Euro and Yen Bounce Back

Lest anyone doubt that we are in the midst of the summer doldrums, one only needs to look at today's North American economic calendar to see that the marquee event of the day is Canadian weekly earnings.

Despite less than a full plate of economic news overnight markets saw relatively good action with both euro and yen firming against the dollar, as the idea of a US slowdown and even a possible recession by early 2007 is being considered seriously by dealing desks across the world.

The euro reclaimed the 1.2800 figure, while the yen dropped below 117.00 on exporter orders. European monetary growth slowed materially in July with M3 expanding only at 7.8% rate versus 8.2% projected. The news, however, did little to slow euro bulls as the overall figures continue to suggest ample increases in monetary aggregates that will likely spur further tightening from the ECB.

Confirming the European central banks recent hawkish posture, ECB executive board member Bini Smaghi stated over the weekend that the ECB must act immediately if there are any signs of inflationary pressure. Although the latest German core CPI figures on Friday showed a slowdown to 1.9% from 2.1% expected - a level below the central banks self imposed 2% limit - the ECB policy makers appear to be more focused on the long term impact high energy prices on inflation and have decided to make a concerted effort to combat this rise in the price levels. Mr. Bini Smaghi noted that the problem could be long lasting as he expects oil prices to remain high, given strong demand from China and India.

Mr. Bini Smaghi's concern over the inflationary effects of high oil was echoed by BOE chief economist Charles Bean who stated that it was a mistake for policy makers to focus solely on lower core prices. Mr. Bean argued that the same forces - namely China and India - which were responsible for lower core prices due to relentless declines in the cost of goods and services were also responsible for higher energy prices due to an increase in demand. Therefore, Mr. Bean stated that it was inconsistent to focus on the deflationary benefits in one component while ignoring the inflationary costs of the other when evaluating overall price levels in G-7 economies.

This divergence in opinion between the European and UK monetary officials and the Fed, suggests that the dollar may come under further selling pressure down the road if it translates into clear policy differences in the next several months. In the meantime, while the week is off to a slow start,, the economic calendar quickly picks up steam culminating with the crucial Non-Farm payrolls on Friday.

As we noted in our weekly," Employment remains the absolute key to the dollar bulls argument that the US economy is in the midst of slowdown rather than on the cusp of a recession. If payrolls cannot expand at the market anticipated 120K, new consumer demand, so critical to the future growth of US GDP will not materialize most likely precipitating a sell off in the greenback."