US Dollar: Is the Rally Over?

Though the US dollar started out the week by plummeting lower against the majors, the currency ended Monday virtually unchanged. For the most part, the forex markets were relatively quiet amidst minimal event risk, but that doesn’t mean that sharp moves aren’t on the way. My fundamental bias for the US dollar this week remains bearish, which is something I talked about in our forex trading weekly outlook. Furthermore, now that I’ve seen the latest COT positioning numbers, I’m even more convinced we’ll see a pullback in the greenback. Why? As Senior Strategist Jamie Saettele discusses in his analysis of the latest COT report, the 52 week index is up from 98 at 100, and the difference between speculators and commercials is its largest since late 2005. This suggests that while the greenback’s rally may not be over yet, the US dollar is close to topping out. In economic news, the NAHB housing index held steady at a record low of 16 in August, as homebuilders balked at building home inventories and persistently weak demand. In fact, looking ahead to Tuesday the release of housing starts is likely to reflect similar sentiment, as the index is expected to fall to a record low of 960K while applications for building permits should be similarly disappointing at 970K. The release of the US producer price index may garner a bit more attention, though, as a gauge of inflation pressures in the US economy. Headline PPI is anticipated to hit a record high of 9.3 percent, while the core measure is forecasted to jump to a nearly 17-year high of 3.2 percent. However, the markets are already well-aware that price pressures are growing in the US given the startlingly strong US CPI numbers last week, which could limit the data’s impact on the currency. As a result, the US dollar may be prone to continuing its consolidation on Tuesday, barring major surprises in the scheduled economic indicators.

British Pound Speculative Positioning Points Toward Rebound

The British pound failed in its early-morning test of 1.8700 as UK housing data continues to disappoint. Indeed, Rightmove home prices fell 4.8 percent in August from a year earlier, marking the sharpest decline since record-keeping began in 2002. Property values in the UK have been falling rather steadily throughout the year, as the start of the credit crunch in 2007 triggered an increase in mortgage rates and more stringent lending standards. Much like the US, the decline in UK home prices is impacting financial institutions, as assets related to mortgages rapidly fall in value. This is much of the reason why Bank of England Monetary Policy Committee members like David Blanchflower continue to vote for rate cuts, but with consumer prices accelerating faster by the month, the MPC will be hesitant to ignore their mandate to maintain price stability. As a result, the BOE is unlikely to cut rates before year-end. How will this impact the British pound? Well, at this point, the currency is simply oversold. Looking at the most recent COT positioning report, the British pound index is at a bearish extreme, indicating potential for a GBP/USD low to form. Consequently, while we could continue to see the pair consolidate above Friday’s lows of 1.8512, GBP/USD is due for a rebound toward 1.8900.

Euro Remains Heavy As Trade Balance Falls To Worst Deficit In 2 Years

The Euro remains heavy as it trades just above Friday’s lows of 1.4644, but like the British pound, forex positioning shows that the currency has hit a bearish extreme and is likely nearing a bottom. Economic did not aid the Euro in any way, as the Euro-zone trade balance plunged to -3 billion euros in June, marking the worst deficit in nearly 2 years. A breakdown of the report shows that surging oil prices were partly responsible for the deterioration in the balance, as they boosted the value of energy imports. Furthermore, the appreciation of the Euro relative to the US dollar dented American demand for European exports. Looking ahead to Tuesday, sentiment amongst Germany’s financial analysts is likely to turn more pessimistic in August, according to the ZEW survey. The figure is scheduled to be released at 05:00 EDT, and this indicator tends to be a significant market-mover for the EUR/USD pair on a very short-term basis. Given persistent inflation pressures, the marked slowing in the Euro-zone’s economies, and the European Central Bank’s increasingly pessimistic tone during the survey period, the ZEW reading is likely to fall in line with – if not more than – expectations.

Japanese Yen Strengthens On Lingering Risk Aversion, Ahead of BOJ Rate Decision

The Japanese yen appreciated against most of the majors, including the US dollar, Euro, and British pound, as hints of risk aversion remain. Indeed, many of the classic signs of deleveraging pervaded the markets, as the DJIA fell nearly 200 points, demand for Treasuries surged, and the CBOE Volatility Index (or the VIX) edged higher. What ignited this sentiment? A Barron’s article noted that it was increasingly likely that the government would have to bail out Fannie Mae and Freddie Mac, sending shares of the mortgage giants down more than 22 percent. As we mentioned last week, financial institutions are by no means in the clear yet, and as a result, the Japanese yen crosses remain at great risk for declines. Tonight, the Bank of Japan is widely expected to leave rates steady at 0.50 percent. While it is clear that economic growth in Japan is slowing dramatically and the threat of recession exists, rates are so low in the nation that the central bank has almost no room for maneuver when it comes to monetary policy. Nevertheless, risk trends tend to have far greater bearing on price action in the Japanese yen, so the upcoming rate decision shouldn’t have a big impact on the low-yielding currency.

Terri Belkas is a Currency Strategist at FXCM.