US Dollar: End of Quarter Flows

When the European markets opened for trading this morning, the greenback came under the same brutal selling pressure that we have seen throughout the previous trading week. The US dollar even fell to a new 25 year low against the Australian dollar, but quarter end flows quickly hit the markets, helping the dollar recover all of its earlier losses. Today is the end of the second quarter and also the end to the first half of the year. Although 2008 has been marked by dollar weakness, the dollar’s performance in the second quarter has been mixed. It is virtually unchanged against the Euro, down more than 5% against the Australian dollar and up more than 5% against the Japanese Yen. Interestingly enough, the Yen and not the dollar has been the worst performing currency this quarter. The Japanese Yen has fallen against every major G-10 currency. It is going to be a very active week for the currency market. The ECB interest rate decision and the non-farm payrolls report collide to create the perfect storm for the US dollar. What ECB President Trichet says about future rate hikes should be more important than the non-farm payrolls report, unless of course job losses are more than 100k. Chicago PMI was slightly stronger than the market expected, but still in contractionary territory. This suggests that the national ISM manufacturing index, which is due for release tomorrow, should continue to trend lower. The Philly Fed, Empire State and Richmond Fed manufacturing indices have all fallen sharply, painting a grim outlook for the US manufacturing sector. The rise in energy prices is now offsetting any stimulative effects from a weaker dollar. Going forward, we expect more US companies to struggle with the difficulties of containing costs as oil prices climbed to an intraday high of 143.67 a barrel.

Euro: Alternatives for the ECB

A 25bp interest rate hike by the European Central Bank on Thursday has been completely priced into the market, but there are increasing signs that the central bank may have to raise interest rates beyond July. The estimate for Eurozone consumer prices for the month June is 4 percent, double the ECB’s 2 percent inflation target. This spike in inflation complicates the central bank’s task on Tuesday. Up until now the ECB has openly hinted that a rate hike in July will one-off, but with inflation pressures continuing to increase, can they really increase interest rates by only 25bp this year? Probably not. We believe that Trichet is mulling over 2 additional alternatives for Thursday. He could proactively clamp down on inflation by raising interest rates 50bp or he can raise interest rates by 25bp and leave the door open for another rate hike this year. Closing the door completely could be mistake especially if oil prices continue to rise. German retail sales and employment numbers are due for release tomorrow. Given the sharp drop in the retail PMI index, consumer spending in Germany should remain weak. Swiss PMI is also due for release. The dovish comments from the Swiss National Bank suggest tepid manufacturing activity.

British Pound: Consumer Confidence Hits Record Low

The British pound lost ground against the US dollar as economic data confirmed further softening in the UK economy. GfK Consumer Confidence hit a record low as worries of high oil prices, turbulent housing market and tight lending conditions took its toll on the locals. Markets reacted sharply to this unexpected drop, as the realization of turbulent times ahead dawned on investors. Record low Mortgage approvals raised further concerns amongst traders who know that the UK housing market is the Achilles heel of the UK economy. Looking ahead, Nationwide Housing Prices and Manufacturing PMI figures are expected to show further weakness, but we actually think that the manufacturing data could improve given the rise in the CBI industrial trends survey. If this is true the British pound should continue to rally.

Australian Dollar Hits Fresh 25 Year, Canadian Dollar Collapses

The Australian Dollar hit a fresh 25 year high against the greenback before reversing violently to end the day lower. Expect the volatility in the Aussie to continue with manufacturing sector PMI and the Reserve Bank of Australia interest rate decision scheduled for this evening. Even though the RBA is not expected to alter interest rates, the recent price action of the Australian dollar suggests that the market expects hawkish comments from the central bank. According to the TD Securities inflation index, price pressures continue to grow, which validates the recent speculation. Meanwhile the New Zealand dollar is the only commodity producing country to end the day stronger against the greenback. Business confidence has improved significantly with the NBNZ confidence index increasing from -49.7 to -38.7. The Canadian dollar on the other hand completely shrugged off its better than expected Q2 GDP numbers and higher oil prices. Profit taking on the last trading day of the year and ahead of Canada day (Tuesday) is the only reason to explain today’s move.

Japanese Yen: Quarterly Tankan Report on the Calendar

The volatility in the Dow has caused a significant amount of volatility in the Japanese Yen crosses. The US dollar broke below the 105 level shortly after the London open but ended the day higher against the Japanese Yen. Aside from NZD/JPY, the other Yen crosses ended the day the lower. The JMMA Manufacturing PMI figures fell to a 6 year low, along with depressed Housing Starts and Construction Orders. Looking ahead, the Quarterly Tankan report which measures business confidence is due for release. Given the slowdown in the global economy, the market expects business confidence to deteriorate materially.

Kathy Lien is the Chief Currency Strategist at FXCM.