NEWS / Fiscal Policy, Budget

FXCM - British Pound Breaks Out as Data Improves

FXCM - DailyFX 07-21-06

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

??? British Pound Breaks Out as Data Improves
??? Canadian Dollar Slips on Surprise Drop in CPI
??? Dollar Outlook Unclear, More Volatility to Come

US Dollar

Today??™s price action in the U.S. dollar illustrates the influence that Federal Reserve Chairman Bernanke yields on the market. Since he opened his mouth last Wednesday, the US dollar has weakened and continued to weaken today. However in the immediate future, additional dollar weakness is not guaranteed. Not only are we coming up on technical resistance, but traders should realize that the Fed could still raise interest rates in August. It is really a matter of whether Bernanke cares more about his credibility or his math models. The upside risks to inflation are clear but at the same time, so are the risks that the economy faces. The next FOMC meeting is scheduled for August 8th, which is only 2.5 weeks away. This means that the short list of economic releases between now and then will not only be even more important for traders to watch, but could also bring about more volatility. This includes the personal consumption expenditures index and the Q2 employment cost index, which will shed more light on the inflation outlook along with consumer confidence, durable goods, advance Q2 GDP, ISM and Non-Farm payrolls. Expect the market to minimize the positive and accentuate the negative as it searches for signs to support an earlier Fed pause. In addition to economic data, signs of whether the Fed will pause may come via comments from Fed Presidents Poole or Yellen later this month or from the Beige Book report due next Wednesday. Taking a look at the forecasts, the economic data on next week??™s plate should continue to paint a bleaker picture for the US economy. There are no data releases on Monday, but we are expecting the Conference Board??™s consumer confidence index and existing home sales on Tuesday. With geopolitical tensions rising, employment growth slowing and oil prices remaining high, it would be surprising if consumers actually remained happy. Dissatisfied consumers could prevent a recovery in retail sales this month while the gradual slowdown in the housing market should be reflected in the existing home sales report as well as the new home sales report on Thursday. Meanwhile, the Canadian dollar has been one of the day??™s biggest movers. Consumer prices took a turn of the worse in June. Originally expected to have risen by a meager 0.1 percent last month, prices actually dropped by 0.2 percent on both a headline and core level. Although the Bank of Canada has already ended their tightening campaign, the fall in inflation only drums in the point even further.

Euro

The Euro has now recovered nearly all of its Monday losses thanks to the Federal Reserve??™s more dovish stance. The rally today was exacerbated by the strong consumer spending numbers from France. Rising by 1.7 percent in the month of June, this is strongest pace of growth in over a year. Once again, the World Cup effect shows up not only in Germany, but throughout the European region. Like in the UK, the biggest sales have been for consumer electronics, but in addition to that, clothing and automobiles have also seen a strong rise. Over in Italy, consumer confidence rose from 106.9 to 108.7. With Italy making it further than most people anticipated to eventually win the World Cup, it is hardly surprising to see a sense of euphoria in the country. The question remains whether this World Cup effect can be sustained and for how long. Italy has hoped that a World Cup win will boost spending because happy people usually spend more. If that is true then, spending in France could see a correction after their loss. Overall, with most international visitors out of the region, the Eurozone is now responsible for generating its own growth. Given that we are still expecting July numbers for the next few weeks, positive data should dominate. It will not be until mid August and September that we see data reflecting economic activity post World Cup.


British Pound

After range trading for the past two months, the British pound has officially broken out to the upside. Following last week??™s strong inflation numbers and yesterday??™s robust retail sales report, the UK surprises us once again with better than expected GDP growth in the second quarter. Economic activity increased by 0.8 percent in the second quarter, the strongest quarterly rate of growth in two years. This solid number in addition to the ones that we have seen over the past week suggests that the UK economy may be turning around. However even if it is, we expect the Bank of England to be patient and leave interest rates unchanged in August. The two new members of the monetary policy committee are not expected to join until September and October. So the meetings with the highest probability for an interest rate hike by the Bank of England will be the October 5th and November 9.

Japanese Yen

After having lost value against most of the majors over the past two weeks, the Japanese Yen was the day??™s best performer. An increase in the reserve requirement by the People??™s Bank of China raised speculation that the central bank may opt for another revaluation move soon. Instead of raising interest rates to tame growth, the PBoC has chosen to increase the amount that local banks are required to deposit with the central bank to 8.5 percent. If their efforts continue to prove futile, like it did in the last quarter when growth hit a 10 year high, another change to their foreign exchange regime may be needed. Despite efforts by the Bank of Japan??™s Fukui and Muto to downplay prospects for another move by saying that monetary policy will remain accommodative for some time and that there will not be consecutive interest rate increases, the Yen has rallied on speculation that Tadoa Noda, Shin Nakahara??™s replacement on the Bank of Japan??™s monetary policy committee will be far more hawkish than his predecessor. If so, it only accelerates the next interest rate hike that the central bank is expected to deliver.