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Euro Recovers but Downtrend May Remain Intact

- Service Sector Data Fails to Help the Dollar - Pound Sterling: Gear Up for Economic Releases

DailyFX Fundamentals 05-05-08

By Kathy Lien, Chief Strategist of

Service sector data fails to help the dollar

The US dollar weakened across the board today despite a stronger than expected non-manufacturing ISM report.

As indicated in Friday’s Daily Fundamentals, the strength was not surprising since the service sector added jobs for the third month in a row.

Even though the weakness of the US economy and the turmoil in the financial markets suggested further deterioration in the service sector, it remained suspicious that if the contraction exacerbated, hiring would not have increased. For this reason and the fact that non-manufacturing ISM was released after non-farm payrolls, the market did not have a lasting reaction to the number.

In the past, non-manufacturing ISM has been very market moving because the employment component of the report is a good leading indicator for non-farm payrolls.

The new orders and business activity components of the report also deteriorated, reflecting weakness underneath the headline number.

The drop in the US dollar today could have also been attributed to the new record high in oil prices and news from the Federal Reserve that the number of US banks tightening lending to companies and consumers hit a record high.

Life is becoming very difficult for the average American and that strain is being reflected in the dollar. However with the European Central bank and Bank of England interest rate meetings looming, we still believe that the US dollar could resume its rise.

Traders just need to be selective of the currency pair they choose to use to express their dollar bullish views. In the meantime, there is no meaningful US economic data until Wednesday.

Euro recovers but downtrend may remain intact

Since hitting a record high above 1.60 less than 2 weeks ago, the Euro has fallen over 600 pips against the US dollar.

Today, the currency pair (EUR/USD) has recovered, which is unsurprising given the strength of its recent move lower. The final figures for manufacturing PMI are due for release tomorrow and any revisions are likely to be to the downside.

However that may be countered by the producer price reports which are expected to be stronger. With the ECB monetary policy decision scheduled for Thursday, we are still sceptical of the latest recovery.

The central bank has a tough decision ahead of them and today’s record high in oil prices is not helping. Economic growth has taken a turn for the worse and if not for the strong inflationary pressures, the European Central Bank would have probably cut interest rates already.

However inflation is rampant and because of that, it is not clear which way Jean-Claude Trichet, President of the European Central will sway on Thursday.

Traders will be hanging onto his every word, looking for a hint of dovishness. For the time being, the downtrend in the Euro remains intact as the market waits for the ECB to ease and the Federal Reserve to pause.

This shift in monetary policy expectations is significant and one that currency traders should not ignore.

Meanwhile Swiss consumer prices are also due for release tomorrow. Although price growth is expected to have accelerated in March, consumer prices have remained relatively tepid across the globe, which means that the CPI number may fall short of expectations.

Pound Sterling: Gear up for economic releases

The Sterling slipped against the Euro but remained unchanged against the US dollar as the lack of economic data left investors concentrating on election news.

The Labour Party suffered their worst defeat, as voters became hesitant about Gordon Brown’s ability to lead the economy out of its current slump.

Brown blamed the current economic situation on the US credit crisis and deteriorating housing market, as he vowed to improve the general health of the economy.

On the economic front, there were no releases today, but the pace picks up tomorrow, as PMI services and Consumer Confidence figures are expected to decline, in light of the global credit crisis.

On the following day, Industrial Production and Manufacturing Production figures should slip further, which could lead the pound lower. BoE’s rate decision on Thursday should set the tone for end of week’s trading session, as it is largely anticipated that the central bank will keep rates steady.

Commodity currencies rise, RBA expected to leave rates unchanged

The Australian, New Zealand and Canadian dollars all gained strength against the greenback today amidst higher commodity prices.

Oil hit a record high above $120 a barrel, triggering a sharp rally in the Canadian dollar.

The IVEY PMI report is due for release tomorrow and even though the Canadian economy has seen some spillover effects from the US, the rise in leading indicators suggest that business sentiment could not be as bad as the market expects.

The Reserve Bank of Australia will be making a monetary policy decision tonight. Although they are expected to leave interest rates unchanged, the Australian dollar could see some volatility on the heels of the monetary policy statement.

Retail sales improved last week, but service sector PMI dropped into contractionary territory in the month of April, which could be worrisome for the RBA. Prior to the interest rate decision, the Australian trade balance report will be released.

Yen crosses mixed despite drop in the Dow

The Dow dropped 88 points today which weighed on some but not all of the Japanese Yen crosses. The US dollar, British pound and Swiss Franc weakened against the Yen but the Euro, Australian, New Zealand and Canadian dollars strengthened.

This divergent performance indicates relative fundamentals rather than risk appetite are the primary driver of market fluctuations. There are no major Japanese economic reports this week.