US Dollar
Continuation was todayâ,"s main theme as oil prices held below the $60 mark while stocks continued to rally, allowing the US dollar to shrug off weaker US economic data to register more gains despite signs of slower growth. It seems like dƒ©jƒ vu as the market banks on the direction of oil prices once again. During the first quarter, the hope was that rising oil prices would deliver more interest rate hikes. This time around, the hope is that lower oil prices will save the US economy by boosting consumer spending. Unfortunately it is too early to tell whether this will be true since the September retail sales report is not due until next week. Nonetheless, the drop in oil prices should lead to a softer landing for the US economy rather than a hard one. Although Federal Reserve Chairman Ben Bernanke failed to make any direct comments about monetary policy in his speech today, he did say that inflation is an ongoing risk which sounds more like an attempt to neutralize his comments about how closely the Fed is watching the housing market for indications on how a â,"substantial correctionâ, will impact economic growth. The sharp drop in the prices paid index of the service sector ISM report confirms that inflation is becoming less of a problem, especially after a similar drop in the manufacturing ISM report. This drove the headline index down from 57.0 to 52.9, the lowest level since April 2003. We continue to believe that the odds for the Federal Reserve to resurrect its interest rate hikes are next to zero and the possibility of a rate cut early next year is growing. In todayâ,"s Wall Street Journal there is a report on the number of hedge funds that have been blowing up. We have been warning recently that increased hedge fund blowups could raise the risk of a banking crisis. Only the large ones are reported by the press of course, but small ones should not be ignored. According to the paper, more than 1000 hedge funds have shut their doors in the past two years. The latest at risk hedge fund is Vega Asset Management, which use to be one of the worldâ,"s largest. From their peak two years ago, they are now down 75 percent and in this past September alone, they are down 11.5 percent. The Federal Reserve is juggling a lot at the moment, and it will be tough for them to continue to keep all of the balls afloat if oil stops being a solution and starts to become a problem once again.
Euro
Although the Euro ends the day weaker against the US dollar, it has recovered most of its earlier losses ahead of tomorrowâ,"s monetary policy announcement from the European Central Bank. The market currently expects the ECB to raise interest rates to 3.25 percent and to signal that they will deliver another rate hike on top of that by the end of the year. Even though the rate hike is pretty much a guarantee, the hawkish comments from Trichet are not. Recent economic data have been very mixed. This morning, we saw stronger retail sales in the month of August, but a weaker service sector PMI report. Overall, growth has been decelerating along with inflation. Yet none of the ECB members have backed off from their hawkish stances. This quietness from members of the central bank lead us to believe that they may still be trying to stick to their mission of normalizing interest rates and in doing so, may opt for more rate hikes even if it means that it could pose a risk to growth. This uncertainty makes Trichetâ,"s comments tomorrow exceptionally important. The trading range in the Euro continues to narrow which means that any unexpected comments from Trichet could bring some excitement back into the markets before Fridayâ,"s non-farm payrolls report.
British Pound
The British pound has tracked the movements of the Euro today as it spent the US session recuperating nearly all of its earlier losses. Economic data released this morning were mixed with the service sector PMI and Halifax house price reports accelerating but the BRC shop price index and wage growth slowing. There is nothing significant to worry about however as the labor market is continuing to improve along with the housing market. The Bank of England is meeting to decide on interest rates tomorrow. No changes are expected after their surprise rate hike in August.
Japanese Yen
Whenever we hit extreme levels in the Japanese Yen, there is always talk of the Bank of Japan checking rates. The central bank is very active in the market and checks rates often, but just because they do so does not mean that they will take action. When the yen is strong they are far more likely to intervene than when the yen is weak. Companies like Toyota and Nintendo recently reported increased sales thanks to the weakness of the yen and we suspect the same of many more Japanese corporations that do business internationally. The new government under Prime Minister Abe probably has a strong interest in boosting growth quickly in the economy to prove that he can do good for his country and one of the easiest ways may be to let the yen remain weak in hopes that stronger corporate profitability will eventually filter into stronger growth for the country as a whole. This may also be part of the reason why Abe was quick to refute comments made by his Finance Minister Omi yesterday. Abe said that deflation has not been eradicated even though they are close to doing so. Like a weak yen, low interest rates also has a beneficial impact on the economy.
Kathy Lien is the Chief Currency Strategist at FXCM.
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