US Dollar Hits Record Lows: What Could Stop the Bleeding?

The US dollar hit a record low against the Euro as risk aversion continues to seep through the global markets. Stock markets have sold off around the world on the fear that another financial market crisis could be right around the corner. Despite the Federal Reserve and US Treasury’s attempts to assuage the markets, traders are skeptical about whether the proposals they have offered and the measures that they have taken thus far are enough. The primary theme across the markets is a reduction of risk. The sharp intraday reversal in oil prices was due entirely to one bank taking risk off the table as most commodity market bets have been to the long side. The CBOE’s Volatility Index (VIX) also continues to climb, confirming that traders are nervous. In his testimony on the economy and monetary policy, Bernanke grew more concerned about growth but remained critical of inflationary pressures. He expects growth in the second half of the year to be “appreciably below trend” as weakness continues to hit various sectors of the US economy. Retail sales last month was much weaker than the market expected, with spending rising by only 0.1 percent. Stripping out gasoline receipts, retail sales actually dropped 0.5 percent. Discretionary spending has been seriously hurt by higher gasoline prices and a weak labor market, forcing consumers to cut back on purchases of cars, electronics, furniture and even food. However underscoring the Fed’s difficulties continues to be strong inflationary pressures. Last month, producer prices grew by the fastest pace on an annualized basis since 1981. The troubles in the financial sector have extended beyond Fannie Mae and Freddie Mac – the bigger fear right now is a repeat of IndyMac and Bear Stearns. Given current market conditions, forget about a rate hike this year. It is time for Bernanke to shift his focus from inflation back to supporting the financial markets and growth. What could stop the bleeding in the US dollar? A big surprise from the US government. At the end of the day, the Bush Administration will come up with something. It is clear that the government’s priority is to return stability to the financial markets. President Bush said this morning that the government has the power to expedite a recovery. Bernanke added that additional stimulus must be timely, albeit temporary. What the Administration needs to do is to restore confidence in the US financial markets and banking sector. Viable long term solutions include nationalization of the GSEs, give debt holders a haircut on rates, or a managed bailout in which stockholders, creditors, taxpayers jointly share the bill (these proposals are from Nouriel Roubini’s RGE Monitor). Meanwhile expect more potentially market moving US data tomorrow including consumer prices, industrial production, and the minutes from the last Fed meeting.

Euro Hits Record Highs as German Investor Confidence Falls to a Record Low

It is ironic that the euro soared to a record high even though German investor confidence hit a record low. The German ZEW survey, of analyst sentiment has been skewed towards pessimism for months, but the combination of the recent rate hike, surging inflationary pressures and weaker domestic and global growth sent confidence tumbling. Eurozone growth should weaken further in the coming weeks, especially with the Euro climbing to a new record high. The ECB has been mute about intervention but if oil prices continue to fall, they will probably start entertaining the notion. However for the time being, it is the US dollar that is driving the currency pair. Eurozone consumer prices are due for release tomorrow and Switzerland will be releasing their retail sales report. The market expects consumer spending to rise, which could lift the Swiss Franc for no other reason than the fact that the country could be doing comparably better than many other G10 nations.

British Pound Hits 3-Month High on Record CPI

The British pound strengthened against the US dollar and Euro as consumer prices hit a record high. Producers are passing on their highest costs to consumers because the rise in prices is not just limited to food and energy. This was much stronger than the market expected and well above the Bank of England’s 2 percent target. The annualized pace of CPI growth has now hit 3.8 percent. The BoE has already warned that inflation could rise above 4 percent. Meeting this prediction will not be enough to force the BoE to raise rates. House price growth remains near a 30 year low while retail sales took another dive in the month of June. UK labor market data is due for release tomorrow which could determine whether the British pound will hold onto its impressive gains.

Australian Dollar Hits New 25-Year Highs, Bank of Canada Leaves Rates Unchanged

The Australian, New Zealand and Canadian dollars continue to gain strength on bullish economic reports and US dollar weakness. The Bank of Canada left interest rates unchanged at 3 percent, which was right in line the market’s expectations but the BoC grew slightly more concerned about inflationary pressures. However like the BoJ, the BoC will not be altering interest rates anytime soon because US economic weakness and the ongoing turbulence in the global financial markets are keeping their hands tied. The New Zealand dollar was one of the market’s best performing currencies thanks to a sharp rise in consumer prices. CPI grew by the fastest pace in 18 years.

Japanese Yen Crosses: All Under Water

The volatility in US stocks has weighed on all of the Japanese Yen crosses. The Bank of Japan left interest rates unchanged at 0.50 percent, which was right in line with the market’s expectations, but they cut their economic forecast and raised their inflation projections. This had no impact on the Yen crosses however, which traded primarily on the wild swings in US equities.

Kathy Lien is the Chief Currency Strategist at FXCM.