NEWS / Fiscal Policy, Budget

Forex - Will Confident Consumers Help the Dollar?

DailyFX Fundamentals 09-25-06

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

??? Will Confident Consumers Help the Dollar?
??? No Sharp Declines Expected in Tomorrow??™s German IFO
??? British Pound Rallies on Hawkish BoE Comments

US Dollar

Although the US dollar??™s performance today has been very mixed, with strength seen against the Euro but weakness against the Japanese Yen and British pound, the mood of the day is certainly more dollar bullish than bearish. This stemmed from the fact that existing home sales came in stronger than expected while oil prices broke below the key $60 level this morning (it later recovered). Whether we see a continuation of strength will depend on tomorrow??™s consumer confidence report. Even though many reports have been signaling a possible slowdown in the US economy, until we see a reaction from the consumer, these are just risks and not reality. Of course, the greater the number of risks, the more significant the potential reaction from the consumer when we see it. This increases the significance of tomorrow??™s consumer confidence report as it will be an important leading indicator of whether next month??™s retail sales will be as strong as last month??™s. The sharp drop in oil prices should help to boost confidence, especially after it dropped to 9 month lows in August. The EIA has already reported that the national average of prices at the pump have fallen 11 cents from the prior week to $2.378 per gallon, far below the $3 plus levels that we saw less than two months ago. If we do see a strong confidence report, it will help the US dollar aim for 1.2685 against the Euro. However we do not expect much strength beyond the recent range lows in the EUR/USD because the two drivers of today??™s strength are fleeting at best. Despite the stronger existing home sales report, total sales still dropped for the fifth consecutive month. Yet the most worrisome aspect of the report was news that the stability of prices are finally breaking as well - for the first time since 1995, we saw a decline in the median home sales price. With inventories building, house prices falling and sales slowing, there is no question that the housing bubble is deflating. Meanwhile oil prices jumped in late trading on rumors that OPEC members may be meeting to discuss the fall in prices. We could easily see oil reverse its recent losses if the group decides to cut output. It is unlikely at the moment, but certainly a possibility if prices continue to slide. Finally, I want to point a great observation made by our Technical Analyst Jamie Saettele in this week??™s COT report. He noted that for the first time since last April, implied US dollar positioning flipped from net short to long. Each time it has done so over the past 5 years after hitting extreme levels, we have seen follow through moves in the US dollar. If the positioning holds in net long territory, it could signal the possibility of a near term bounce in the dollar.

Euro

Volatilities in the currency market are continuing to trade near records lows, particularly in the Euro. The hope is that the combination of the German IFO report on business confidence and the US Conference Board??™s report on consumer confidence will deliver to us some much needed excitement. The German IFO is forecasted to come in weaker as the World Cup effect continues to subside. Despite a sharp drop in last week??™s German ZEW survey, analysts are only looking for a small drop in business confidence. Over the past six years, the ZEW survey has had a surprisingly weak 23 percent correlation with the IFO survey. The Belgian Business Survey on the other hand has a surprisingly strong 80 percent positive correlation with the German business confidence survey. Therefore last week??™s improvement in the Belgian index suggests that the IFO could hold on strong as well. We stop short of calling for an improvement in the IFO however since domestic spending has been lackluster at best as retail sales dropped 1.5 percent in the month of July. We expect the IFO report to follow in the footsteps of today??™s business confidence report from France. Deterioration was reported, but it was less than predicted with actual improvements seen in the components of the report. The only other release today was the preliminary German consumer price report for the month of September. Unsurprisingly, the fall in energy prices has caused a larger drop in inflationary pressures. If this trend continues, we could see the ECB lean more towards one instead of two more rate hikes this year.

British Pound

Unlike the Euro, the British pound is holding onto its gains against the US dollar and even adding on more against the Euro. There was no news out of the UK today, but hawkish comments from Bank of England monetary policy member Gieve has helped to rally the pound. According to an interview with the Financial Times, Gieve confessed that he considered voting in favor of an interest rate hike in both August and September on concerns that the fall in oil prices would not immediately translate to a drop in global inflationary pressures. This sentiment seems to be a bit more widespread as the Sunday UK Times separately speculated that the BoE could raise interest rates again this year despite the risks of a potential slowdown in the US economy. We do not get any meaningful UK economic data until Wednesday, which means that tomorrow??™s movement in the pound will be dependent entirely on how German and US data are released.

Japanese Yen

Despite the lack of any Japanese economic data, the Yen is stronger today against most of its major counterparts. The combination of the end of the Japanese fiscal half year and the last week in the quarter could lead to some erratic trading due to repatriation by some Japanese corporations. The earlier drop in energy prices helped to lead the Yen higher as the country??™s heavy economic calendar does not take off until Thursday of this week. We have the corporate service price index due tonight, but the report is only expected to show a mild improvement in inflation during the month of August.