DailyFX Fundamentals 07-17-07
By Kathy Lien, Chief Strategist of DailyFX.com
Carry Trades Take on New Life As Dow Breaks 14,000 (July Seasonality Bonus)
New highs have become a regular daily occurrence in both the currency market and stock market. Today, not only did the Dow Jones Industrial Average rise above 14,000, but GBP/JPY and AUD/JPY also hit fresh 14 and 15 year highs.
In fact, all of the Yen crosses are up strongly today with USD/JPY setting up for a move back towards 124. This is of course contingent upon a break of 122.50, which is moving average and Fibonacci
resistance. Once that level is cleared, the July seasonality effect is back in play.
July has proven to be a positive month for USD/JPY nine out of the past 10 years. As long as we close the month above 123, 2007 will mark the tenth out of 11 years that USD/JPY has rallied in July. Seasonality is not 100 per cent reliable, but the frequency of this repetitive price pattern makes it important.
There are many reasons to explain why USD/JPY tends to behave this way in July, including the fact that it is the end of the first quarter in Japan and the beginning of the second half of the year in the US.
Fundamentally, the rise in core producer prices in June and strong foreign purchases of US securities in May has outweighed the drop in headline producer prices. If we get a similar situation of strong core, weak headline in US consumer prices tomorrow, we could see the breakout that we are looking for in USD/JPY.
Federal Reserve Chairman Ben Bernanke will be giving his semi-annual testimony on the economy and monetary policy. Many traders may not want to be short dollars going into the testimony. Meanwhile the surprise drop in the Japanese tertiary activity index last month has only helped to drive the yen lower today. Japanese leading indicators are due for release tonight, but they should not be market moving.
US Dollar: Comments from Fed Chairman Bernanke Could Set a Near Term Bottom
Even though a weak US dollar is good for the economy, Federal Reserve Chairman Ben Bernanke is not expected to say anything that will cause further dollar weakness at tomorrow's congressional testimony.
The stock market is already trading at very high levels, if the Fed loosens the reins on monetary policy, they risk creating an even bigger bubble. The mixed performance of the US dollar today suggests that the market is not sure what to make of today's US numbers.
Headline producer prices dropped in June, but core price growth accelerated. The strong correlation between the headline Producer Price Index (PPI) and Consumer Price Index (CPI) suggests that consumer price growth was also soft last month. For those watching gas prices, the average national price of gasoline dropped from $3.20 down to $2.95 in June.
But we all know that the Fed watches core prices, which still have a chance of surprising to the upside. The inflation reports were not the only mixed signals sent by US data today. Foreign purchases of US assets hit a record high in May, while homebuilder sentiment dropped to a 16 year low.
For the time being, inflation is bigger focus. Tomorrow's housing starts and building permits will shed more light on whether the drop in homebuilder sentiment has translated into actual building activity.
British Pound Comes Within a Whisker of 2.05
The British pound climbed to another 26 year high after consumer and retail prices rose more than expected in June. The annual pace of retail price growth increased from 4.3 to 4.4 per cent, indicating that inflationary pressures are still a big problem in the UK.
This means not only could we be looking at six per cent interest rates over the next few months, but more immediately, the price action in the British pound suggests that traders are looking for the minutes from the Bank of England meeting earlier this month to reveal a unanimous - if not close to unanimous - decision to raise interest rates.
Anything short of seven out of nine votes in favour of a rate hike would be construed as dovish. The bigger risk is certainly to the downside, given the extent of the recent rally.
In addition to the minutes, we are also expecting the UK's labour market report for June. If wage growth slows as expected, 2.05 could be the peak in the GBP/USD.
Commodity Currencies Retrace After Solid Gains
After yesterday's blockbuster gains, the Canadian and New Zealand dollar consolidated amidst the lack of any meaningful economic data. Canada has consumer prices and leading indicators due for release tomorrow morning. The strong Canadian dollar is expected to drive inflation down, but the overall strength of the economy could limit any major slide.
The Australian dollar pushed higher despite the smaller growth in exports in June. The country is also releasing leading indicators tonight, but the data is never market moving because it dates back to May. Overall, the commodity currencies are continuing on their trends, but the moves are becoming exhausted. The sustainability of the rallies will be dependent upon how dollar bullish Fed Chairman Ben Bernanke will be tomorrow.
Euro Hovers Near Its All-Time Highs
Trading the EUR/USD is like trading EUR/CHF (Swiss franc) these days. The currency has remained stuck within an 80 point range for the past five trading days.
Such a tight range usually leads to an extremely volatile breakout so instead of becoming complacent, traders should be on guard since tomorrow's event risks could easily lead to a major move. The deterioration in the German ZEW business confidence indicator barely put a dent into the Euro.
In the past, the market would watch analyst sentiment carefully. However business sentiment has recently become far more important. Meanwhile over in Switzerland, retail sales were much stronger than expected in May. This helped the franc rally against both the euro and US dollar. Economic growth has been strong in Switzerland, paving the way for another rate hike this year.