Euro and Dow Hit Record Highs: More to Come?

· Euro and Dow Hit Record Highs: More to Come?
· Yen: Carry Traders are Not Giving Up Just Yet
· Canada and New Zealand Not Expected to Raise Rates Next Week

US Dollar- Led by the US dollar, it has been a record setting week in the financial markets. Today, on a closing basis, the dollar sunk to an all-time low against the Euro (the 1.3667 EUR/USD high is an intraday record), a 26 year low this week against the British pound, a 25 year low against the New Zealand dollar and a 16 year low against the Australian dollar. We also saw the Dow Jones Industrial Average hit a record high with the index ending the week 60 points shy of 13,000. The weakness of the US dollar has made US stocks exceptional values for foreign investors at a time when earnings by US companies are solid. According to Thomson Financial, of the companies in the S&P500 that have already reported earnings, 61 percent have beaten expectations, 19 percent have matched forecasts while only 15 percent disappointed. If this trend of earning releases continues, it will reassure both foreign and domestic investors that the odds for a recession are extremely low. The bulk of the US data released this past week still indicates that the economy is stable with housing starts increasing and consumer spending rising. However the week ahead brings for us a potential turn in the currency markets especially since many of the currency pairs have become severely overbought. We are expecting durable goods, consumer confidence, existing and new home sales along with first quarter GDP. Most of these pieces of US data are expected to be dollar positive. Yet, the US data will not be the only catalysts for a turn since the main driver of market activity over the past few weeks has been yield. We have rate decisions from Canada, New Zealand and Japan along with inflation figures from Australia. If currency traders have any reason to question the timing of rate hikes, the records hit this past week could mark a top in both the currency and equity markets.

Euro – The lack of concern that Eurozone Finance Ministers have for the current level of the Euro sent the EUR/USD to a record high on a closing basis. Despite the potential drag that the strong currency has on the export sector and overall growth, the Finance Ministers were more focused on the beneficiary impact that a rising currency has on inflation. They felt that barring any unexpected contraction in global growth, the economy would be able to handle a stronger currency. Although economic data has been solid with French consumer spending doubling expectations this morning, we remain skeptical about how much longer the Eurozone can grow at its current pace as we remember that the peak in late 2004 / early 2005 was triggered by a series of back to back disappointments in Eurozone data. Until we see these disappointments however, the Euro could continue to rise. Part of this will be contingent upon the German IFO report next week. The rally in the Euro has been driven by the market’s expectation that the ECB will raise interest rates as early as next month. Should the IFO report disappoint, the ECB may delay a rate hike until June, which could trigger a near term top in the EUR/USD. Aside from the IFO we are also expecting consumer price releases from Germany, Eurozone current account, industrial orders, and retail PMI. French elections are this weekend as well. Results will start coming out Sunday night. A victory by Sarkozy could be short term bearish for the Euro. Read more about this in our special report, What Could the April 22 French Election Mean to the Euro. Meanwhile Switzerland reported slightly stronger producer prices in the month of March. Even though the monthly pace of growth remained unchanged, the annual pace rose from 2.2 percent to 2.4 percent. In the week ahead, we are expecting the UBS Consumption Index and KoF leading indicators.

British Pound – After hitting a 26 year high on Wednesday, the British pound has been struggling to hold above the psychologically important 2.0 level. For the first time this week, we had disappointing UK economic data. Retail sales fell short of expectations, with consumer spending rising by only 0.3 percent in the month of March. Even though, sales in the month of February were revised higher, this inkling of weakness was enough to tempt GBP/USD bulls to take profits ahead of the weekend. Overall the UK economy remains strong and we do not believe that the latest piece of UK data will alter the Bank of England’s plans to tighten monetary policy again this year. Bank of England Governor King was on the wires this morning confirming that the central bank is “absolutely determined” to bring inflation back down to 2 percent. He went on to say that they will stop until they see a peak in consumer prices - comments from a central banker do not get much more hawkish than that. The UK calendar is just as busy next week as it has been this past week. We are expecting more housing data, money supply, CBI industrial trends and the first release of first quarter GDP.

Japanese Yen – Even though the Japanese Yen crosses were the most volatile currency pairs over the past few days, they essentially ended the week unchanged. Sharp intraday reversals indicate that carry traders are not ready to give up, but at the same time, any one who wants to be long probably already is. The Yen pairs and to some degree the Dow as well, is once again moving in lockstep with the Chinese stock market. The Shanghai stock market recovered overnight and we saw the same type of recovery in both the Dow and USD/JPY. Yen traders should keep an eye on China for any fresh attempts to cool the economy. The Yen should remain the market’s focus in the week ahead with trade balance, CPI, unemployment, personal income, household spending, industrial production, and retail sales data due for release. The Bank of Japan also has a rate decision scheduled, but no changes are expected.

Commodity Dollars (AUD, NZD, CAD) – The rebound in the commodity currencies today is clear evidence that the market is still hungry for yield. Australian economic data was mixed with leading indicators rising in the month of February, but import prices falling 1.7 percent in the first quarter. New Zealand also reported a 1.0 percent drop in visitors in the month of March. Canada on the other hand continues to perform strongly. Retail sales jumped 0.1 percent in February, which compares to the market’s forecast for a 0.2 percent drop. Looking ahead, the marquee events on the calendar next week are the Australian inflation figures, and the Bank of Canada and Reserve Bank of Australia interest rate decisions. No changes are expected from either central bank, but the market is looking for hawkish comments.

By Kathy Lien, Chief Strategist of