NEWS / Central Banks

Forex: Traders Send Dollar Lower on the Fear that Weak PPI Equals Weak CPI

DailyFX Fundamentals 08-15-06

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

??? Traders Send Dollar Lower on the Fear that Weak PPI Equals Weak CPI
??? Pound Loses Out to Euro After Disappointing PPI Numbers
??? Things Turn Up Down Under, Helping Aussie and Kiwi to Rally

US Dollar

Disappointments in US data could very well mark a turning point for the US dollar. Over the past three trading days, the US dollar has remained firm and quietly scored some more gains after the surprisingly strong retail sales number on Friday. The market??™s focus has now turned to inflation and the first report of producer prices failed to meet expectations suggesting that consumer prices due out tomorrow could disappoint as well. The Federal Reserve??™s mandate is to maintain both price stability and sustainable economic growth. We would need to see strength in both sides of the equation - inflation and consumer spending figures - to have a good enough reason to expect the Fed to change their mind by reigniting their tightening cycle. Unfortunately, today??™s softer PPI report not only failed to signal that another rate hike was needed before the year??™s end, but actually validated the Fed??™s decision to pause and suggests that rates will remain on hold for the remainder of the year. More specifically, despite a large increase in energy prices, headline producer prices only rose by 0.1 percent in the month of July while core prices fell by 0.3 percent. Traders are still waiting for the consumer price report to seal the deal and should it also disappoint, the turn in the dollar would be validated. In addition to the PPI report, sharp declines were also reported in the Empire State manufacturing survey and NAHB housing market index. The index measuring the manufacturing activity in the New York area fell from 16.6 to 10.3 while the NAHB housing index dropped from 39 to 32, a 15 year low. The confidence of builders have slumped significantly and with so many housing projects underway, many builders may have to rely on price cuts to drive sales. It is slowly becoming a buyers market as they become more selective in the midst of rising inventories. This hasn??™t quite spilled over to the consumer yet, which is the main reason why the dollar did not react significantly to it. However things are getting grimmer by the day for the US economy and we will be closely watching the retail sales reports over the next few months to see if consumers are reacting to the slowdown. Meanwhile the only piece of good news was the report net foreign purchases of US securities. Foreign demand rose from a downwardly revised $63.6 billion to $75.1 billion in the month of June, driven primarily by an increase in private demand. However, the strong TIC data was not completely bullish for the US dollar. Foreign central banks were net sellers of US Treasuries, confirming that reserve diversification is indeed underway. Aside from the UK, no one was a major buyer. Japan, the world's largest holder of US Treasuries actually sold Treasuries for the fourth month in six. The high yield of US fixed income investments is the only thing that is keeping foreign investors here as June marked the strongest level of private inflows since November.

Euro

The Euro is stronger against the US dollar despite the lack of any economic reports from the Eurozone. Part of the strength was due to broad dollar weakness and the other part was an extension of Euro bullishness following yesterday??™s robust GDP numbers. We are still expecting Eurozone CPI and industrial production along with German producer prices and French payrolls later this week, so there is more to come. For the time being, another rate hike is still expected from European Central Bank this year while traders are still trying to confirm whether the Federal Reserve is truly done with raising rates. Therefore, any evidence confirming or denying the Fed??™s present stance will have a more significant impact on the EUR/USD currency pair until the ECB suggests otherwise.

British Pound

Even though the British pound has appreciated in value against the US dollar, it is benefiting purely from broad dollar weakness as the pound sells off against the Euro after weaker than expected economic data. Originally expected to remain unchanged, headline consumer prices fell by 0.1 percent in the month of July, driving down the annualized pace of price acceleration from 2.5 percent to 2.4 percent. Annualized core prices fell from 1.2 percent to 0.9 percent. The softer inflation reports suggests that the Bank of England??™s interest rate hike earlier this month could very well be their last for the year, especially with oil prices quietly trending lower. Meanwhile the housing market continues to show signs of stabilization with the RICS house price index jumping from 28 percent to 31 percent, recording the fastest pace of increase in more than 2 years.

Japanese Yen

Trading in the Japanese Yen has been very mixed today after the tertiary activity index came out weaker than expected. The Yen is stronger against the dollar thanks to the combination of weaker US numbers and large US Treasury coupon payments made to bond investors, of which the Japanese represent a big lot. The rest of the week is fairly quiet for Japan will little on the calendar. The Bank of Japan will be releasing the minutes from their monetary policy meeting last month and we will be looking for not only how urgent they felt that the rate hike needed to be delivered, but also any timing of future rate hikes.

Australia, New Zealand

The Australian and New Zealand dollars were the best performing currencies against the US dollar today The Aussie benefited from comments from Finance Minister Costello who said that inflation risks are still significant due to higher oil prices. After last week??™s stronger employment data and smaller trade deficit, the market has already begun to price in the possibility of another rate hike by the Reserve Bank. However this may not come until the fourth quarter as Reserve Bank Governor Macfarlane prepares to hand over his seat to the Deputy Governor Glenn Stevens on September 18. Meanwhile, the Kiwi is higher thanks to the sharp rise in producer prices. Input prices jumped from 0.9 to 2.7 percent in the second quarter while output prices increased from 0.7 to 2.7 percent. Both were much stronger than expected and are quietly suggesting that the RBNZ may have to reconsider raising rates further down the line as well. It is still a bit early to tell, but it is certainly a possibility.