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Euro: On Its Way to 1.58

- Is the Dollar Rally Over? - British Pound Hits 7 Week High

DailyFX Fundamentals 06-26-08

By Kathy Lien, Chief Strategist of DailyFX.com

Meltdown in stocks hurts the Dollar

In the first minute of trading, the Dow Jones Industrial Average broke its Bear Stearns low.

The combination of higher oil prices, the technical break in the Dow and news that Goldman Sachs put Citigroup stock on its sell list sent equities tumbling more than 200 points on an intraday basis.

The currency market was already bearish dollars following the Fed’s interest rate decision yesterday and today’s meltdown in stocks sent the greenback even lower.

Economic data was mixed, with GDP and existing home sales rising more than expected but jobless claims and the help wanted index deteriorated.

The average selling price of a home was $208,600, down 6.3% from a year ago.

However the market’s focus is now on the labour market and traders realize that even if the housing market stabilizes, US consumers still face a deteriorating labour market and rising living costs.

We expect non-farm payrolls to drop for the sixth month in a row. According to the jobless claims and help wanted numbers, no one is hiring.

Car manufacturer Volvo announced today that they are cutting their workforce by 8% globally due to soaring raw material costs and weaker demand from the US.

This follows recent layoff announcements from Citigroup and Goldman Sachs, reinforcing the Federal Reserve’s cautiously hawkish bias.

Even though the FOMC statement was less bearish on growth, we believe that downside risks for the economy have actually grown. But for currency traders, the real question is whether weaker economic data will actually hold the Federal Reserve back from raising interest rates.

Personal income, personal spending, the PCE deflator and the final release of the June University of Michigan consumer confidence numbers are due for release tomorrow.

These are tier 2 economic data, which means that they are not very market moving. However given the overwhelmingly bearish bias in the market right now, weak numbers could add further fuel to the dollar’s selloff.

Euro: On its way to 1.58

The Euro is on its way to 1.58 as stronger inflation data reinforces the need for a rate hike.

German import prices rose 2.4% last month, the strongest gain in 18 years.

Unsurprisingly this jump was due largely in part to the surge in oil prices. With the European Central Bank interest rate decision exactly a week away, the ECB will almost certainly raise interest rates.

In fact, that is exactly what ECB officials have been telling the markets on a near daily basis. However the market mover will not be the rate hike itself, but Trichet’s post meeting press conference.

Judging from the other comments from ECB officials, there is a strong chance that Trichet will downplay further rate hikes, which could be perceived as Euro bearish.

He will have to be particularly careful in choosing his words because they could determine whether the Euro breaks 1.60 or falls below 1.55.

The move in the Euro over the last 48 hours has been driven entirely by the market’s belief that there is a growing differentiation between what the ECB and Federal Reserve are doing.

Retail PMI and the Eurozone current account numbers are due for release tomorrow morning. German retail sales have been weak, but French consumer spending has been strong, making it unclear how retail PMI will fare.

British Pound hits seven week high

The British pound rallied for the third day in a row against the US dollar, hitting a seven week high in the process.

Although the pound strengthened across the board, there was little to drive the move other than the weaker US dollar.

Ironically enough, Bank of England members testified before the Treasury Committee today and their comments were relatively dovish as central bank Governor King specifically noted that the market is too aggressive in pricing rate increases.

The only reason that could explain the sterling’s strength is expectations for tomorrow’s GDP and current account figures. No revisions are expected to the Q1 growth figures but the current account deficit could narrow given the strong trade balance reports for the first quarter.

Australian Dollar hits six year high against New Zealand Dollar

Despite higher commodity prices, the Canadian, Australian and New Zealand dollars gave back some of their gains as high yielding currencies came under the pressure of falling risk appetite.

Economic data from the commodity countries was mixed.

Australia reported stronger leading indicators and higher job vacancies while New Zealand reported a less than expected improvement in the current account deficit.

This divergence in economic activity drove the Australian dollar to a six year high against the New Zealand dollar. New Zealand GDP and the trade balance are due for release this evening. Growth is expected to contract given the sharp deterioration in consumer spending last quarter. Trade should also be weak given the drop in business PMI.

Yen crosses crumble under the weight of the Dow

Japanese Yen crosses crumbled under the weight of the Dow.

Even though EUR/JPY hit a record high during the European trading session and CHF/JPY climbed to a 17 year high right before the US open, most of the Yen crosses struggled throughout the US trading session.

The fear of further trouble in the banking sector has taken a big toll on risk appetite. There is a lot of Japanese economic data due for release this evening including unemployment data, consumer prices, retail sales and industrial production.

These reports have a better chance of being weak than strong, but that may only have a minimal impact on the Yen. What matters now is whether the Nikkei follows the Dow lower and if it does, the Yen crosses will continue to weaken.