US Dollar Rockets Higher As Investor, Consumer Confidence Surprisingly Improves

The US dollar rebounded across the majors as the financial markets speculated that the Treasury’s bailout bill would be approved by the US House of Representatives eventually, despite its failure on Monday. Meanwhile, overnight interest rates as measured by Libor surged in the US relative to other countries, providing more incentive for dollar bulls. Likewise, US economic data proved to be better than expected, as Chicago PMI fell less than estimated to 56.7 from 57.9. The bigger surprise, though, came in the form of sentiment indicators, as the Conference Board consumer confidence index actually improved during the month of September to 59.8 from a downwardly revised 58.5. This marked the third consecutive improvement, but looking at the report's breakdown, it is clear that we should remain cautious going forward on the continuation of this strong trend. Indeed, the current condition and outlook figures were clearly split. The present situation reading dropped to a new low with the labor differential dropping (a net 20.6 percent of respondents expect fewer jobs) and perceived business conditions slumped. Countering this, expectations improved for a third month. It’s worth noting that this survey’s cutoff date was on September 23rd, so it may not accurately reflect consumers’ responses to the credit crisis and the House’s vote down of the bailout bill.

Looking ahead to Wednesday, the release of ISM Manufacturing presents a good amount of event risk for the US dollar as the index is forecasted to slip further below 50, signaling a contraction in business activity for the second consecutive month. The news could weigh on the US dollar slightly, but as I mentioned yesterday, going forward, the fundamentals on the other side of the coin – such as emerging recessions in the UK, Euro-zone, Australia, New Zealand, and Japan – presents potential for the greenback to recover.

Euro Tumbles As Weaker CPI Adds to Speculation of ECB Rate Cuts – Will They Do It?

The euro crumbled versus the US dollar on Tuesday as Eurostat’s estimate of September CPI eased in line with expectations to an annualized reading of 3.6 percent. This isn’t incredibly surprising as we’ve seen lower commodity prices have helped to cool global inflation pressures, and as a result, the data added to speculation that the European Central Bank’s next policy move will be a rate cut. Furthermore, just yesterday we saw indications of spreading financial problems. Belgium, the Netherlands and Luxembourg invested 11.2 billion euros in Belgium’s largest financial-services firm, Fortis, while Germany’s Hypo Real Estate, the country’s second-biggest commercial-property lender, received a 35 billion euro loan guarantee in order to provide liquidity. As a result, Credit Suisse overnight index swaps are pricing in just over 75bps worth of reductions during the next 12 months. So will we see a cut this Thursday when the ECB announces their next policy decision? According to a Bloomberg News poll, all of the 58 economists surveyed say no. While there are significant risks to the Euro-zone financial markets and economies, CPI is still well above the ECB’s 2.0 percent target. Since the ECB’s primary mandate is to maintain price stability, a rate cut would put their goal of cooling inflation pressures in jeopardy.

British Pound Plunges 300 Points For Second Day On Confirmation Of Q2 Economic Stagnation

The British pound remains under significant pressures as evidenced by the 300 point decline against the US dollar on Tuesday, as traders recognize what dire conditions the UK economy faces. While the annualized rate of Q2 GDP growth was revised up to a final reading of 1.5 percent, this was still the weakest reading since 1992. Furthermore, the quarterly rate – which reflected a complete stagnation in growth – was not revised from initial estimates. Indeed, the lingering financial crisis and waning foreign demand served to curb investment, construction and industrial production. Things are only expected to get worse, especially given the nationalization yet another bank - Bradford & Bingley – on Monday. This was the second nationalization after the UK seized Northern Rock back in February. What do the markets think of this? Credit Suisse overnight index swaps are still pricing in over 125bps worth of rate cuts by the Bank of England (BOE) during the next 12 months. While the BOE is not anticipated to reduce rates at their next meeting on October 9, the sentiment alone could continue to weigh on GBP/USD.

Japanese Yen Slips On Improvement In Investor Confidence – Will It Be Short-Lived?

The Japanese yen was generally weak across the majors, especially against the US dollar – which surged across the board – and against high-yielders as stock markets rebounded. In fact, the DJIA ended the day up 4.68 percent while the S&P 500 rallied 5.27 percent. While this does not make up for all of Monday’s massive losses, it does signal somewhat-better investor sentiment. This may be a bit misguided though, as traders are essentially betting that the Treasury’s $700 billion bailout bill will eventually pass a House vote. What if it doesn’t? That seems to be something that the markets don’t want to think about at this point, but with the credit crisis still hitting the world’s financial markets quite hard, true financial stability is not likely to come soon. This leaves traders highly unlikely to pile back into the carry trade. My long-term fundamental bias for the Japanese yen: bullish.

Terri Belkas is a Currency Strategist at FXCM.