NEWS / Trade Policy

Forex - Dollar Remains Weak - ECB and Non-Farm Payrolls to Be Major Driver This Week

DailyFX Fundamentals 07-04-06

By Kathy Lien, Chief Strategist of www.dailyfx.com

- Dollar Remains Weak ??“ ECB and Non-Farm Payrolls to Be Major Driver This Week
- Biggest Rise in Producer Prices Since 2000 Confirms Need for ECB Rate Hike
- Conflicting Dynamics of ZIRP Removal and Fukui Resignation Could Keep Yen Rangebound

US Dollar

The markets here in the US are closed for Independence Day. Unsurprisingly, trading has been excruciatingly quiet. The only currency that is seeing any significant movement is the Canadian dollar, which is rallying on the back of increasing pressure on commodity prices. Despite initially showing some willingness to cooperate with the world on its nuclear enrichment program back in June (which was what took oil prices below $70 and USD/CAD above 1.12), Iran??™s top negotiator has just rejected the United Nations Security Council??™s demand to suspend their uranium enrichment. Geopolitical risks run high these days as North Korea ups the ante on their threats. This trend will only exacerbate the current dollar bearish environment. Even though the markets reopen tomorrow, we only have US factory orders due for release. Hardly expected to be market moving, traders primarily have their eyes on Friday??™s non-farm payrolls report. As we said yesterday, analysts are once again predicting for a very strong NFP report. The broad sentiment seems to be that we will see exaggerated strength after exaggerated weakness. However, this is the same argument that analysts have been using for the past two months and if you recall, the number of jobs created in May were 75k versus a forecast of 170k. A similar shortfall of 62k was seen the month prior. Even if payrolls do come out strongly on Friday, the three month average job growth is still weak. The only significance is that it does not completely close the door on an August interest rate hike which could be moderately dollar bullish. A weak number of 110k and less (the market??™s current forecast is 158k) would of course slam the door shut on rate hikes for the time being. Nothing is absolute in the foreign exchange market however and with another job report, 1 ISM, 1 retail sales and 1 consumer price index still due for release after that, expectations and market sentiment could still be changed. In the meantime, although dollar weakness should remain dominant, after having already sold off quite a bit, a significant extension of the current sell-off could be harder to achieve before Friday??™s release.

Euro

Even though the European markets are open, it appears that many European currency traders have taken this opportunity to go on vacation as well. The EUR/USD has remained in a very narrow 20 point trading range since yesterday??™s close. Eurozone producer prices were released this morning and they were right in line with expectations, rising 0.3 percent in the month of May. However inflation pressures are clearly mounting as this brought the annualized pace of growth up from an already robust 5.5 percent to 6.0 percent. Energy prices have been the primary driver of the rise in overall prices and the rapid pace of growth is confirming the need for the European Central bank to raise rates in August. The rise in producer prices was the most since 2000 and even though consumer prices are more important, they signal that inflation is indeed a problem which means that the central bank will need to continue to remain tough. Tomorrow we expect a lot more data that could shed more light on what type of tone ECB President Trichet will be taking at Thursday??™s press conference following the monetary policy meeting. The market expects Trichet to reintroduce the word ???vigilance??? to his comments but the high level of the Euro could deter him from being too hawkish. Either way, another rate hike is inevitable; it is just a matter of how soon.

British Pound

The British pound is stronger despite the fact that construction sector PMI fell significantly last month. The index slipped from 52.7 to 50.8. Teetering just slightly above the 50 expansion / contraction mark, the construction sector is growing at a slower pace which comes in contrast to some of the recent housing market data reports that have been showing a bit of strength. There is still a great deal of UK economic data due for release this week, but following the more neutral comments from the Bank of England last week and the death of BoE member Walton, it is extremely unlikely that the central bank will move on interest rates anytime soon. Therefore their rate decision on Thursday should be a non-event.

Japanese Yen

The Japanese Yen is trading quietly with a mixed performance against the majors. Two questions have been at the front of the minds of Yen traders which are will the Bank of Japan lift their zero interest rate policy before the end summer and will the central bank governor be forced to resign. In the latest developments on these two topics, even though officials within the Japanese government are at odds on how soon ZIRP can be removed, they are still clearly moving in that direction. Economy Minister Yosano said that although conditions are not fully in place now, they are ???aligning.??? Finance Minister Tanigaki said that the zero interest rate policy should be retained for the time being but the economy is steadily improving. Meanwhile in the private sector, Japan??™s business lobby group feels that the time is right for the central bank to increase interest rates now. As we move closer to the inevitable, it is important for Yen traders to prepare for a rate hike that could result in sharp volatility if there is a massive liquidation by carry traders. Meanwhile whether Fukui will be able to keep his job still remains a question. Two recent surveys by Sankei Shimbun and the Tokyo Broadcasting System indicated that 69 percent of their voters are favoring a resignation. The conflicting dynamics of ZIRP and Fukui removals could keep Yen pairs relatively range bound.