US Dollar Gains, But Don’t Call It A Comeback

The US dollar rose on Tuesday, but it was more of a technical retracement rather than a true rally as the majors failed to register any significant directional moves. Discussions about the US government’s $700 billion bailout plan dominated the headlines, as US Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke testified on the latest credit turmoil amidst harsh criticism from the Senate Panel. There wasn’t really anything new revealed in the testimony, though, as the heads of the Treasury and Fed were, for the most part, just taking the heat and pushing for lawmakers to quickly pass the rescue legislation for the sake of the health of the credit markets, labor markets, housing markets, and the economy at large. However, Mr. Bernanke did say that the Treasury should buy illiquid assets at “hold-to-maturity”' values rather than at “fire-sale” prices, as the shock of the low values would hurt already-jittery investor confidence.

Mr. Bernanke’s concern about stoking fears in the market is understandable as risk aversion clearly remains a problem in the markets given the approximately 1.5 percent declines in the DJIA and S&P 500, the robust demand for Treasuries, and the jump on the CBOE’s VIX Volatility index. Furthermore, we’ve seen that fed fund futures are still pricing in a decent chance of a 25bp rate cut at the end of October, but it’s worth questioning how reliable this measure is at this point. Indeed, we saw futures were pricing in a rate cut at the Fed’s September meeting, which didn’t come to fruition. It appears that the strong demand for Treasuries - which drives down Treasury yields - is impacting fed fund futures as well since they tend to rise and fall together. As a result, the fundamental view of the US dollar is a bit cloudy at this juncture, making technical factors in the forex markets even more important. Through the end of the week, I think we’ll see a bit of a consolidation period for the US dollar above the recent lows, especially as the trade-weighted dollar index has run into support at the 50% fib of 71.31 - 80.38, but additional declines are quite possible.

Euro: Is the Euro-zone Headed Straight Toward Recession?

The euro slipped against the US dollar as data out of Europe proved to be exceptionally weak. Indeed, the Euro-zone purchasing managers’ index (PMI) for both the manufacturing and services sectors fell below 50 - signaling contracting business conditions - for the fourth consecutive month. Even worse, the composite index slumped to a reading of 47, which is the worst reading since November 2001. The data suggests that the risks for a Euro-zone recession remains high, and is much of the reason why the markets are expecting at least one rate cut by the European Central Bank with in the next 12 months, according to Credit Suisse overnight index swaps (OIS). On the other hand, we need to keep in mind the fact that inflation in the region remains well above the ECB’s 2 percent target at 3.8 percent, and with their primary mandate being to maintain price stability, traders shouldn’t count on seeing that rate cut anytime soon. Looking ahead to Wednesday, the German IFO survey will be released and is expected to reflect more pessimistic business sentiment. However, last week’s German ZEW figures actually revealed an improvement in investor confidence, and as a result, there is potential for a surprise rise in this German IFO reading and a boost in EUR/USD on Wednesday morning.

British Pound Hits Resistance at 1.86 - Additional Declines In Store?

The British pound did little but consolidate between 1.85 and 1.86 during Tuesday’s trading session, which is nothing compared to the 200-400 point ranges we’ve been seeing lately. Nevertheless, the quieter price action suggests the bullish momentum that had pushed GBP/USD higher has died down for now. However, according to Senior Strategist Jamie Saettle’s Daily Technical Report, a drop in the pair toward 1.83/1.84 could present a buying opportunity as Cable is likely to ultimately target a zone of resistance at 1.88. Meanwhile, UK economic data has been just as dismal as one would expect with mortgage approvals, as measured by the British Bankers’ Association (BBA), plummeting 64 percent in August from a year earlier to 21,086. This is the lowest level since record-keeping began in September 1997, and highlights the severity of the housing collapse in the UK. This presents even greater risks to the UK economy and financial markets, but the Bank of England has thus far been relentless in their effort to keep monetary policy restrictive, as UK CPI has rocketed well past their 2 percent target and 3 percent ceiling in recent months. Regardless, this is an old story for the UK and with no key economic indicators scheduled for release this week, GBP/USD price action will depend more upon US dollar flows and technical levels.

Australian, Canadian, and New Zealand Dollars Fall on Broad Drop in Commodities

The commodity dollars pulled back versus the greenback on Tuesday, as the Australian dollar and New Zealand dollar both lost more than 1 percent. The move was in line with the broad drop in commodities like oil and gold, but had more to do with a sell-off in carry trades as risk aversion remains high. Furthermore, as we discussed in yesterday’s Daily Fundamentals, Monday’s record surge in crude oil futures was due to the fact that it was expiry day and traders were simply covering their positions, and thus the decline on Tuesday was not totally unexpected. The Canadian dollar managed to hold its ground, slipping only 0.25 percent against the greenback, as Canadian CPI numbers reflected a pick up in inflation pressures. Indeed, headline CPI rose to an annualized pace of 3.5 percent, marking a nearly 5 year high, while the Bank of Canada’s core measure accelerated to 1.7 percent from 1.5 percent. Nevertheless, Credit Suisse overnight index swaps are still pricing in at least one rate cut by the BOC within the next 12 months. There is no data on hand for the comm bloc in the next 24 hours, but traders should watch out for the release of New Zealand Q2 GDP on Thursday.

Terri Belkas is a Currency Strategist at FXCM.