NEWS / Central Banks

Forex - FOMC Comments Hint at Prospect for Strong Retail Sales, Dollar Rallies

DailyFX Fundamentals 10-11-06

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


??? FOMC Comments Hint at Prospect for Strong Retail Sales, Dollar Rallies
??? Potential for EURUSD Bottom
??? British Pound Holds Steady After Hawkish Comments From BoE

US Dollar

The US dollar??™s momentum is merciless as traders take aim at the 1.25 level against the Euro. The proximity of that important level could make it too tempting for traders not to test especially since this week has proven to be a very dollar positive despite the lack of any significant economic data over the past few days. The trade balance and retail sales reports are due for release tomorrow and Friday. The odds are strongly in favor of stronger and more dollar positive reports. According to the FOMC minutes, the Federal Reserve is relatively optimistic about the economy??™s growth prospects and expects it to return to at or above trend levels over the next year. Earlier comments by FOMC voting member Lacker already gave us some clues about potential drivers. He expects retail sales to expand at a good pace and for capital spending to continue to increase. The optimistic take on retail sales was something that we saw in the FOMC statement as well. Taken together with the recently strong same store sales and Redbook report, we could see a jump in Friday??™s consumer spending numbers. Besides the comments on growth, the minutes indicate that the Federal Reserve was worried about inflation not declining as forecasted, which was the one liner that sent the dollar rallying after a quiet morning. As a result, they wanted to keep a tough leash on inflation which the market perceived as a sign that they will not move to cut interest rates anytime soon. Even though recent data has yet to warrant an interest rate cut, the Federal Reserve will not be raising them either. Patience is key at the moment. Oil prices just began to fall in the weeks prior to the September meeting and it may have been a bit premature for them to assess whether the drop would impact inflation. However the inflation reports from other countries indicate that it is indeed having an impact on prices elsewhere and there is no reason why it would be different in the US if the country??™s initial inflation fears were also energy driven.

Euro

Although near term fundamentals call for more dollar strength than weakness, the potential of the EUR/USD hitting a bottom is growing by the day. The currency has now sold off for seven consecutive days, which is the longest stretch of weakness since June when it also faced seven days of continuous losses. Aside from that time, there has only been one instance over the past seven years that the EUR/USD has sold off for more than seven days, which was back in August of 2003. This morning??™s report from the European Commission was very bearish for the currency. The EC cut its forecasts for fourth quarter 2006 and first quarter 2007 Eurozone growth. They expect higher interest rates, a strong Euro and an increased VAT tax in Germany to threaten growth so much that the economy has the potential to remain stagnant in the first quarter. Although the ECB is still on track to raise interest rates again this year and recent economic data has been encouraging, this certainly puts a dent in the outlook for the region. It will be interesting to see if the ECB??™s monthly bulletin confirms the more pessimistic outlook.

British Pound

After close to 300 point losses over five trading days, the British pound ended the day relatively unchanged against the US dollar and slightly higher against the Euro. The pound was able to hold steady after relatively hawkish comments from Bank of England Governor King. He expects the predicted dip in inflation last month to only be temporary. CPI numbers are due next week and are forecasted to rise by only 0.2 percent after a 0.4 percent rise the prior month. Wages may also begin to tick higher as suggested by the jump in the REC permanent staff pay index for the month of September. The index hit a 6 year high, prompting the central bank governor to announce that they are watching wage and cost pressures closely.

Japanese Yen

Japanese Yen linked currency pairs are beginning to show signs of a top. Traders are no longer sitting at the edge of their seats figuring out how the international community will respond. The US government is trying to play down North Korea??™s actions by suggesting that the nuclear test may have been a failure. They are taking their time to respond, especially after North Korea announced that any US sanctions will be considered an act of war. China and South Korea also have no interest in seeing a large influx of immigrants into their countries if a war is imposed. The longer the international community takes to respond, the faster the markets will forget about North Korea??™s tests. Machinery orders ticked higher in the month of September. Tonight??™s numbers may not be as promising. The weak yen should help to boost exports, but oil prices remained stubbornly high for most of the month, which should keep the import bill large as well. Money supply data is predicted to continue to reflect a low inflation environment. Overall the outlook for the Japanese economy still remains more positive than negative, but like 1.25 in the EUR/USD, 120 may be a level that is too tempting for traders not to test.