DowntownForex

U.S. Dollar Rally May Have Legs

By FX360 – The primary theme in the currency markets today was the recovery in the U.S dollar as the greenback staged its strongest rally against the Euro since March. However it was a combination rather than a single factor that drove the dollar higher. Concern about the financial sector in Europe, Russia’s shift on reserve diversification, riots in Iran and risk aversion all contributed to the sharp moves in the currency market. In the past few weeks, the dollar become deeply oversold and was due for a serious bounce. Although we are long term bearish dollars the near term outlook has changed. The single biggest reason why investors and traders bailed out of the U.S. dollar over the past few weeks is because they expected central banks to do so as well and now that they have changed their minds, we expect the dollar to extend its gains. Alternatively, traders could wait for a deeper pullback in the currency market before reloading their dollar short positions.

Change of Heart

Central banks around the world are having a change of heart following Treasury Secretary Tim Geithner’s visit to Asia earlier this month. China was the first to tone down their comments about reserve diversification by acknowledging that at this time, there is no alternative to the U.S. dollar. Japan followed suit last week when they said that the country’s trust in Treasuries is unshakable and now, Russia has jumped on board. With Brazil, Russia, India and China holding their first ever BRIC Summit on June 16, this complete U turn indicates that the single biggest near term risk for the dollar is off the table for the time being. It was only last week that Russia said that would shift out of U.S. dollars and buy IMF bonds. We have long said that it is unrealistic to expect a new world reserve currency to replace the dollar within the next 5 and possibly even 10 years. Confirming our thesis was the IMF’s clarification that any bonds issued by the agency would not be traded on the open market, reducing its ease of use as a transaction vehicle. The reason why this summit is receiving so much focus is because BRIC nations own more than 40 percent of the world’s global currency reserves and represent 15 percent of the $60.7 trillion global economy. They are a force to be reckoned with but this “force” is not expected to be critical of the dollar this week and could actually make comments that would drive the dollar higher.

TIC Data, Fed Comments, Empire State and NAH B

Disappointments in U.S. data have contributed to risk aversion in the currency markets. Manufacturing activity in the NY region contracted, foreign purchases of U.S. securities fell short of expectations while home builder index unexpectedly declined in June. These weaker reports threaten the market’s optimistic outlook for a global recovery and question the validity of the IMF’s upward revisions to their growth forecasts for the U.S. Fed officials are also cautiously optimistic according to the latest comments from a number of Federal Reserve Presidents. Fisher believes that there is too much slack in the U.S. economy right now and therefore he doesn’t see any need to raise rates in the immediate future. In his eyes, deflation is just as a big of a threat as inflation. Bullard on the other hand stressed the need to avoid inflation risk as deflationary risk is abating. He actually expects to see positive growth in the second half of the year. Evans seems to agree as the economy is “better” than his earlier forecasts. He believes that the economy is at a turning point but inflation is expected to turn down and the labor market is likely to deteriorate further. Meanwhile according to the latest Treasury International Capital flow report, central banks are selling U.S. dollars. However most of the liquidation is in the short end of the curve as purchases of long term Treasuries increased. Since this data is from April, currency traders are putting greater weight on the recent comments from Russia, China and Japan, all of whom are saying that they are not looking to bail out of dollars at this time.

Producer prices, housing starts, building permits and industrial production are due for release on Tuesday. We expect inflationary pressures to pick up given the weakness of the U.S. dollar last month and the rise in commodity prices. As for the housing market reports, the decline in builder confidence suggest that starts and permits should remain weak.

EUR/USD: BREAKS DOWN ON CONCERN FOR FINANCIAL SECTOR

Even though the Australian dollar dropped the most on a percentage basis against the greenback today, on a pip basis, the steepest slide was in the EUR/USD. Economic data was weaker than the previous quarter with Eurozone employment declining 0.8 percent in the first 3 months of the year. However what really did the euro in was concern that the credit crunch in the Eurozone will deepen. The U.K. Telegraph reported that Germany’s top industrial group has warned that credit conditions are going from bad to worse across the country, threatening the survival of new companies. It is becoming increasingly difficult for companies in Germany to borrow and for anyone that has access to credit the cost of borrowing has increased even though the ECB has cut interest rates aggressively. The ECB Financial Stability Review echoed these concerns. According to the report, Eurozone banks could face another $283 billion in write-downs. The central bank said that the risks in the financial sector has increased in the last six months and therefore write-off rates could rise more than expected. Trouble in the financial sector comes at a difficult time for the euro. Economic data over the next couple of weeks will start to reflect the consequences of euro strength starting with tomorrow’s German ZEW survey and Eurozone consumer prices. We expect investor confidence to deteriorate and inflationary pressures to subside. Furthermore, now that the EUR/USD has broken the key 1.38 technical level, the door is open for a move down to 1.36.

