Euro: ECB President Trichet’s Comments Could Shake Up the Markets, Expected to Leave Rates At 4.25%

The euro remained a laggard this morning as Euro-zone GDP in the Euro-zone was revised down to match a 3+ year low of 1.4 percent in Q2 from a year earlier from 1.5 percent. Furthermore, Euro-zone retail sales fell more than expected by 0.4 percent in July (something we forecasted in yesterday’s Daily Fundamentals). Nevertheless, the key to the euro this week will almost certainly be the European Central Bank’s policy meeting. They are widely anticipated to leave rates steady at 4.25 percent, but as usual, ECB President Trichet should be the bigger market-mover as his commentary tends to be biased and direct. In fact, the latest EUR/USD bear leg was sparked by his comments on August 7, as he turned his attention away from inflation to slowing growth. Since the ECB’s last meeting, evidence continued to point toward a sharp economic slowdown, while CPI estimates for August unexpectedly slipped to an annualized rate of 3.8 percent, down from the official July reading of 4.0 percent. That said, CPI is still well above the ECB’s 2 percent target. The news is in line with Credit Suisse overnight index swaps, which are pricing in just over 25bps worth of rate cuts within the next 12 months. In the end though, Mr. Trichet’s comments could prove to be a non-event, as his stance in unlikely to shift dramatically from last month.

US Dollar Rally Shows Signs of Pausing, ISM Serves Expected To Signal Contraction

The US dollar may have ended the day higher against many of the majors, but there are indications that the tide may be turning for the greenback. First, the plunge in crude oil futures - which has supported much of the dollar’s gains - has started to cool down. Next, Credit Suisse overnight index swaps, which priced in 62bps worth of Federal Reserve rate hikes over the next 12 months on Tuesday, have backed off to price in 49bps as of Wednesday’s close. US economic news proved to be a non-event, as the Fed’s Beige Book was similar to previous releases, noting that consumer spending is weakening while price pressures remain an issue for most industries. Thursday’s US data, however, should be a bit more market-moving with ISM non-manufacturing (services) scheduled to be released. This figure has held below the critical 50 level – signaling contraction – during 5 of the past 7 survey periods, and unfortunately for dollar bulls, ISM services is anticipated to hold at 49.5 in August. The key to the currency’s reaction, though, is where the index stands relative to 50, as a push above there could trigger another rally for the greenback while a sharper contraction could spark dollar sell-offs. The other factor to watch is the employment component, as this tends to be a good leading indicator for Friday’s US non-farm payrolls. My fundamental bias for the US dollar through the end of the week: bearish. I do think the ECB and BOE rate decisions bear watching though. As we saw last month, ECB President Trichet’s comments can spark wild volatility market-wide.

British Pound Awaits BOE Rate Decision – Will They Consider Cutting Rates?

The British pound ended the day slightly lower versus the US dollar, and is down almost 2.5 percent from last week’s close. There was no data on hand today, but bearish sentiment on the currency is proving hard to shake, especially since Credit Suisse overnight index swaps are pricing in almost 100bps worth of cuts within the next 12 months. While the Bank of England is widely anticipated to leave rates unchanged at 5.00 percent on Thursday, I think there is some potential for a surprise rate cut. Commentary by Bank of England policy makers and government officials suggests that many are truly worried that the UK is headed for recession, and it’ll be worth watching to see of MPC member David Blanchflower will remain the lone dove of the group, or if the sharp economic slowdown will convince others to vote for a reduction in the Bank Rate as well. Unfortunately, if the central bank leaves rates unchanged, no policy statement will be released and traders will have to await the release of the minutes from the meeting on September 17 for a glimpse at the vote count.

Commodity Dollars Ready to Rebound? Bank of Canada Leaves Rates at 3.00%

From a technical perspective, it appears that commodity currencies like the Canadian dollar, Australian dollar, and New Zealand dollar may all be due to recoup some of their massive losses. Indeed, AUD/USD has run into trendline support going back to 3/2006, NZD/USD has held up above a rising trendline going back to late 2001, and USD/CAD has backed off from falling trendline resistance going back to mid-2004. Likewise, the plunge in commodities may be slowing down, as WTI crude oil futures were down as much as $2.50 on Wednesday, but ended the day down $0.35 at $109.38/bbl, right near the 200 SMA. From a fundamental perspective, the only real contributing forex market-mover was the Bank of Canada’s rate decision. While they did not change the Bank Rate from its current level of 3.00 percent, the Bank’s Governing Council said that rates are "appropriately accommodative," suggesting that they had no intention of even considering reducing rates. This runs counter to Credit Suisse overnight index swaps, which are pricing in approximately 50bps worth of cuts within the next 12 months, and explains why the Canadian dollar rallied on the news. In the next 24 hours, there is little event risk on hand for the Loonie, Aussie, and Kiwi, but given technical factors my bias is for the commodity dollars to recover further through the end of the week.

Japanese Yen Strong Against High Yielders As Carry Trades Sell-Off

We know that risk sentiment remains the primary driver of the Japanese yen because political turmoil has recently emerged and Japanese economic data has been absolutely abysmal, but yet the low-yielding currency has remained strong against its foreign counterparts. This remains the case, as the currency gained across the majors, but especially so against the high-yielding Kiwi and Aussie dollars. What gives? 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 versus most of the majors: bullish.

Terri Belkas is a Currency Strategist at FXCM.