US Dollar: The Triple Blow

The US dollar suffered a triple blow today from the lack of any direct comment about the dollar at the G8 meeting and weaker economic data. The Finance Ministers of the G8 nations have now relegated the task of talking about currencies to attendees of the G8 Summit in July since the communiqué made no mention about the need to strengthen the US dollar and instead focused on the threat that increasing inflation poses to economic growth. Going into the meeting, there were a lot of back and forth comments from unnamed G8 officials about the possibility of currency intervention, but with no central bank heads present, the chance of some major change to the FX language was minimal. Nonetheless some traders speculated that there could be a big announcement and have now reversed their dollar bullish trades. Adding to the selling this morning was the weaker than expected Empire State Manufacturing survey which fell for the fourth time in five months and the drop in the NAHB housing market index which matched its lowest level on record. This suggests that the problems in the housing market are not behind us and this news comes at a precarious time as the leading banks on Wall Street continue to report major losses. This morning, Lehman Brothers confirmed that they posted their first quarterly loss ever. There are now rumors that Lehman Brothers will either be forced to raise capital or seek a buyer. With Goldman Sachs and Morgan Stanley also set to report earnings this week, more bad news from the Financial Sector could weighs on stocks as well as the US dollar as traders realize that the summer of credit worries may be happening all over again. However it says a lot that the losses in USD/JPY and USD/CHF have been relatively mild today. This may be in anticipation of the producer price report tomorrow, which the market expects to be hot. If inflation proves to be strong and Goldman Sachs earnings, which will be released before the market opens is not as bad as the market may have feared, then the US dollar could resume its uptrend.

Europe’s Inflation Problems

Currency traders came face to face with the Eurozone’s inflation problems this morning when May consumer price figures were released. Although traders were already looking for inflation to rise, they may have not expected CPI growth to hit a 16 year high. These numbers validate the European Central Bank’s concerns about inflationary pressures and explain why they are in such a rush to raise interest rates. ECB members Tumpel-Gugerell and Papademos both warned about inflation risks and how the annualized pace of price growth will probably remain above 3 percent for the remainder of the year. The German ZEW survey is due for release tomorrow along with the trade balance. The trade deficit is expected to narrow following Germany’s better than expected trade numbers, but the odds are skewed towards weaker investor and analyst sentiment. High inflation and the threat of an interest rate hike could offset any optimism that may have stemmed from stable economic data.

Bank of England Could be Forced to Outline Plans to Curb Inflation

The British pound was hands down the best performing currency today as it rose against the US dollar, Euro and Japanese Yen. This was partially due to dollar weakness and the expectation that tomorrow’s consumer price figures will be hot. Like the rest of the world, the UK has not been immune to the sharp rise in crude, but one unique problem that Bank of England Governor King faces that his peers do not is the need to publicly explain himself. Consumer prices are currently at 3 percent and if it rises any higher than that, King will be forced to submit a letter to Chancellor Alistair Darling explaining why inflation has increased more than 1 percent above their 2 percent target and how he plans to bring inflation down. He is also required to give a timeline on when he plans on achieving this and that may include an interest rate hike. This is the only the second time ever that the central bank governor has written this letter of explanation to the Chancellor since the BoE was granted independence in 1997. Therefore expect this to be a big week for the British pound.

Oil Hits Record High, Canadian, Australian, and New Zealand Dollars Rise

Oil prices hit an intraday high of $139.89 a barrel, sending the Canadian, Australian and New Zealand dollars higher. Even though crude prices eventually reversed to end the day lower, the commodity currencies are still positive on the day. Part of the reason why the rise in oil prices did not stick is because there wasn’t one concrete reason to explain this move. Instead, the buzz in markets was that US dollar weakness, possible sanctions on Iran, a fire on a North Sea platform and option expiration was behind the move. In other words, the new record high in oil was once again, driven by speculators. This managed to take the focus of currency traders off of economic data which disappointed in both Canada and New Zealand. New motor vehicle sales fell 2.6 percent in Canada during the month of April while manufacturing activity slowed to 3.7 percent from 8.3 percent in New Zealand during the first quarter. Service sector PMI was slightly better than expected but still in contractionary territory.

USD/JPY Holds Onto Gains Despite Dollar Weakness

The market’s expectations for US interest rates seem to be best expressed through USD/JPY these days. Even though the US dollar weakened against all of the major currencies, the dollar managed to hold onto its gains against the Japanese Yen. Yen weakness was universal with the currency falling to the lowest level against the Swiss Franc in 17 years. A tiny minority expects a rate hike from the Swiss National Bank this week and if that is true, the currency pair may see further gains.

Kathy Lien is the Chief Currency Strategist at FXCM.