Dollar Rally Set To Continue

The recoveries in the US dollar and equities have been very impressive. In yesterday’s column, we said that “despite today’s move, the dollar’s rally may not be over.” Gold continues to provide a strong indication of the market’s risk appetite and dollar sentiment. If you want to figure out if investors are really nervous, just take a look at gold. Today, gold prices have fallen by another $10 to $919.00 an ounce. This suggests that the dollar’s rally is set to continue. There could and will probably be retracements, but the overall trend of the dollar is up. As previously indicated by the bounce in the University of Michigan consumer confidence numbers, sentiment in the US has improved according to the Conference Board’s survey. Although jobs are increasingly “hard to get,” consumers are starting to accept the current state of the US economy as the way of life. This does not mean that the troubles are behind us because house prices in May fell by the largest amount on record. Going forward, the stability of the US economy will depend on oil prices staying low. Crude is trading at approximately $121 a barrel and as long as it remains at current levels or falls further, inflation and inflation expectations will ease. Not only will this loosen the noose for central banks around the world, but it will also provide respite for consumers and businesses. In turn, this will add further fuel to the dollar which we expect to break 1.55 against the Euro and at least 109 against the Japanese Yen. However keep in mind that even if the dollar is rallying, it does not necessarily mean that the US economy is stabilizing. Instead, it represents a realignment of expectations. The weakness of the US economy has already been priced into the market, but the deterioration in places like the Eurozone, New Zealand and the UK is catching many traders by surprise. This has triggered weakness for the Euro, New Zealand dollar and British pound. Looking ahead, the ADP Employment report is due for release tomorrow. The market expects private sector employment to fall by 60k jobs. Although the report is a leading indicator for non-farm payrolls, traders need to be careful of relying solely on this report since it can have a shaky track record.

Euro Headed Below 1.55

The Euro took a nosedive today as the US dollar strengthened across the board. As expected, inflation in Germany held at a 12 year high with consumer prices rising by 3.3 percent last month (the EU Harmonised rate was 3.4 percent). It is encouraging that inflation did not continue to rise and given the trend in food and energy prices over the past month, we may have seen the high in CPI. French consumers are joining their German counterparts in growing more pessimistic about the outlook for growth. Tomorrow, we are expecting consumer confidence for the entire Eurozone as well as retail PMI. Given the recent trend of Eurozone economic data, we expect more disappointments. We could just be at the beginning of a major dollar rally. According to our Technical Analyst Jamie Saettele, not only is the Euro headed below 1.55 but the target for this latest wave of weakness is 1.5283. Meanwhile the Swiss economy is headed in a completely different direction. The UBS Consumption Indicator rebounded strongly in June, to the highest level in 4 months.

British Pound Falls as UK Consumers Cut Back

The deterioration in the UK economy is intensifying. According to the Confederation of British Industry, retail sales dropped to the lowest level in 25 years last month as higher gasoline prices, job losses and falling house prices prompted Britons to cut their discretionary spending. As a big contributor to GDP, the latest survey of the retail sector points to the potential of a sharp deterioration or negative GDP growth in the coming quarters. Consumer credit, mortgage approvals and net lending on dwellings have also fallen, reflecting the tough conditions in the UK housing market. Yesterday, Hometrack announced that house prices dropped by the most in 7 years last month. The GfK consumer confidence survey is due for release tomorrow evening. The drop in retail sales suggests that consumer spending will take a big hit as well, dragging the British pound lower.

More Bad News Out of Australia and New Zealand

The Australian, New Zealand and Canadian dollars all fell under the weight of broad dollar strength and lower commodity prices. However, news out of Australia and New Zealand has also weighed on the currencies. Leading indicators in Australia dropped 0.1 percent in May, reflecting a gradual slowdown in the Australian economy. The big news however was from New Zealand, where a finance company has suspended withdrawals and new investments. They are not first to do so, Canterbury Mortgage Trust, New Zealand’s second largest mortgage fund announced similar measures last week. Looking ahead, we continue to expect the New Zealand economy to deteriorate. Canada has industrial product and raw material due for release tomorrow – inflation should remain hot.

USD/JPY Hits 1-Month High

The US dollar hit a one month high against the Japanese Yen on an intraday basis. Despite the 266 point rally in the Dow Jones Industrial Average, which completely erased the prior day’s drop, the only Yen crosses to follow suit were USD/JPY and CAD/JPY. Japanese economic data was mixed with the jobless rate rising, but household spending beating expectations. Despite the improvement, Japanese retail sales are still negative, reflecting the problems in the overall economy. Labor cash earnings are due for release this evening, but as usual, Japanese data should only have a limited impact on the Yen.

Kathy Lien is the Chief Currency Strategist at FXCM.