Federal Reserve Versus the Market: Who Is Right?
The story of the day is not the US dollar but rather carry trades, which are up sharply on the back of the strength in the stock market. News that Citigroup received a $7.5 billion cash infusion from the Abu Dhabi Investment Authority has sent financial shares skyrocketing on the hope that the cash infusion will stabilize the banking giant that announced another round of job cuts on Monday. Unfortunately economic data indicates that even if this will help Citigroup, the US economy is not out of the woods. Consumer confidence fell to the lowest level since the series began in October 2005, following the destruction of Hurricane Katrina. With oil prices and adjustable rate mortgage payments rising, the consumer is really feeling the pinch of higher living costs. Consequently, this has prompted traders to fully price in a quarter point rate cut next month with a strong possibility of further easing in the first quarter of next year. However Fed officials need to wake up and realize the strain that the US economy is currently facing. As recently as this morning, Fed President Evans and Plosser downplayed recession risks. Evans said that the spending outlook is favorable despite the worries of traders and analysts while Plosser said that lowering interest rates could cause more harm than good because it would lead to significantly higher inflation pressures. Tomorrow we are expecting the Beige Book report, which could go a long way in telling us who is right, the markets or the Fed. If growth in the individual districts are deteriorating, then that would validate the market’s belief that the odds for a recession are growing. If the districts report stability, the Fed would prove to be the wiser ones. The market and the Fed have both been wrong in the past with the markets overly pessimistic and pricing in downturns that never happened and the Federal Reserve not acknowledging that the US economy has fallen into a recession until after it has happened. Therefore the only things that we can rely on are economic data and so far economic data supports the market’s belief and not the Fed’s.

Eurozone Data Supports Higher Interest Rates
Throughout the past few months the European Central Bank has been staunchly hawkish, refusing to bow to political pressure and market criticism. Today’s economic data gives us clear evidence of why they have chosen to act this way, because inflation pressures are a serious problem. This morning, German consumer prices were released and according to the numbers, inflation in November reached its highest level in 13 years. Not only are gas prices causing inflation, but also food prices and unfortunately, the strength of the Euro has not done enough to offset that pressure. Also, German business confidence remains unfazed despite the strong currency. To the surprise of the market, confidence for the month of November actually increased, ending a 6-month losing streak. French business confidence was also stronger than expected. These numbers come in stark contrast to the German ZEW survey of analyst sentiment, which fell to a 15 year low. The main reason why investors and analysts have been pessimistic is because they believe that the strong Euro will hurt the economy but so far it hasn’t. Businesses have also done a far better job of predicting the trend of the region’s economic health than investors and we expect this upper hand to continue. As for Switzerland, inflation pressures are actually subsiding with producer prices growing less than expected in October.

British Pound: Waiting for More Direction
There has not been that much action in the British pound over the past 24 hours because of the lack of UK economic data. Therefore the pound is unchanged against the US dollar but has strengthened against the Euro for the third consecutive trading day. For the British pound, traders are simply waiting for more direction on whether the Bank of England will actually be following through with the three interest rate cuts that the market is pricing in. The latest Bank of England minutes and the Quarterly Inflation Report has suggested to the market that the central bank is growing increasingly dovish, but the BoE is full of surprises. They are a very dynamic central bank that is keen to engineer a stable economy through monetary policy. However at the same time, they face the same inflation risks as the Eurozone, albeit by a smaller degree. Therefore until the BoE actually lowers interest rates or we get more economic data that necessitates them to do so, the British pound may continue to trade on US data and risk appetite.

USD/CAD Hits Parity, Australian and New Zealand Dollars Strengthen
Even though the Canadian dollar has been range trading over the past week, it has been extremely volatile on an intraday basis. We have seen swings of 50 to 70 pips within minutes at all hours of the day. We finally have seen the breakout that we are waiting for with USDCAD taking a stab at parity. It has not been able to hold onto those gains but we think that there could be another push higher before USDCAD meets it stiff resistance around 1.0125. With no Canadian data until Thursday, the currency is trading on the back of oil, which is off its highs. The Australian and New Zealand dollars on the other hand are stronger thanks to a 200-point rebound in the Dow.

Kathy Lien is the Chief Currency Strategist at FXCM.