Dollar Gains as Oil Drops More Than $4, Slightly Better Fundamental Outlook

There have been solid gains in the US dollar against the Euro, British pound, and Canadian dollar. Will these moves continue? It appears that this could be the case. The first factor working in favor of the greenback is oil, as the downgrade of Hurricane Gustav to a Category 2 status sent crude oil futures down more than $4/bbl. It is worth noting, though, that trading may be subject to exceptionally volatile moves due to light volumes as the US observes the Labor Day holiday. Traders should also keep global fundamental factors in mind this week. While conditions in the US are by no means “good”, indicators released this week are likely to suggest that the economies of the Euro-zone and UK (among other regions) are in a significantly worse place relative to the US. Surely, with the US unemployment rate picking up at a rapid pace and the housing sector still in shambles, consumption is bound to wane further. However, short-term traders tend to keep the near-term picture in mind and over the next few days, ISM manufacturing and ISM services are both anticipated to hold steady while a bevy of foreign rate decisions (including the ECB, BOE, RBA, and BOC) are likely to yield pessimistic comments by the world’s central bankers and possibly even a rate cut. As a result, I will hold a bullish fundamental bias for the US dollar over the next few days against most of the majors (except the Japanese yen).

British Pound Tumbles 200 Points to 1.80 as UK’s Darling Sounds the Recession Alarm

The British pound started out on a weak note at the start of trading on Sunday, as the currency plunged 200 points versus the greenback following the release of comments by UK Chancellor of the Exchequer Alistair Darling from an interview with the Guardian newspaper. During the interview, Mr. Darling said that the UK economic conditions “are arguably the worst they've been in 60 years” and that the slowdown may be “more profound and long-lasting than people thought.” Looking at the latest economic data, there’s little reason to doubt Mr. Darling’s dour sentiment. The August reading of the purchasing managers’ index (PMI) for the manufacturing sector reflected a contraction in business activity for the fourth consecutive month, though the index did rise slightly to 45.9 from 44.1. Meanwhile, the Bank of England’s reading of mortgage approvals fell to 33,000 in July, marking the lowest level since record-keeping began in 1999. Overall, there are literally no bright spots on the horizon for the UK economy, but nevertheless, the Bank of England is widely expected to leave rates unchanged at 5.00 percent on Thursday. However, it is also widely known that the central bank has sought to maintain a hawkish stance against inflation in an effort to keep the public’s expectations in check. Thus, a rate cut may not be on hand this week, but with Credit Suisse overnight index swaps pricing in over 75bps worth of cuts within the next 12 months, it’s simply a matter of time before the Bank Rate comes down.

Australian Dollar: What Impact Will the RBA Rate Decision Have?

The combination of a strong US dollar and weak commodities have helped drive the Australian dollar, New Zealand dollar, and Canadian dollars start the week on a soft note. As we mentioned in our discussion of the US dollar, the downgrade of Hurricane Gustav to a Category 2 status sent crude oil futures down more than $4/bbl. While the threat of the storm did force significant cutbacks in production at oil and natural gas facilities, there has been little reported damage to drilling rigs and refineries in the oil-rich Gulf of Mexico, so production should be able to return to normal after the storm. However, the Reserve Bank of Australia’s upcoming rate decision should be a major driver for the Australian dollar (and thus, the New Zealand dollar since the two currencies have a positive correlation). A Bloomberg News poll shows that 22 of 23 economists surveyed expect the RBA to cut rates by 25bps to 7.00 percent. This would mark the first reduction in the central bank’s Cash Target since December 2001, as they have long sought to quell rising inflation stemming from robust domestic demand. However, with the Australian economy showing broad signs of weakening, the RBA appears to be ready to put down their guard. A rate cut of 25bps has the potential to weigh quite a bit on the already-weak Australian dollar, but if the central bank surprisingly leaves rates unchanged at 7.25 percent, the currency could easily spike higher. Indeed, Credit Suisse overnight index swaps are pricing in over 100bps worth of rate cuts within the next 12 months, which has helped drive AUD/USD down almost 1,200 points from 25+ year highs since mid-July. If we see any sort of shift in these expectations, the currency is apt to change course. Nevertheless, my fundamental bias for the Australian dollar overnight remains bearish. The 0.8500 level presents solid support for AUD/USD, but a rate cut by the RBA could trigger a break lower.

Euro: Commerzbank to Acquire Dresdner Bank – Better Competition, More German Job Losses

European economic data released early this morning revealed much of the same story we’ve been seeing for a while: the region is experiencing a marked slowdown, if not nearing recession. The purchasing managers’ index (PMI) for the Euro-zone manufacturing sector was confirmed at 47.6, signaling contraction for the third consecutive month. Meanwhile, German retail sales fell for the second month in a row, slumping 1.5 percent in July. As a good leading indicator for Euro-zone retail sales, the broader report is likely to disappoint upon release on Wednesday morning at 5:00 EDT. Perhaps the bigger story, though, was news that Commerzbank has agreed to acquire German rival Dresdner Bank for 9.8 billion euros. This would effectively allow the former to become a stronger competitor for their chief domestic rival, Deutsche Bank. However, the move is also expected to result in approximately 9,000 job losses. Furthermore, according to the Wall Street Journal, the transaction has the potential to “trigger further consolidation in a country blanketed with more than 2,000 financial institutions.” Clearly, this is good for business, but not necessarily good for a weakening labor market and slowing consumption.

Japanese Yen Gains Despite Abrupt Resignation by Japanese PM Fukuda – Why?

On Monday, the second Japanese Prime Minister in a row quit after less than a year in office. PM Yasuo Fukuda unexpectedly announced his resignation, as he said that efforts to overhaul the economy were unable to overcome a split parliament. The news came after the Asian markets closed, so volatility in Japanese equities but especially Japanese bonds could pick up during the opening of tonight’s Asian trading session. Nevertheless, we know that risk sentiment remains the primary driver of the Japanese yen. How? Political turmoil has recently emerged and Japanese economic data has been absolutely abysmal, yet the low-yielding currency has remained strong against its foreign counterparts. With global credit risks remaining high and equity markets susceptible to sharp decline, traders aren’t rushing to pile into the carry trade quite yet. My bias for the Japanese yen going forward: bullish.

Terri Belkas is a Currency Strategist at FXCM.