US Dollar, Euro: Who Needs Intervention When You Have ECB President Trichet?

If you didn’t believe the US dollar could last on Thursday, you probably changed your mind on Friday as the US dollar rally went on undisturbed and broke through critical resistance levels. Indeed, versus the Euro, the US dollar broke above the 200 SMA – an average that has served as strong support and resistance in the past – while the US dollar index surged above a rising trendine connecting the March, May, and June highs. Furthermore, as Quantitative Analyst David Rodriguez mentioned yesterday, forex positioning shows that traders are still selling the greenback across the majors. As a contrarian indicator, this points toward further US dollar gains. Just a few weeks ago, the currency was trading at record lows and speculation was mounting over what the possibility of physical or verbal intervention by the US.

However, ECB President Trichet has proven to be the tried-and-true market mover of the year, as his commentary following the European Central Bank’s rate decision on Thursday was really was drove this move by turning interest rate expectations in favor of the US dollar. Currently, the ECB holds their key rate at 4.25 percent while the Fed holds theirs at 2.00 percent. Two weeks ago, overnight index swaps were pricing in 16.5bps worth of rate hikes by the ECB within the next year and 64bps worth of increases by the Fed, which was on net EUR/USD positive. Now, though, swaps are pricing in almost 30bps worth of rate cuts by the ECB and 78bps in rate hikes by the Fed. Since the forex markets are driven primarily by interest rates, the shift in expectations was more than enough to spark the US dollar bullish breakout witnessed on Thursday and Friday.

With economic indicators in the Euro-zone only anticipated to deteriorate further, especially as next week’s Q2 GDP report is forecasted to reflect a 0.2 percent quarterly contraction, the Euro is likely to remain a laggard in coming weeks. Does this mean the US dollar has bottomed out versus the Euro? Not necessarily, but for now, the trend for EUR/USD is down and it is not a move to be ignored.

British Pound Suffers At Hand of Dollar Rally – Critical Support Near 1.90

Though there was no data on hand out of the UK on Friday, the British pound continued its descent versus the greenback. Like the Euro-zone, economic conditions in the UK look bleak as recent PMI reports reflect a three-month old contraction in the services, construction, and manufacturing sectors. Also like the Euro-zone, UK consumer prices are growing much faster than the central bank’s 2.0 percent target. However, unlike in the Euro-zone, the UK’s central bank has a dual mandate to maintain price stability and sustainable economic growth. As a result, it is far more logical to believe that the Bank of England’s Bank Rate will fall in line with the probabilities reflected by overnight index swaps, which are pricing in almost 50bps worth of rate cuts in the next year. While this may sound like enough evidence to sell the British pound, news out of the UK will go a long way to determine the currency’s next move. On Tuesday, UK CPI will hit the wires and on Wednesday, the BOE’s Quarterly Inflation Report will be released, though the latter is likely to be more important since forecasts for inflation and growth may be revised. Furthermore, critical support looms below near 1.90. Looking at the weekly charts, since breaking above the 200 SMA in June 2002, the level has served as solid support following multiple tests in August 2002, November/December 2005, January 2006, and March 2006. If GBP/USD breaks below this point, though, it will essentially signal that the pair topped out back in November 2007.

Gold, Oil Price Declines Weigh On Commodity Bloc, Loonie Hit By Labor Market Data

The commodity dollars like the Australian dollar, New Zealand dollar, and Canadian dollar all remained weak on Friday thanks to sharp declines in oil and gold prices and a lack of demand for yield. The Canadian dollar was also hard-hit by economic data, as the Canadian net employment change surprisingly plummeted by 55,200 versus expectations of a gain of 5,000. As I mentioned yesterday, “the employment component of the latest Ivey PMI report fell below 50 for the first time since December, indicating contraction. The last time this happened, the government release of the net employment change was surprisingly weak.” This particular economic indicator is actually one of the most tradable events in the forex markets, as the sentiment reflected in the release tends to have a sharp impact on the Canadian dollar. Looking ahead to next week, Australia faces the release of the RBA’s Quarterly Monetary Policy Statement, NAB Business Confidence, Westpac Consumer Confidence, and the Q2 Wage Cost Index. New Zealand will grapple with Q2 Producer Prices, Business PMI, and Retail Sales. Meanwhile, Canadian data includes Housing Starts, Int’l Merchandise Trade, and Manufacturing Shipments. Given the extent of the recent drop in the commodity dollars, pairs like AUD/USD and NZD/USD could be in for a short-term bounce next week.

Japanese Yen Surges As Carry Trades Remain Weak, USD/JPY Breaks Above 110

The Japanese yen rose across the majors on Friday, though the low-yielder actually weakened versus the greenback, as traders sell high-yielding and risky assets. In fact, many of the same factors we mentioned above that are weighing on the commodity dollars are doing the exact opposite for the Japanese yen, and we’re seeing that the correlation between EUR/JPY and the DJIA has faded. That said, all of these assets are still essentially range trading and consolidating the larger moves from earlier in the year, but there is potential for the Japanese yen crosses to plummet, with the exception of USD/JPY. Indeed, USD/JPY is trading on the whims of the greenback and will likely continue to do so within the next week of trading.

Terri Belkas is a Currency Strategist at FXCM.