Dollar Benefits With An Outlook Just Better Than Its Peers

The U.S. dollar was relatively strong on Friday during a very volatile session where most traders decided to take profits ahead of the Labor Day holiday. To some extent, a rapid weakening of economic growth outside the United States continues to benefit the U.S. dollar against higher yielding currencies like the Australian dollar and against commodity currencies like the Canadian dollar. Indeed, the rapid deterioration of the Australian economy has prompted many investors to exit the so called carry trades and with the world economy slowing down is reasonable to think that the demand for Australia’s main commodities will also begin to dry up. Yet, although the U.S. economy looks in better shape than most of the world’s largest economies, one cannot say that everything goes well. In fact, consumer spending which accounts for more than two thirds of the U.S. economy, grew only 0.2 percent in July from 0.6 percent in June, the Commerce Department said today in Washington. This number comes without surprising since yesterday the U.S. Labor Department said that 425,000 people filed initial claims for unemployment during the previous week and its becoming clear that Americans continue to worry more about job security and falling house prices than about the need for items like automobiles or furniture. Nonetheless, the recent sell off in commodities continues to alleviate some downward pressure in the US economy. For instance, the National Association of Purchasing Management in Chicago said today that its index of business activity advanced in August to 57.9 from 50.8 in July. Moreover, the University of Michigan final index of consumer sentiment was at 63 this month, from 61.2 in July. Looking ahead, there is a 90% change the Federal Reserve will keep rates unchanged during its next monetary policy meeting, according to Fed Funds futures. However, the U.S. dollar is likely to rise further on speculation that other central banks could have to cut interest rates to prevent their country’s economies from falling into a recession.

Euro Ends The Week With Another Reason For The ECB To Consider Cuts

Though it is highly unlikely to happen during their meeting next week, the European Central Bank will move to rate cuts some time in the not-so-distant future. Though overnight index swaps are suggesting there is only one quarter point cut due over the next 12 months, the future of economic activity could easily make speculation for easing jump as long as recent trends hold up. Friday saw the release of the Euro Zone unemployment rate for July – one of the last bastions for a positive outlook; but ultimately doomed to follow broader economic trends. For a more realistic look into the health of the euro, this past week we had: a 2Q GDP reading from Germany confirming the beginning of a recession; business confidence at a 3 year low; consumer optimism at 5 year lows; and even German inflation that has pulled back from 12 year highs to 3.1 percent. Today we saw that the EZ’s CPI estimate for August finally pulled back from a 16 year high to 3.8 percent. Realistically, this figure is still miles beyond the ECB’s target rate; but they have already started to shift away from an inflation only outlook even when price growth was still pushing new highs. Now we look ahead to next week’s rate decision. The policy board is widely expected to hold the benchmark steady though there is always the public address to measure the shades of gray. Though the shifts in Trichet’s commentary is subtle, you can bet the market will pick up on each one and will be more than ready to base speculation on those nuances.

British Pound Ends The Month 1600 Points Lower

What a day, week and month for the British pound. For Friday’s close, GBPUSD ended with a fresh 13-month low. On the week, the pair dropped below a major 38.2 percent retracement of a 7-year trend. But, to really get the feeling for the health of the currency, a chart of the 1600-point plunge through August really reflects the position of the sterling. Is this a reasonable decline? Has it reached a point of exhaustion? The answer to the first question is: yes. For the past six months or so, the UK economy has eroded from beneath the currency as the housing sector fell into recession, consumer spending and confidence dried up, and trade ground to a halt. Despite this economic malaise, the sterling’s exchange rate with the US dollar held up – whether through a worst US outlook, technicals or trade interests we can’t tell. What we do know is that the pressure eventually won out. Now for the more important question: is the sterling oversold. It is hard to tell how over valued the pound was before prices collapsed. What is more obvious is that the outlook for economic activity is worsening. What truly matters if the outlook is worse for the UK than it is for the US. Another consideration is the rate forecast. Next week, the BoE will meet for what is expected to be a pass on the benchmark rate. Usually, when there is no change to rates, there are no comments. Nonetheless, speculation will follow.

Rate Decisions And Oil Prices Promise A Volatile Week For The Comm Bloc

The Australian, New Zealand and Canadian dollars ended the week mixed against their primary counterpart – the greenback. Taking the top seat for event risk on the day, the Canadian currency saw a steep 130 point drop Friday despite a rebound in oil prices. The impetus for the move was a weaker than expected 2Q GDP report and worrisome revision to the previous number. Growth in the 8th largest economy in the world grew at a mere 0.3 percent annualized pace through June as capital expenditures and exports failed. As for the revision, a 0.8 percent contraction marked the worst performance since 1991. This will give the BoC something to think about for their rate decision next week. On the topic of monetary policy, the RBA is the only central bank expected to deliver a change. A 25bp cut is forecasted and priced in; and the market is waiting. And, should central bank activity not be enough for volatility, Tropical Storm Gustav is threatening turmoil for oil prices.

Japanese Yen Fights The Dollar Trend

Though the Japanese currency couldn’t win a major breakout against the dollar before the week ended, it was able to push the pair to boundaries of its range. Data played a small role in this strengthening. Housing activity posted a sharp rebound, household spending cooled less than expected, retail trade averted a contraction, factory activity rose and core inflation surged. However, Japanese data has little impact on its currency; because a recession will be ushered in through trade lines rather than domestic trends. More important here is the failing carry trade. With global growth fading fast, rate differentials contracting and banking crisis looming; the carry is under constant threat.

Terri Belkas is a Currency Strategist at FXCM.