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US Dollar May Continue to Gain as the Dow Plummets, Treasuries Surge

By Terri Belkas
28 August 2007 21:29 GMT

How Will The Markets React?

The release of the second reading of US GDP for Q2 could prove to be market moving on Thursday, as expansion is anticipated to be revised up to 4.1 percent – the best rate of growth since Q1 2006. This may be encouraging to some as a signal that the US economy will be better equipped to weather the storm of the subprime mortgage industry implosion. However, this indicator clearly looks back at the economy’s performance rather than looking ahead, which may limit its impact on the markets (barring a huge unexpected revision). One of the other factors that traders will be also be looking at is personal consumption for the same quarter, which is estimated to be revised up to 1.5 percent from 1.3 percent. Nevertheless, this still represents the weakest rate since Q4 2005 and a sharp slowdown from the 3.7 percent pace we saw in the first quarter. With consumer confidence dwindling and lending standards tightening, concerns have been brewing that spending will slowdown even further and serve to damage the already-fragile economy in coming quarters. The Federal Reserve has recently noted that “financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward.” Furthermore, the FOMC’s statement that it is “prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets” has led traders to ramp up speculation of a rate cut on September 18th. While activity in the financial markets may have more to do with this decision that the Q2 GDP release, a softer-than-expected growth reading certainly won’t help the case of hawks within the FOMC.

Bonds – 10-Year Treasury Note Futures

Wednesday’s breakout in 10-year Treasury note futures hit a high of 109-17 today – just below the high of 109-18 established last December – creating the potential for move to 110-00 before fading. Such a rally in Treasuries will likely require additional weakness in equities to help push it along, and we could see a bit of a retrace towards trendline support near 108-18 first. The release of US GDP on Thursday adds additional event risk, as a disappointing figure could ramp up further speculation of a rate cut by the Fed on September 18th.

10-Year Treasury Note Futures (Daily Chart)
cross markets 08.28.07 a

FX – EUR/USD

As the status of risk aversion remains the primary theme of the forex markets and liquidity crunch jitters subside, the US dollar has started to gain in recent days after running into resistance at 61.8 percent fib of 1.3855 – 1.3361 at 1.3665. The next level of resistance sits at the 78.6% fib at 1.3750, which could be the pair’s next bullish target. However, EURUSD faces massive event risk on Thursday and the pair’s reaction may sound counterintuitive, as stronger-than-expected figures could send EURUSD higher as the data would help to assuage credit crunch concerns. Since the US dollar has traded more as a safe-haven asset over the past two weeks, we may actually see encouraging data contribute to dollar weakness. On the other hand, if Thursday’s data proves to be very disappointing, equity markets could unravel as risk averse sentiment returns and pushes EURUSD down towards support at 1.3526, with sharp declines taking on 1.3485.

EUR/USD (Intraday Chart)
cross markets 08.28.07 b

Equities – Dow Jones Industrial Average

The Dow Jones Industrial Average plunged for the second consecutive day, ending Tuesday down 2.1 percent at 13,041.85. A descending trendline (which is currently at 13,350) has blocked gains for the equity index, and the Dow’s hesitance to break above this level signals that price could be moving lower to target the 200 SMA at 12,880 once again. On the other hand, a surge through that resistance level would aim to complete a 78.6 percent retracement of the decline from 14,021.95 at 13,665, but this will only be possible if credit jitters subside. While US equities face event risk from Thursday’s GDP release, price action in the Dow will likely remain contingent upon volatility and risk aversion trends related to concerns about the liquidity crunch. Nevertheless, surprisingly strong revisions to GDP would underpin any positive sentiment amongst equity traders. On the other hand, weak data could quell market optimism and push the Dow lower, especially if traders become increasingly worried about companies directly involved with the housing sector.

Dow Jones Industrial Average (Daily Chart)
cross markets 08.28.07 c


Written by Terri Belkas, Currency Analyst for DailyFX.com

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28 August 2007 21:29 GMT