GBP/USD: CONSUMER PRICES ON TAP

There was no U.K. economic data released today and therefore the British pound fell victim to broad dollar strength. Compared to the rest of the major currencies, the British pound saw the second smallest slide against the dollar (behind the Japanese Yen) while strengthening against the Euro and Swiss Franc. Surprises in U.K. economic last week has helped to keep the currency afloat. Starting tomorrow the U.K. economic calendar will heat up and traders will be looking at the reports to confirm or deny a recovery in the U.K. economy. The recent improvements have fueled broad based speculation that the U.K. economy could recover before the U.S. and Eurozone. Consumer prices are expected to fall given the decline in producer prices and the rise in the British pound. Weaker price pressures will reduce the central bank’s urgency to raise interest rates.

USD/CAD: BOC FINDS SIGNIFICANT STRESS IN GLOBAL ECONOMY

The Canadian, Australian and New Zealand dollars were battered today as risk aversion finds its way back into the financial markets. In the medium term, this is good news for these countries as recent reports indicate that the severe rise in their currencies is starting to have a negative effect on economic activity. Last week, New Zealand central bank Governor Bollard spurred intervention talks when he called the rise in the U.S. dollar “unhelpful.” Canadian economic data showed that Manufacturing Shipments came in better than expected at -0.1 percent, while New Motor Vehicle Sales were much worse at 0.0 percent versus last month’s 6.3 percent. The better shipments report masks underlying weakness. While the number was boosted primarily by a rise in transportation equipment, the New Orders component plunged 11 percent. Similar testaments to continued economic weakness have translated into a slightly pessimistic Bank of Canada Semi-Annual Review of the Financial System. The report grimly indicated that Canada’s economy is pretty much at the same point as it was in December. This is a glaring deviation from those hoping that Canada was approaching a rebound on the heels of a rise in commodity prices. Furthermore, the report found that the global financial system as a whole is still under significant stress. Even though they added that the Canada has largely outperformed their peers, it is a bleak account of what we thought was an improving system. New Zealand data yesterday showed that Manufacturing Activity fared slightly better in the first quarter. The main release for tomorrow will be the RBA’s Minutes which should shed some light on whether interest rates will be decreased anytime soon.

USD/JPY: YEN MAY KEEP BOJ’s HANDS TIED

USD/JPY has remained trapped in a 150 pip range for the last five trading days. Even today’s sharp jump in volatility has proven insufficient to buck the pair from its current state. Nevertheless, price action in AUD/JPY and NZD/JPY is performing as expected, with yen strength spurred by safe haven demand. The apparent confusion in USD/JPY should give the BoJ plenty to discuss at their Monetary Meeting today. The bank is expected to keep their target rate unchanged at 0.10%. Fluctuations in the yen will become the chief concern for the economy but not likely to have a heavy influence on the BoJ’s monetary decisions. It will be this uncertainty that will prevent the bank from taking any action in unwinding their quantitative easing program. Recent speeches have shown that the bank is interested in planning for an exit strategy, but the effect on the yen is very uncertain at this point. There will be a delicate balance between pulling out too early and waiting too late, creating a tricky decision for the bank to make. Japanese data for tomorrow will include Tokyo Condominium and Department Store Sales.

GBP/USD: Currency in Play for Next 24 Hours

The GBP/USD will be the currency pair in play for the next 24 hours. UK Consumer and Retail Prices will be released at at 4:30 am ET or 8:30 GMT. The US is set to release its inflation report, the Producer Price Index and Housing Starts at 8:30 am ET or 12:30 GMT followed by Industrial Production at 9:15 am ET or 13:15 GMT.

The GBP/USD has slipped into the Bollinger band range trading zone after failing to breach 1.6600 which seems to be the most important resistance level at this point. This is now the second instance the pair has failed and may be forming a double top. Support can be located as the 23.6% retracement from the March low to the June high at 1.5952. Furthermore, there is an important level at 1.5800, which has both psychological relevance and was the low from June 8th. Therefore, support will be a range between 1.5952 and 1.5800. The most important thing to look out for is a confirmation of the double top pattern, which should be completed at the break of 1.5800.

As Originally Posted on Fx360.com

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