·         Dollar Rally Hits Ceiling, Strong US Data Will be Needed to Continue On

·         British Pound Rallies as Housing Market Continues to Stabilize

·         Current Yen Level is Attracting A lot of Portfolio Adjustments


US Dollar

Despite the strength embedded in last Friday’s retail sales report and the non-farm payrolls number the week prior, the dollar has struggled to break its key resistance levels.  In fact, a quick survey of the charts will reveal that many of the pairs are in the process of “rolling.”  USD/JPY appears to be rolling downwards while the EUR/USD and GBP/USD appear to be rolling upwards.  Whether this becomes a true reversal rather than just consolidation will be determined by this week’s reports.  We are expecting a great deal of inflation data along with other key numbers.  Tomorrow, producer prices, net foreign purchases of US securities, industrial production and the NAHB housing market index are due for release.  It is extremely unlikely that the US will be able to escape the softer inflationary pressures that we have already seen in other countries.  Producer prices should reverse some of its earlier growth while core price growth should remain relatively limited.  The drop in manufacturing payrolls suggests that industrial production could also be weak, but don’t bank too much on that report impacting the dollar because today’s jump in the Empire State manufacturing index should offset any bearish sentiment by leaving the outlook for the manufacturing sector cloudy.  What could drive major movements in the dollar besides the PPI number is the net foreign purchases report, which is also known as the TIC (Treasury International Capital flow) report.  Last month’s release for the month of July reflected the smallest gain since May of 2005.  For the month of August, foreigners are expected to have snapped up $56 billion worth of US investments.  The Dow began to really take off in the month of August and we expect the TIC report to reflect active and growing foreign participation.  There were a number of Fed speeches today.  FOMC member Poole was slightly hawkish on inflation citing more positive inflation data, however Yellen pointed to the slowdown in the economy and reiterated her support for keeping interest rates unchanged.  Bernanke has learned from his mistakes and kept to the topic on regulation.  Fed Presidents Bies and Stern will be speaking tomorrow, neither of them are expected to touch on the economy or monetary policy. 



The Euro is continuing to hold the psychologically and technically important 1.25 level against the US dollar but only by a very thin margin.  The drop in business sentiment as well as Italian consumer prices has limited the currency’s gains against the US dollar.  Should US data come in very positive tomorrow, expect the Euro to lose more against the dollar than the British pound.  The Eurozone’s consumer price releases due for release tomorrow will confirm that inflation has fallen below their 2 percent target while the ZEW survey of analyst sentiment is predicted to reflect the tougher economic conditions that the August rate hike and upcoming German VAT tax increase will pose to the economy.  The prospect of another rate hike later this year should also keep sentiment negative.  The members of the European Central bank however are not as bearish, which means that unlike the case where Euro rallies can be very sharp, Euro weakness will probably be choppy. 


British Pound

The British pound continues to benefit from a stable and improving housing market and merger and acquisition related flow.  The Rightmove house price index released overnight reported a sharp 2.0 percent rise in prices during the month of October.  With the market trying to calculate whether the Bank of England will raise interest rates again this year, the latest housing market report is another check mark in the yes group.  UK water company Thames Water is also up for grabs with an Australia bank winning the bid to buy the company for a deal valued at GBP 8 billion, which will have positive ramifications for GBP/AUD.   Meanwhile the FTSE also hit a five year high, which is helping to boost confidence in the British pound.  Looking ahead, like its peers, the UK is due to release inflation reports tomorrow.  Inflation rates in the UK remain very high with an annualized rate of 2.5 percent.  Only a slight moderation is expected, which is one of the main reasons why the BoE could still consider raising interest rates again this year.


Japanese Yen

The biggest news today was yen related.  Russia announced that it plans to diversify a portion of its reserves into the Japanese yen, sending all of the yen crosses lower.  As a major holder of foreign exchange reserves, Russia’s decision brings the topic of reserve diversification back into play.  The country previously increased its share of Euros and are now boosting its holdings of yen.  Both of these changes will and have been made to the detriment of the US dollar and we expect that many other central banks are considering doing the same, if they have not already done so, especially as the yen trades at such cheap levels.  In fact, companies are also taking advantage of the current yen levels to adjust risk.  Life Insurance company Sumitomo announced last Friday that they have reduced their hedged foreign bond holdings by USD 3.77 billion over the past 5 months.  The have reinvested the money into yen bonds and will only be looking to buy dollar denominated bonds when the yen rises to 110 against the US dollar.  Sumitomo’s decision may also reflect an internal opinion that the yen may rise.  If they believe this, it would be smart to cut dollar holdings at this point because even if they earned income on the US dollar hedges, the income would be eroded if the US dollar depreciated in value when they converted the investment back into Japanese Yen.  The current yen value against both the US dollar and Euro are at points that may attract a lot of portfolio adjustments on behalf of central banks, corporations and individuals.