daily fundamentals

US Dollar Weakens as Risk Appetite Returns (Sort of)

Friday, 24 August 2007 21:00:15 GMT  |  Kathy Lien, Chief Currency Strategist

• US Dollar Weakens as Risk Appetite Returns (Sort of)
• ECB: September Rate Hike Not a Done Deal
• British Pound Breaks Above 2.01

US Dollar Weakens as Risk Appetite Returns (Sort of)
New home sales and durable goods completely blew away expectations today.  Orders for goods made to last for more than 3 years increased 5.9 percent last month, which was the largest rise since March 2004.  New home sales also broke its 2 month downtrend, but the most optimistic aspect of the report was not the rise in sales, but rather the rise in prices and drop in inventories. Collectively, these reports suggest that the US economy may not be doing as poorly as many people may have thought.  The US dollar should have rallied on the back of these releases, but it did not.  Why? The bigger theme in the markets at the moment is risk or no risk.  Today’s data gave traders the confidence to plow out of their safe haven assets and back into riskier positions.  The bottom line is a green light for risk means a green light for carry trades and high yielding currencies.  Therefore the biggest gainers from today’s numbers were currencies like the Euro, British Pound, Australian and New Zealand dollars.  Although risk appetite appears to have returned given the renewed demand for carry trades, volume is thin ahead of the Summer Bank holiday in London on Monday.  This exacerbated the push higher which made the market appear overly optimistic about today’s reports.  It is important to realize that the data reflected economic conditions in the month July, which was before financing became an issue.  We need more than just one month of data to make a more accurate assessment of how bad these sectors have been hit by the tightening of credit.  The Federal Reserve on other hand may not have that luxury.  They will be holding their annual retreat in Jackson Hole next week where Bernanke will be delivering a speech on the state of the housing market.  With the number one focus of the market being the timing of the Federal Reserve’s interest rate cut, this will be the most important event on the economic calendar next week.  The Fed will also be releasing the minutes from their August 7th FOMC meeting.  Besides that, we are expecting existing home sales, Q2 GDP, personal income and spending, PCE, Chicago PMI and factory orders.  Things could still get worse before they get better, but the recovery could be swift since everyone is in cash or US Treasuries.

ECB: September Rate Hike Not a Done Deal
It is not the European Central Bank’s style to keep the markets guessing about what they will do with interest rates at their next monetary policy meeting.  Usually, they like to suppress market volatility by letting everyone know their plan months in advance.  The fact that their message is so convoluted this time indicates that they too have yet to figure out what to with interest rates.  The ECB has not officially convened since August 2nd.  Yesterday, they released a press statement saying that they are sticking to the monetary policy stance expressed by Trichet earlier this month, but today, comments from a senior official at a Euro zone national central bank suggests otherwise.  Reuters quoted the official as saying "If there is a normalization in the markets a rate hike is still possible. If not the ECB will wait with the next step."  Rate hike expectations have plunged from 50 percent back yesterday down to 20 percent today.  This confusion makes Monday’s speech by ECB President Trichet even more important.  Hopefully he will clear the air on whether a September rate hike is a done deal.  There is a very heavy Eurozone economic calendar that includes the IFO survey, German CPI, retail sales, retail PMI and unemployment.  Meanwhile Switzerland will be releasing consumer prices and the KoF report of leading indicators. 

British Pound Breaks Above 2.01
After hitting a low of 1.9653 last week, the British Pound has rallied close to 500 pips to end the week above 2.01.  Recent UK economic data has been encouraging, which is part of the reason why the British pound has staged such a strong recovery.  Although second quarter GDP was left unchanged at 0.8 percent, private consumption and government spending was revised upwards, which helped to cover the reversal in fixed capital spending.  Whether or not the Bank of England will still raise interest rates at the end of the year will be dependent upon how data fares in the weeks to come.  UK markets are closed on Monday, but we are expecting a number of housing market related reports this week in addition to the CBI distributive trades survey and consumer confidence. 

Japanese Yen Crosses Recover, but Not Enough to Cover Last Week’s Losses
Japanese Yen crosses staged a strong recovery this week as the Bank of Japan leaves interest rates unchanged for another month.  They are committed to normalizing interest rates, but always seem to have their hands tied either by the government or in this case, financial market conditions.  The sharp rise in the corporate service price index in the month of July indicates that the country is slowly escaping deflation and validates their need to raise rates.  We will get more evidence to confirm or deny that in the week ahead with retail sales, consumer prices, unemployment, PMI and industrial production due for release along with the minutes from last month’s monetary policy meeting.  Although important, they will probably have a far smaller impact on the Yen than the market’s overall appetite for risk.  

Australian, New Zealand and Canadian Dollars End a Strong Week
The recovery in the high yielders has been most beneficial for the Australian, New Zealand and Canadian dollars.  On a percentage basis, these currencies saw the strongest recovery this week against both the US dollar and Japanese Yen.  The market’s appetite for risk will continue to determine whether these rallies continue.  There is also a lot of economic due for release next week.  They include Australian retail sales, the trade and current account balance, New Zealand producer prices, Canadian GDP, industrial prices and current account. 

Written by Kathy Lien, Chief Currency Strategist of DailyFX.com

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