NEWS / Foreign Exchange

Euro Pops Above 1.3650 ??“Can It Take Out All Time Highs?

Talking Points

??? Japanese Yen: Merchandise Trade Surplus much better
??? Euro: IFO near record highs
??? British Pound: GDP beats
??? US Dollar: New Homes Sales and Durable Goods on tap

Euro Pops Above 1.3650 ??“Can It Take Out All Time Highs?

The IFO survey surprised to the upside printing at 108.6 vs. 108 expected as German business optimism sparked by the ongoing global investment boom, overcame any currency concerns of the country??™s exporters. Despite the near record value of the euro which was within striking distance of all time highs against the dollar, demand for German goods remained unabated as massive investment projects in Middle East, Eastern Europe and China continued to instill a strong level of optimism amongst German businesses. Indeed, the markets now expect official German GDP estimates for 2007 to inch higher from 2.3% to 2.4% as traders see further evidence of decoupling in economic growth between EZ and US.

The strong IFO results bode well for further EURUSD gains especially if they present a sharp contrast to yet another negative result in US data. Today, the US calendar contains New Home Sales and Durable Goods. Durable Goods are expected to jump to 2.5%, but the market will likely ignore the headline number given the fact that it may be skewed by large Boeing orders and will focus on the extransport read. If the number once again misses forecasts it will suggest a serious slowdown in US economic activity and will almost assuredly push the EURUSD to record highs. However, unless US data is especially poor, fueling speculation of a possible recession, euro gains may be capped. Given the record high value of the currency, the ECB is likely to only raise rates once by 25bp in June and then observe the impact of the tightening on EZ economy for considerable amount of time. Therefore, the compression in interest rate differentials between the euro and the dollar may not materialize as quickly as euro longs expect.

As we noted last week, the extraordinary dichotomy between the currency market (which is decidedly dour in its outlook on the US economy ) and the stock market (which is remarkably sanguine about US growth prospects) continues unabated. The strength in US equities is also affecting the trade in USDJPY. Since so much of the liquidity for equity investments is financed by the carry trade, a short USDJPY position has become an implied bet on the decline of the US stock market. So far that bet has not paid off given the relentless strength of the DJIA and despite the fact that Japanese data continues to surprise to the upside. In the latest evidence of Japanese economic strength today??™s March trade surplus showed a 74% year over year increase as exports remained string while imports dropped by -7.9%. The rest of the week, brings a slew of Japanese economic news from Overall Household spending to employment figures. If Japanese economic reports continue to impress and the US stock market finally recedes from its stratospheric highs, the case for long yen positions will become materially more compelling.