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Euro Could Fall on German Business Confidence

- What is Next for the US Dollar? - British Pound Slips ahead of Retail Sales Report

DailyFX Fundamentals 04-23-08

By Kathy Lien, Chief Strategist of DailyFX.com

What is next for the US Dollar?

After hitting a record low against the Euro on Tuesday, there has been little follow through selling in the US dollar, leaving many traders wondering whether this may be a pause before further losses or a potential bottom.

Although we are long term dollar bears, the break of 1.60 is far from impressive. This indicates that there isn’t much speculative interest in taking the Euro higher in the near term, especially as economic data and official comments start to turn against the Euro and in favour of the US dollar.

Earlier this week we had better than expected US housing market numbers. We would not be surprised to also see a recovery in new home sales. Even though US durable goods will be pressured by the sales of furniture and electronics, Boeing’s incredibly solid end of quarter earnings and their expectations of another strong year suggests that sales of non-defense aircraft could be firm.

As for the Eurozone, we expect German business confidence to deteriorate materially (discussed in Euro section). Fed fund futures are currently pricing in an 82% chance of a quarter point rate cut next week with the remaining 18% probability in favour of no rate cut at all. This is a sharp departure from just a week ago when the market was pricing in a 76% chance of a 25bp cut and a 24% chance of a 50bp cut. The only reason for this dramatic shift in expectations is the increased inflationary pressures. A week ago, oil prices were trading at $113 a barrel and yesterday it hit an intraday high of $119.90 a barrel.

The dollar should continue to recover for the rest of the week, but the party may end the following week when we have the Federal Reserve interest rate decision and non-farm payrolls due for release. We believe that the market may be under pricing the degree of Fed rate cuts because the problems in the US economy are far from over. Non-farm payrolls should continue to drop while consumer spending will probably slow, leaving the Federal Reserve with a lot of work ahead of them.

Euro could fall on German business confidence
The Euro has failed to extend its gains beyond 1.60 and we believe that another day of losses may be in store for the single currency. More signs of weakness in the Eurozone economy are beginning to reveal themselves.

Even though service sector PMI improved in the month of April, manufacturing sector PMI deteriorated. This suggests that German business confidence could have also decreased this month as indicated by the ZEW survey. A little watched report called the Belgium Business Sentiment Index also tends to have a strong correlation with German IFO (chart). The index fell to a 2.5 year low in the month of April with the drop being the steepest on record.

A large decline in German business confidence would be exactly what the Euro needs for a more meaningful turn. Meanwhile ECB member Noyer backtracked the comments that he made yesterday, which drove the EUR/USD to a record high. He said that the market misinterpreted his words and that the ECB is not looking to hike interest rates. For the time being, don’t expect them to lower rates either.

Sterling slips ahead of retail sales report
Over the next 2 trading days, the big action should be in the British pound. We are expecting retail sales tomorrow followed by the first quarter GDP report on Friday. The deterioration in the UK housing market and the UK economy in general will weigh on consumer spending, while the GDP numbers may be partially dependent upon how bad retail sales fared in March.

Unfortunately the minutes from the latest monetary policy meeting failed to provide any clarity on how the central bank may vote at the next meeting because the committee was split 3 ways. Six of the nine members voted in favour of the 25bp rate cut, 2 members voted for no cut at all while 1 member voted for a 50bp cut.

As a group, they were concerned about everything from growth to credit markets to inflation. Looking ahead, the only things that will shed more light on where the BoE stands would be tomorrow’s retail sales report.

Economic data are big movers for the Australian, Canadian and New Zealand dollars
With no US economic data on the calendar today, reports from Australia and Canada triggered big moves in the Australian and Canadian dollars.

Consumer prices in Australia jumped 1.2% in the first quarter thanks to sharp increases in the prices of gas, pharmaceuticals and electricity. Although this number drove the Australian dollar significantly higher, it should not have been too much of a surprise following the strength of producer prices reported earlier this week.

The Canadian dollar on the other hand took a big tumble following much weaker than expected retail sales. This was the first decline in 5 months and coming a day after the Bank of Canada cut interest rates by 50bp, it highlighted the vulnerability of the Canadian economy.

Meanwhile the Reserve Bank of New Zealand has their own interest rate decision tonight. Unlike the BoC, interest rates are expected to remain unchanged which means that the RBNZ rate decision could be a non-event for the New Zealand dollar.

Japanese Yen crosses mixed
The Japanese Yen crosses were mixed today with USD/JPY rallying but many of the other yen crosses dipping despite a 42 point rally in the Dow.

After breaking higher last Friday, there has not been much follow through in US equities, which leaves many traders nervous about whether risk appetite is really here to stay. The latest merchandise trade balance report was weaker than expected, but the surplus still increased last month.

The strength of the Japanese Yen is beginning to take a toll on exports, particularly in the electronic components and machinery sector. Imports on the other hand rose 11%, mainly due to the rise in oil prices.