NEWS / Foreign Exchange

Euro Buoyed By Surprisingly Strong IFO

Talking Points

??? Japanese Yen: Corporate Services Price Index eases off highs
??? Euro: IFO beats expectations despite global turbulence
??? Swiss Franc: UBS Consumption indicator shows Swiss growth maintains pace
??? US Dollar: Consumer Confidence on tap

Euro Buoyed By Surprisingly Strong IFO

The IFO report beat expectations tonight in early European trade, as the reading in the Business Climate conditions rose to 107.7 from 106.5 reversing the pattern of two consecutive monthly declines. The news surprised the market given the sharp drop off in the Belgian Business indicator last week, the persistently high exchange rate of the euro and the recent upward creep in oil prices. Yet despite all of these challenges,  European business sentiment continued to hold near record highs, confirming the euro bull argument that the EZ economic growth may be decoupling from the evident slowdown in the US.

This week also brings the German employment figures and if, as the market expects, that release shows improvement as well the case for another ECB rate hike will be assured. At present the market expects another 25bp bump in May which would take EZ rates to 4.00% and narrow the interest rate differential with the greenback to an almost insignificant 125 basis points.

Although the euro gained only modestly against the dollar in the aftermath of the release,  it enjoyed a much stronger rally against the Japanese yen as traders put on fresh carry trade positions in the wake of new evidence that inflation in Japan remains well contained. The Corporate Services Price Index receded from its recent highs printing at 0.4% vs. 0.6%. The report was just the latest confirmation that subdued pricing pressures in Japan  provide no fundamental reason for the BOJ to expedite the normalization of its monetary policy which is likely to keep rates at 50bp throughout Q2 of 2007.  

In US today,  Consumer Confidence is the sole economic report of interest to the market.  Traders expect a decline to 108.5 from 112.5 the month prior. Given the massive media coverage of the sub-prime crisis and the steep decline in New Home Sales,  a contraction in consumer sentiment seems to be a reasonable bet.  Still, it may be worthy to watch how this release impacts not only the currency market but the stock market as well. Up to now the  US equity market has been remarkably resilient in the wake of overwhelming evidence of a US economic slowdown. Yesterday??™s recovery in the Dow Jones from a near 100 point plunge in morning trade was just the latest demonstration of investor bullishness.  If  Consumer Confidence  data does show a large decline which in turn finally cracks the US equity market, the latest carry trade positions could come under pressure later in the day. Carry trades are typically nurtured in an environment of low volatility which fosters high risk seeking behavior.  If US capital assets suddenly experience a second wave of selling this month, currency traders may run for safety to the low yielders like the yen and the Swissie and the carry trade flows could reverse yet again.