US Dollar is Struggling to Recover, Watch Out for GDP and New Home Sales
The US dollar is struggling to recover ahead of tomorrow’s figures for final second quarter GDP and new home sales. Strength was seen against all of the major currency pairs with the exception of the Australian and New Zealand dollars. The strike has ended at GM which means that the impact on non-farm payrolls will be limited. A strike needs to last at least a month for the impact to be meaningful. Despite the weakness of the US dollar, durable goods dropped 4.9 percent in August, which was the largest drop in seven months. Fed fund futures are continuing to price in 50bp of easing by the end of the year and tomorrow’s data will go a long way in confirming or denying that. Existing home sales have already fallen to a 5 year low and new homes are not expected to be pretty either. This of course has been discounted by the market which leaves GDP as the wildcard. Growth was hot in the second quarter, but it could be revised down to as much as 3.6 percent. At this point, there is no reason to expect dollar weakness to end even though prices are simply consolidating at the moment, leaving many currency pairs range bound. On a side note, Martin Wolf made a great point in today’s Financial Times. He said that “The resolution of each crisis lays the seeds of the next.” The Federal Reserve has often resorted to lowering interest rates to get the economy out of a financial crisis, but easier monetary policy is exactly what has been blamed for creating the bubble that we have now. Therefore as the Fed continues to lower rates in reaction to softer economic data, inflation can return with a vengeance. One of the biggest disadvantages of a weak US dollar is its impact on inflation. Coupled with the high level of oil prices and the Federal Reserve may actually under deliver on rate cuts if the credit markets stabilize.

Another Day, Another Record High in the Euro
The Euro made yet another record high of 1.4163 in the beginning of the Asian trading session. Yesterday we learned that business confidence has suffered greatly as a result of the global turmoil in the financial markets, problems in the US, tight monetary policy in the Eurozone and the high level of the Europe. Today we see that consumers are also becoming increasingly pessimistic. Even though European Central Bank officials have yet to complain about the strength of the Euro, the impact on the economy is already being felt. Germany, France, Italy and Spain, the four largest countries within the Eurozone, are not only heavily reliant on exports, but they are also heavily reliant on tourism. France is the most visited country in the world, Spain is number two and Italy is number five (the US is number three followed by China). There have already been reports of decreased interest in European travel and heavy discounting which is a reflection of how the strong currency is already hitting the region’s bottom line. The Euro is hovering not far from its all-time highs. Tomorrow we have German consumer prices, unemployment and Eurozone retail PMI which could trigger some Euro driven flows. Meanwhile the Swiss franc is weaker despite stronger than expected leading indicators. This is in line with the market’s recent trend of completely shrugging off any surprises in Swiss economic data.

Australian Dollar: Seventh Straight Day of Gains
Over the past week, aside from US dollar weakness, no trend has been as apparent as the one in the Australian dollar. After breaking out of a range last Tuesday, the currency rallied for seven days straight and hasn’t looked back. The central bank has been very positive about the outlook for the Australian economy as well as the country’s ability to weather the global financial turmoil. Economic data in Australia has also been decent, the labor market remains tight and they are benefiting from the high level of gold prices. This has also helped to take the New Zealand dollar higher despite the fact that New Zealand reported a wider than expected trade deficit last month. The New Zealand dollar will be in play tonight with building permits, current account, money supply and business confidence due for release. The pair is hovering near resistance and tonight’s numbers could trigger a breakout. Meanwhile the Canadian dollar is still hovering around parity with the US dollar. There will be no CAD data until Friday.

British Pound Extends Weakness
The British pound continued to weaken against both the Euro and US dollar despite slightly stronger UK economic data. Second quarter GDP was right in line with expectations on a quarterly basis, but the annualized figure was revised up from 3 to 3.1 percent. The current account deficit also narrowed from –GBP11.5B to –GBP9.1 billion. Continued bearishness in the pound, particularly against the Euro, is a direct result of concern for the UK banking sector. According to the Bank of England’s Q2 to Q3 credit conditions survey, 49.3 percent of lenders are expected to cut credit supply over the next 3 months compared to 20.2 percent. Nationwide house prices are due for release tomorrow along with consumer confidence. Both are expected to deteriorate modestly.

Japanese Yen Crosses Follow the Dow Higher
With the Dow up close to 100 points, the Japanese Yen has weakened against all of the major currencies. As we have said, the Yen will move almost predominately to the tune of the Dow and nothing else. Last night, the Japanese trade balance was much stronger than expected. The market was looking for the surplus to shrink from Y671.2B to Y235.5B but instead it rose to a whopping Y743.2B. It mattered little that exports saw the fastest pace of growth since November 2002. Instead, Yen trades should keep their eyes on the Dow.

Kathy Lien is the Chief Currency Strategist at FXCM.