Euro Stabilizes Ahead of NFP

The EUR/USD recovered the 1.2800 figure in steady overnight trade as economic data generally confirmed Mr. Trichet's view that the 12 member region is in the midst of a sustainable recovery and will likely see further monetary tightening as the year comes to a close.

PMI Manufacturing slipped a notch printing at 56.5 against 57 expected as higher oil prices and a higher currency weighed slightly on demand in July. However, the gauge of industrial activity in the Euro-zone remained materially above the 50 boom/bust level indicating that the sector should continue to contribute to overall growth.

The Euro-zone GDP on the other hand surprised to the upside registering a 2.6% gain against 2.4% expected. The higher print was fueled by strong contribution from Fixed Capital Investment and slightly higher Government Spending. The one missing factor from the Euro-zone growth story - consumer spending - may pick up pace in Q3, especially if oil prices fall to the $60/bbl level increasing discretionary income in a region where gasoline costs can exceed $6/gallon.

It is worthy to note that with tonight's GDP report the EZ growth rate now trails US's by only 30 basis points (2.6% vs. 2.9%) while at the same time EZ interest rates are fully 225 basis points lower than US rates (3.00% vs. 5.25%) In light of this massive discrepancy it is reasonable to assume that the monetary policies of the two largest economies in the world will likely converge as we proceed towards 2007.

Therefore, as ECB hikes rates further while the Fed remains stationary, the concomitant rebalancing in yields should favor the euro in the intermediate term time frame assuming the geo-political climate remains calm.

Today is of course NFP day, yet we can't remember a time when the report has garnered as little interest as it has this month. With market players essentially excepting a range between 90-120K the impact of the news appears muted.

However, should the data surprise to the upside the euro could suffer sharp losses as talk of potential restart of Fed monetary tightening will once again sweep across the dealing desks. Given the fact that positioning remains highly skewed to the euro, a knee jerk dollar rally is certainly not out of the question if payrolls suggest that US growth is stronger than the consensus view.