeed fall, especially after tonight's euro-boosting IFO news.

In US today the Durable Goods report is expected to show a -.0.3% decline from the month prior. Given the weak housing data yesterday, the assumption seems reasonable, although this is a notoriously volatile report and could be subject to an upside surprise. In general recent price action in EUR/USD has confounded many analysts as the pair has not followed the direction of the news.

The fact that EUR/USD refused to rally yesterday on what was clearly dollar bearish housing data and the fact that euro's gains from IFO so far appear to be capped at the 1.2850 level suggest that we are likely remain in a broad range bound pattern through the last dog days of summer as traders treat every new piece of economic data with skepticism until they can better ascertain the long term trends.