EUR/USD Risk Reversals Signals Further Losses
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EUR/USD Risk Reversals Signals Further Losses

EUR/USD Risk Reversals Signals Further Losses

- US Dollar Fights its Way Back - British Pound: UK Unemployment Rises by the Most in 16 Years

    DailyFX Fundamentals 07-16-08

    By Kathy Lien, Chief Strategist of DailyFX.com

    US Dollar fights its way back


    After hitting a record low against the Euro on Tuesday, the greenback is fighting its way back.

    The fundamental factors that are driving the dollar higher today include falling oil prices, a rebounding stock market, intervention risk and hawkish FOMC minutes.

    Although each of these factors has the power to turn the dollar around individually, the primary story is oil.

    Since Tuesday, oil prices have fallen more than $10 a barrel, leaving many consumers and investors hoping that this is a top.

    Lower oil prices is a big relief for US consumers and businesses, which is why the Dow rose more than 270 points today.

    Meanwhile the dollar is also benefitting from speculation that the Federal Reserve could intervene to prop up the US dollar.

    In his testimony this morning, Bernanke said that forex intervention should be done rarely and that USD intervention may be justified in disorderly times.

    Since most of us would argue that current conditions can be described as 'disorderly,' Bernanke may be warning about possible plans for intervention, but we think that is unlikely.

    According to the minutes from the June FOMC meeting, Fed officials were prepared to raise interest rates 'very soon.' They felt that growth risks diminished but inflation was on the rise.

    However don't read too much into these minutes given that a lot has changed since June; Growth risks have increased significantly and inflationary pressures or at least inflation expectations are beginning to ease.

    The same can be said of the Treasury International Capital flow numbers which indicated that even though foreign purchases of US securities fell last month, there is no sign that China or Japan has reduced their holdings of US dollars.

    In fact, purchases of Fannie Mae and Freddie Mac's debt actually increased in May. We suspect that the data for June and July will look very different.

    Finally, other pieces of US data were mixed. Consumer prices raced to the highest level since 1991 on an annualized basis, industrial production was strong but the NAHB housing market index fell to a record low.

    Given current market conditions, traders should forget about a rate hike from the Fed this year.

    Inflation is a problem, but the stability of the financial markets; growth and global investor confidence are even bigger problems. If oil prices fall back towards $120 a barrel, the Fed will remain on hold for the remainder of the year.

    EUR/USD Risk Reversals signals further losses


    Broad dollar strength has driven the EUR/USD lower.

    Eurozone Consumer price figures were right in line with expectations, providing no real support for the currency.

    Instead, a multitude of factors have contributed to the dollar's recovery (outlined in the US dollar section above), but the bottom line is that US dollar weakness was overdone.

    Risk reversals in the EUR/USD hit an extreme level. The 25 delta three month risk reversals are at the highest level since June 2007.

    Whenever risk reversals hits critical levels, it indicates that anyone who wants to be long Euros are already long and as a result, sentiment has hit an extreme.

    The last time EUR/USD risk reversals were near these levels was in June and September 2007. Both times, we saw a relief rally in the US dollar that lasted for approximately 250 to 300 pips.

    Risk reversals are once again telling us that the US dollar is oversold and due for a further recovery. However as we saw in previous months, a rebound in the EUR/USD is not the same as a long term bottom (risk reversal chart).

    Meanwhile Swiss retail sales doubled expectations as spending on electronics and leisure products increased. The Swiss National Bank is comfortably on hold as they expect inflation to ease back to their 2% target next year.

    Pound Sterling: UK unemployment rises by the most in sixteen years


    The latest labor market report from the United Kingdom confirms that the UK economy is in trouble.

    Jobless claims rose by 15.5k, the largest increase in 16 years with average earnings growth including and excluding bonuses falling.

    The layoffs in the financial sector and the problems in the housing market have taken a big toll on the UK economy.

    We fully expect employment to deteriorate further in the coming months which will prevent the Bank of England from raising interest rates despite strong inflationary pressures.

    The weaker outlook for the UK economy has not hurt the British pound much, as the currency is holding up well against the US dollar and Euro. Even though the pound fell victim to dollar strength, it is still trading above Tuesday's low.

    Australian, New Zealand and Canadian Dollars retrace


    The Australian, New Zealand and Canadian dollars retraced their recent gains on the heels of broad dollar strength.

    The biggest decliner was the Australian dollar, which had raced to a 25 year high as recently as yesterday.

    Squashing any speculation for a rate hike were comments from Reserve Bank of Australia Governor Stevens who said that the current level of interest rates will help drive consumer prices lower even though it will probably bring down growth as well.

    The Westpac Leading indicators index was flat in May, confirming the gradual slowdown in the Australian economy.

    There was no economic data from New Zealand but Canada reported a sharp rise in manufacturing shipments, which coincides with the recent jump in the IVEY PMI index.

    USD/JPY sticking its neck back above 105


    The 270 point rally in the Dow has helped to drive many of the Japanese Yen crosses higher.

    The best performer was USD/JPY which is back above 105. Given the strength of today's rally in the US equities, we will probably see continuation.

    We expect the Dow to rebound back up 11,400, which would be bullish for USD/JPY. The tertiary index was weaker than expected, which has weighed on the Yen

    Author
    AMEinfo Staff

    AMEinfo staff members report business news and views from across the Middle East and North Africa region, and analyse global events impacting the region today.

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