Euro Breaks Out After Surprise Drop in Philly Fed (page 1 of 2)

US Dollar

It has been an extremely exciting day in the currency markets as the breakouts that we have been waiting for in the EUR/USD and USD/CHF finally materialize. The combination of a weak leading indicator report and Philadelphia Fed survey has sent the dollar tumbling. Leading indicators rose by a less than expected 0.1 percent in the month of September while the Philadelphia Fed survey of manufacturing conditions shocked traders by falling for the second month in a row to a fresh 2.5 year low.

With the market accentuating its reaction to negative US data and minimizing its reaction to positive data, the double blow from today's reports was exactly what the EUR/USD needed to break higher. As we have warned yesterday, the tight consolidation that we have been seeing foreshadowed a sharp break. Although the US dollar could recuperate some of its losses with no data is due for release tomorrow, 1.25 in the EUR/USD has become a hard cement floor that is be extremely difficult to break.

The recent reports that we have seen suggest that we could still see slowing in the US economy over the next few months, with the manufacturing sector particularly vulnerable. Even the first ever close above 12,000 in the Dow Jones Industrial Average failed to help the US dollar. Instead, traders latched onto the Saudi and Venezuelan support of the recent OPEC cuts and warning of more to come if oil prices do not budge by sending the Canadian dollar to the highest level in a week. If oil prices creep back above $60 a barrel, it will be perceived as a negative development for the US and in effect, create more downward pressure on the US dollar.

Euro

After being yesterday's quietest currency pair, the EUR/USD was the day's second biggest market mover, behind USD/CHF. European economic data was disappointing this morning, but that did not matter as the disappointments in the US were even more unexpected. Producer prices in Germany fell 0.3 percent in the month of September, led by the drop in energy prices. The French current account deficit was also larger than expected, but the real surprise was from Italy. Even though industrial orders were stronger in the month of August, rating agency Fitch downgraded Italy's credit rating from AA to AA minus with a negative outlook.

They were worried about growth and the strains the country would have to undergo to bring down the deficit. Despite the rather grim reports, ECB members continue to be very hawkish as council member Gonzalez-Paramo reiterated the central bank's familiar message of keeping a tight leash on inflation today. We are certain that the central bank will bring rates up by another quarter point by year end, especially with the recent weakness in the Euro making it easier for the central bank to tighten monetary policy. The only question is, will there be more after that. So far, economic data suggests otherwise, but it is all dependent upon whether inflation picks up in the months ahead.

British Pound

The British pound extended its gains after a brief pause yesterday despite mixed economic data. Retail sales took a turn for the worse and actually fell by 0.4 percent in the month of September. The market was looking for a 0.4 percent rise given the strength of recent economic data, but with wage growth squeezed by rising inflation, consumer spending was not able to hold up. Although the index is generally volatile, the recent surprise rate hike by the central bank appears to have hurt consumers.

We are expecting the first release of third quarter GDP tomorrow and judging from today's report, growth should have slowed in the third quarter.