The US dollar continued its rally on Tuesday, but had trouble sustaining those gains as the ISM survey for the manufacturing sector unexpectedly slipped to a reading of 49.9 from 50.0, signaling a contraction in business activity.
[B]• US Dollar Rally Supported By Drop in Oil, But May Be Due To Pause
• Euro Struggles to Hold Above 1.45 Ahead of Retail Sales, Swiss CPI, GDP Growth Slows
• British Pound Down Over 2% Vs Dollar Since Last Week, Near Record Lows Vs Euro
US Dollar Rally Supported By Drop in Oil, But May Be Due To Pause[/B]
After last week’s strong revision to US Q2 GDP, the markets started to judge that the outlook for the economy had stabilized. While the US may be in a somewhat better position at this point compared to the economies of the Euro-zone and UK, the ISM release suggests a US recovery is not in the works quite yet. As Currency Strategist John Kicklighter discussed in his analysis of ISM manufacturing, factories have not been able to capitalize on the still relatively weak US Dollar and the recent plunge in raw material costs, such as oil and metals. Even worse, the breakdown shows that production has cooled, inventories have grown, and employment conditions have worsened in the sector (boding ill for this Friday’s US non-farm payrolls).
In Monday’s Daily Forex Fundamentals, I said that I would hold a bullish fundamental bias for the US dollar over the next few days for the simple fact that the US economy will likely appear relatively strong compared to regions like the UK and Euro-zone. However, I now think the currency may be nearing a near-term top. First, one of the greatest threats to the US dollar rally this week is commodity prices, as Quantitative Analyst David Rodriguez’s latest forex correlations report shows that the correlation between EURUSD and NYMEX Crude Oil futures has recently hit its highest levels since the inception of the euro. Next, forex positioning shows that euro and British Pound shorts are at record levels, suggesting that the currencies may be bottoming out. As a result, my fundamentals bias for the US Dollar for the rest of the week is cautiously bullish, but I think it may be time to start looking for levels at which to sell the greenback.
Euro Struggles to Hold Above 1.45 Ahead of Retail Sales, Swiss CPI, GDP Growth Slows
While European data released this morning was mildly bullish for the euro, the currency remained broadly weak. The Euro-zone producer price index rose 9.0 percent in July from a year earlier, marking the biggest increase since record keeping began in 1990. While this suggests that price pressures are strong at the factory gate, sharp drops in commodities at the end of July and in August should help to cool upcoming inflation-related figures. Looking ahead to Wednesday, Euro-zone retail sales and Q2 GDP revisions will be released. The former could be surprisingly weak, as German retail sales (released on Monday) unexpectedly plunged 1.5 percent. GDP, on the other hand, should be a non-event as no revisions are forecasted. Meanwhile, the Swiss Franc faltered in the face of US dollar strength, though fundamentals likely added to Swissie weakness as well. Swiss GDP slowed to a three-year low of 2.3 percent in Q2 from a year earlier, down from 3.0 percent, due primarily to a contraction in investment and surge in imports. Likewise, Swiss CPI fell 0.3 percent in August, pulling the annualized rate down to 2.9 percent from 3.1 percent. Looking at a breakdown of the index, a reported 4.4 percent drop in energy product prices played a big role in the decline and like much of the world’s central banks, the Swiss National Bank will be hoping to see the commodity-market sell-off continue.
British Pound Down Over 2% Vs Dollar Since Last Week, Near Record Lows Vs Euro
The British pound continues to get hammered lower, and since Friday’s close, GBP/USD is down 2 percent while EUR/GBP trades just below record highs of 0.8166. There was no data on hand today, but bearish sentiment on the currency is proving hard to shake, especially since Credit Suisse overnight index swaps are pricing in 85bps worth of cuts within the next 12 months. While the Bank of England is widely anticipated to leave rates unchanged at 5.00 percent on Thursday, I think there is some potential for a surprise rate cut. Commentary by Bank of England policy makers and government officials suggests that many are truly worried that the UK is headed for recession, and it’ll be worth watching to see of MPC member David Blanchflower will remain the lone dove of the group, or if the sharp economic slowdown will convince others to vote for a reduction in the Bank Rate as well. Unfortunately, if the central bank leaves rates unchanged, no policy statement will be released and traders will have to await the release of the minutes from the meeting on September 17 for a glimpse at the vote count.
Australian Dollar Collapses on RBA Rate Cut, Outlook for the Bank of Canada’s Rate Decision
As expected, the Reserve Bank of Australia cut rates by 25bps to 7.00 percent on Monday night, sending the Australian dollar for a freefall below 0.8500. The move marked the first reduction to the cash rate since December 2001, despite the fact that RBA Governor Glenn Stevens said in his policy statement that “inflation is likely to remain relatively high in the short term.” Nevertheless, Mr. Stevens left the door open to additional cuts, noting that it is “more likely that household demand will remain subdued and overall economic growth slow,” allowing the Monetary Policy Board scope to make monetary policy “less restrictive.” AUD/USD could drop further overnight as Australian Q2 GDP is scheduled to be released and is forecasted to slow to an annualized rate of 2.9 percent from 3.6 percent. Meanwhile, the Canadian dollar faces heavy event risk on Wednesday morning as the Bank of Canada will announce their rate decision. A Bloomberg News poll shows that 27 of the 28 economists surveyed expected the BOC to leave rates steady at 3.00 percent (1 forecasts a 25bp cut). My view? The BOC will leave rates unchanged, but the key to trading USD/CAD will be the policy statement. Headline CPI remains extremely strong, but core prices remain contained. Meanwhile, growth has held up fairly well despite the slowdown in the US, but it is clear that there are significant downside risks to the economy going forward. Overall, though, the statement may reflect a slightly hawkish bias by the BOC’s Governing Council, which could contribute to some Canadian dollar strength on Wednesday.
Japanese Yen Strong Against High Yielders As Carry Trades Sell-Off
As I mentioned yesterday, we know that risk sentiment remains the primary driver of the Japanese yen because political turmoil has recently emerged and Japanese economic data has been absolutely abysmal, but yet the low-yielding currency has remained strong against its foreign counterparts. This remains the case, as the currency gained approximately 1 percent versus the high-yielding Kiwi and Aussie dollars. Meanwhile, yen lost roughly 0.4 percent versus the US dollar and Canadian dollar. What gives? With global credit risks remaining high and equity markets susceptible to sharp decline, traders aren’t rushing to pile into the carry trade quite yet. [B]My bias for the Japanese yen going forward versus most of the majors: bullish.
**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]>
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