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British Pound Snaps Back on Strong Consumer Spending

- EURUSD: Headed for the All Time High - British Pound Snaps Back on Strong Consumer Spending - Watch Out for Canadian Retail Sales

DailyFX Fundamentals 02-21-08

By Kathy Lien, Chief Strategist of

EURUSD: Headed for the All Time High

The US dollar sold off aggressively following the release of a much weaker than expected manufacturing survey. With conditions in both the Empire State and Philadelphia regions deteriorating significantly in the month of February, the national ISM manufacturing index should fall back into contractionary territory. Readings below 50 for the manufacturing and service sector ISM indicates that the US economy is in a recession regardless of whether the Federal Reserve wants to admit it. The last time the Philadelphia Fed index was this low was back in 2001 which was the same year that non-farm payrolls dropped as much as 300k. On top of the already bearish headline number, the expectations of business activity in the manufacturing sector fell to the lowest level since the recession in the 1990s. In yesterday’s Daily Fundamentals, we said that the EURUSD should see a push above 1.48 and a possible test of the all time high. Now that we are above our first target, a run to the 1.4968 and beyond seems even more likely. Today’s numbers indicate that there will be at least another round of disappointing US economic data before there are signs of a recovery. We expect non-farm payrolls and consumer spending to drop once again and if the EURUSD has not already hit a new all time high before that, these are the perfect triggers to make it happen. The futures curve is still pricing in a 94 percent chance that the Federal Reserve will bring interest rates down to 2.50 percent next month, which would make the US dollar the second lowest yielding currency in the developed world. Although this screams funding currency status for the dollar, if the US economy begins to stabilize, the greenback may actually rise in value. However that’s a trade for another day as the light at the end of the tunnel is still months away. In the meantime, there are no US economic releases due for release tomorrow, which suggest that it could be a quiet trading day.

British Pound Snaps Back on Strong Consumer Spending

The British pound staged a strong recovery today on the heels of a much healthier expected retail sales report, erasing nearly all of its past week losses. Consumer spending snapped back in the month of January, rising by 0.8, which was the fastest pace of growth since February 2007. Although the Bank of England is worried about a slowdown in the coming months, the strength of the labor market and discounting by retailers last month have helped to fuel consumer spending. This unambiguously positive news has helped the British pound carve out a near term bottom, but it will not stop the Bank of England from looking to lower interest rates again next month.

Watch Out for Canadian Retail Sales

The Australian, New Zealand and Canadian dollars extended their gains despite mixed price action in commodity prices and weaker economic data. Average weekly wages and new motor vehicle sales dropped in Australia while credit card transactions slowed in New Zealand. The chart of the Australian dollar suggests exhaustion but we still believe that any retracements will be temporarily because of the overall strength of the Australian economy. Canadian retail sales are the only piece of economic data with any consequence tomorrow. A sharp decline in wholesale sales suggests that retail sales will fall short of expectations as well, but traders need to be careful because employment in the month of January was particularly strong which means that even if spending slows, it should not be negative.

Dollar Weakness Offsets Weak European Data

Look no further than this morning’s release of the current account balance for evidence of a slowdown in the Eurozone economy. The 2.3 billion current account surplus turned into a 10.3 billion deficit in the month of December due to weaker export demand and slowing growth. As EU economic and monetary affairs commissioner Almunia said this morning, even though the economies of the European Union are in very different shape than the US economy, they cannot decouple completely. According to the latest forecast by the ECB, growth should slow to 1.8 percent this year from approximately 2.6 percent last year. This would be only marginally above the mid range of the Fed’s 1.6 percent forecast for US growth. The Eurozone cannot rely on China alone, especially since Chinese growth could slow materially after the 2008 Olympics. Tomorrow, we are expecting the advance release of Eurozone PMI numbers for the month of February. We continue to expect deterioration in Eurozone economic data. Meanwhile Swiss producer prices and the trade balance both surprised to the upside in the month of January.

Japan Posts the Biggest Trade Deficit in 2 Years

Like many other countries around the world, Japan is slowing. The country is very much dependent on trade and the fact that the surplus turned into the biggest deficit in the past 2 years last month is extremely worrisome. Exports rose 7.7 percent, but shipments to the US and China continued to slow. Imports actually rose 9.0 percent, but that was due to a 41 percent increase in the value of crude oil imports and not robust domestic demand. Trade with the US has actually fallen for the firth consecutive month, but the fact that demand from China also slowed indicates that even the Asian Giant may no longer be immune to the US slowdown. In addition to the trade deficit, the tertiary activity index dropped 0.2 percent which can be compared to the market’s forecast for a 0.2 percent rise. Carry trades in general were mixed with the Yen rising against the US and Australian dollars, but falling against the British pound and Swiss Franc.