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Euro Benefits from ECB President Trichet’s Continual Stubbornness

- Selling Dollars Ahead of the FOMC Meeting? - Euro Benefits from ECB President Trichet's Continual Stubbornness - Strength of the British Pound is Fading

DailyFX Fundamentals 01-28-08

By Kathy Lien Chief Strategist of

Selling Dollars Ahead of the FOMC Meeting?

Are traders selling US dollars ahead of Wednesday’s FOMC meeting? Today’s price action certainly suggests that with the dollar weakening across the board. Even though the greenback did strengthen slightly against the Japanese Yen, given the 176 point rally in the Dow, the move should have been far more impressive than the currency pair’s 10 point rise. The reason why traders may be dumping their long dollar exposure or shorting dollars outright is because no one believes that the outcome of the Federal Reserve meeting will be dollar bullish. Fed fund futures are now pricing in an 86 percent chance of a 50bp rate cut. Although this will only bring interest rates down to 3.00 percent, don’t expect the next rate cut to be the Fed’s last. At minimum, US interest rates will come down to 2.50 percent before this easing cycle is over. Stocks have stabilized, but risk aversion is still the predominant theme in the financial markets. Sales of new homes fell 4.7 percent, indicating that housing remains weak. Supply also increased to a new cycle high of 9.6 months while the median price of a home dropped over 10 percent. The plunge in new and existing home sales makes it hard to believe that orders for durable goods were strong in the month of December. We already know that retail sales were very weak and we expect sales of big ticket items like furniture to suffer as well. Consumer confidence is also due for release and even though the University of Michigan reported an increase in consumer confidence in the month of January, the disappointment in retail sales makes it hard to believe that the Conference Board’s report will follow suit. The only thing that can help the dollar would be some groundbreaking stimulus measures announced by President Bush in his State of the Union address tonight. Unfortunately this is his last State of the Union speech and since more details of the stimulus package have already been announced, President Bush may choose to focus on other issues.

Euro Benefits from ECB President Trichet’s Continual Stubbornness

European Central Bank President Trichet remains committed to fighting price stability, at all costs. He reminded the markets today that rate cuts are not needed because the current level of monetary policy should not hamper growth. As much as some economists have warned that the ECB’s stubbornness will lead to the downfall of the Eurozone economy, for the time being, their economic data reflects stability in an environment where US economic data reflects a rapidly deteriorating economy. Money supply was the only data released from the Eurozone today and even though the numbers fell short of expectations, the 3 month average rate of M3 growth jumped to 12.1 percent from a year ago, the fastest pace of acceleration on record. The Eurozone current account balance and French consumer confidence is due for release tomorrow, but that should be overshadowed by US data. Meanwhile Switzerland will be reporting the UBS consumption index and the trade balance figures for the month of December. Any deterioration may not have a lasting impact on the Swiss franc because SNB President Roth indicated today that there is no urgency to alter interest rates.

Strength of the British Pound is Fading

After two very powerful moves on Thursday and Friday, the strength of the British pound appears to be fading. Last week, the rally in the pound was largely due to the belief that a February rate cut is not a foregone conclusion. This week however, we face a lot of housing market numbers that could bring the vulnerability of the UK economy back to the forefront. In a speech this morning, BoE member Blanchflower said that interest rates are too restrictive, but if you recall, Blanchflower was the one MPC member that voted in favor of cutting interest rates this month. Therefore his dovish comment is in line with his usual stance on monetary policy and nothing new. Tomorrow we have the CBI Distributive trades survey due for release; weak numbers could tip the pound over. An article in today’s Wall Street Journal questions whether Bank of England Governor King will be able to keep his job in June (Listen to the podcast). He received a lot of criticism for his delayed respond to the credit crunch in August and now he is struggling to restore his credibility. His reappointment could not come at a worse time with the economy slowing and inflation pressures mounting.

Record Gold Prices Drive Australian, New Zealand and Canadian Dollars Higher

With gold and platinum prices hitting a record high of $929.20 an ounce today, it would be surprising if we did not see similar strength in the Australian, New Zealand and Canadian dollars. These three currencies have already performed extremely well last week despite mixed economic data. The drivers remain the same this week with the New Zealand dollar rallying despite a sharp drop in the country’s service sector PMI report which fell from 62.6 to 53.9 in the month of December. Although there is no way that we will be fading New Zealand dollar’s strength, the combination of weak economic data and RBNZ Governor Bollard’s warning that the currency is overvalued leads us to believe that if the market becomes suddenly risk averse once again, the New Zealand dollar may fall the hardest. Meanwhile traders of the commodity bloc should keep an eye out for Australian business confidence and Canadian business orders, which are due out tomorrow.

Is the Correlation Between Carry Trades and Interest Rates Going to Break Down?

In the Financial Times today, there was an interesting article that talked about whether the correlation between carry trades and interest rates will break down. The main argument is that the countries cutting interest rates are taking active measures to boost growth while those keeping rates steady or raising them could face a sharp contraction in the coming months. We do not believe that the correlation between carry and interest rates will collapse, but we do believe that the correlation between carry trades and equities are at risk.