Euro/US Dollar - Why the Decline May Not Continue For Much Longer

The US dollar remains strong across the majors, but there are indications the rally could end soon. Meanwhile, the RBNZ unexpectedly slashed rates by 50bps to 7.5% - what does this mean for NZD/USD?

• Euro/US Dollar – Why the Decline May Not Continue For Much Longer
• New Zealand Dollar Tumbles As RBNZ Slashes Rates To 7.5%, Signals More Cuts
• British Pound Slumps Toward 1.75 - Recovery on the Horizon?

Euro/US Dollar – Why the Decline May Not Continue For Much Longer
Normally I discuss the euro and US dollar separately, but trade in the currencies rely so much on each other that today, it seems worthwhile to talk about them together. We’ve seen that the US dollar remains strong across the majors, especially the euro and Japanese yen. Was there strong US data on hand? Nope. Hawkish comments from a Federal Reserve member? No. So why did the dollar gain? Bearish outlooks for the Euro-zone.

Indeed, this morning, the EU said that the robust growth seen in the Euro-zone “has come to an end” as they revised GDP forecasts for 2008 to 1.3 percent from 1.7 percent, while raising inflation forecasts to 3.6 percent from 3.1 percent. Meanwhile, the EU warned of a “significant downward revision” to 2009 forecasts, as “global headwinds” intensify and the financial system remains “fragile.” Furthermore, despite comments from ECB Executive Board member Juergen Stark saying otherwise, the EU said they saw “no evidence of widespread” second-round inflation effects stemming from commodity price gains earlier in the year, suggesting that the ECB will be more likely to cut rates in the future. Credit Suisse overnight index swaps (OIS) are pricing in nearly 50bps worth of reduction by the ECB within the next 12 months, which leaves the odds in favor of a EUR/USD test of 1.40, especially since OIS price in over 25bps in increases by the Federal Reserve during the same period. Nevertheless, according to COT forex positioning, the dollar is extremely overbought and the euro is oversold, suggesting we may be nearing a point where risk/reward warrants selling the greenback. With US event risk picking up in coming days (US Import Price Index on Thursday, US Producer Price Index and Advance Retail Sales will hit the wires on Friday), indications of softer inflation pressures or weakening consumption could trigger a reversal.

Related Article: US Dollar Still Strong on Expectations the Fed Will Raise Rates, ECB Will Cut - But When?

New Zealand Dollar Tumbles As RBNZ Slashes Rates To 7.5%, Signals More Cuts

The New Zealand dollar pulled back sharply at the end of the US session to a nearly 2-year low as the Reserve Bank of New Zealand cut rates more than expected by 50bps to 7.50 percent. This is the second rate cut in a row by the central bank, as the move was exacerbated by the post-meeting press release issued by RBNZ Governor Alan Bollard. Indeed, Mr. Bollard said that “it is appropriate to move towards a less restrictive monetary policy stance,” suggesting that they will continue cutting rates in the future as weakening economic activity is “expected to translate into lower inflation pressures in the medium term.” This sentiment has left Credit Suisse overnight index swaps to continue pricing in 150bps worth of cuts by the RBNZ over the next 12 months. The Australian dollar was weighed down by the RBNZ news as well, but the currency faces its own event risk tonight as the Australian unemployment rate is anticipated to pick up to a 9-month high of 4.4 percent. On the other hand, the net employment change is forecasted to rise by 5.9K, and this tends to have a greater impact on the Aussie than the unemployment rate. Indeed, like the US Non-Farm Payrolls release, the figure rarely meets expectations and can lead to volatile short-term price action for the Australian dollar immediately following the news at 21:30 EDT.

Check out our DailyFX Instant Insight for more on the RBNZ rate cut and NZD/USD.

British Pound Slumps Toward 1.75 - Recovery on the Horizon?

The British pound slumped against the US dollar, as the latter remained strong across the majors. However, we’ve been saying for days that COT forex positioning shows that the currency remains oversold and other indicators suggest potential GBP/USD buying opportunities, and this has not changed. Meanwhile, for the first time in a while, UK data was surprisingly strong as the Visible Trade Balance unexpectedly reflected a narrowing trade deficit of 7.667 billion pounds in July, compared to 7.993 billion pounds the month prior. The move was the result of a 3.1 percent jump in exports, as a weaker British pound made UK goods more attractive. Nevertheless, the odds are wildly out of favor for the UK economy, as expansion is widely anticipated to slow sharply going forward. This is much of the reason why Credit Suisse overnight index swaps are pricing in nearly 100bps worth of rate cuts by the Bank of England over the next 12 months, and if the official UK CPI numbers (due to be released on 9/16) signal that inflation is not accelerating as quickly as they expected, the central bank could start reducing interest rates before year-end. Thus, from a fundamental perspective, downside risks remain for the British pound, but from a technical perspective, I believe GBP/USD is due for a bounce in the near-term.

Japanese Yen Consolidates As Financial Markets Remain Jittery
The Japanese yen slipped against most of the majors, especially versus the Canadian dollar, Australian dollar, and US dollar. Indeed, in the aftermath of the US government’s seizure of Fannie Mae and Freddie Mac, risky assets have been quite volatile. For example, the DJIA rallied nearly 150 points mid-day on Wednesday, only to end the day up a tepid 38 points at 11,268.92. The moves suggest that the latest intervention efforts by the US will do little to stop the bear market in equities and sooth the global credit crunch. Furthermore, we continue to see that Japanese fundamentals have little bearing on the currency, as the latest forex correlations report shows that carry trades and the DJIA have increasingly been moving in lockstep (though the correlation is not as high as it was in 2007). Going forward, the Japanese yen will continue to depend on the status of risk appetite in the market, and while the currency could pull-back in the near-term, I still think there is long-term bullish potential for the low-yielder. As a result, I will look for JPY buying opportunities on sharp declines.

[B]For a full list of upcoming event risk and past releases, check out the DailyFX Calendar.

Written by Terri Belkas, Currency Strategist for DailyFX.com

E-mail: <[email protected]>
[/B]