Dollar sells off as traders fear weak data means more to come

US Dollar

Broad dollar weakness was the overwhelming theme in the markets yesterday as
traders continue to come to the realization that the Federal Reserve is nearing
the end of its tightening cycle.  GDP was revised higher to 1.6 percent for the
fourth quarter, which was right in line with expectations. Personal consumption
growth was slightly weaker, but that was offset by higher inflation as suggested
by the 3.3 percent rise in the GDP price deflator. The market barely budged on
the higher number, since deep down, they were expecting a much more explosive
upward revision. 

What traders did not expect however, were the dismal reports
that followed at 10am EST.  The Chicago purchasing managers index slipped down
to 54.9 from 58.5, consumer confidence fell from 106.8 to 101.7 while existing
home sales slowed from 6.75 million to 6.56 million.  With such strong jobless
claims figures over the past few weeks, the market was really positioned for
good data this week.  Now the fear is that the poor Chicago PMI number may be
foreshadowing an equally dismal ISM number due for release tomorrow. 

Also, with confidence falling hard this month, it remains
questionable as to whether tomorrow’s personal spending release can actually
show improvements.  Having started a busy week on a weaker footing, the market
has been caught by surprise causing much of last week’s dollar bullishness to be
erased.  If the anti-dollar rally manages to continue for one more day, we could
have the makings of a reversal in the EUR/USD and GBP/USD.   

Euro

The Euro staged a strong rally today thanks to the combination of better than
expected European economic data and worse than expected US data.  Over in the
Eurozone, German unemployment fell by 5,000, which marked the tenth decline in
eleven months.  The ILO unemployment rate also fell from 9.0 percent to 8.8
percent.  By now, it should be no surprise that the German economy is gradually
improving with France not trailing all that far behind. 

The country’s consumer confidence indicator improved from -27
to -24. Producer prices increased more than expected last month which also leads
well into the continued inflation concerns going into Thursday central bank
meeting.  Even though consumer price inflation fell 0.4 percent last month, the
annualized rate of growth increased from 2.2 percent to 2.4 percent, which is
solidly above the central bank’s 2 percent pain threshold for inflation.  Both
consumer and industrial confidence improved this month, which should overall be
quite encouraging for Trichet’s staff.  There are even some optimists who expect
the ECB to raise their inflation forecast for 2007 if things continued to
improve.  Given the length of time that the Euro has spent below 1.20, we could
see a more hawkish stance by the ECB, which would really be the wild card on
Thursday.  

British Pound

Although economic data was somewhat negative for the British pound yesterday,
the currency pair managed to be the biggest mover of the day, rallying close to
200 pips against the US dollar.  Strong month end demand and portfolio
rebalancing has apparently helped to lead the pound higher as it extends the
momentum from the major merger and acquisition announcement made yesterday by
Japan’s Nippon Sheet Glass for Britian’s Pilkington.  The purchase is worth
USD$3 billion and marks the glass’ industry’s biggest deal ever. 

Meanwhile offsetting some of the optimism that may have come
from yesterday’s Hometrack house price report, building society Nationwide
reported a 0.2 percent drop in house prices this month, which was far short of
the market’s 0.4 percent forecast.  However, taking both of the reports into
consideration, the argument for stabilization in the UK housing market still
holds.  Consumer confidence also ticked lower along with the CBI distributive
trades report confirming the market’s belief that the Bank of England will still
has to lower rates again some time this year, even if they are not in a rush to
do so at the moment.  The move in the British pound has been impressive with
prices breaking above some key resistance levels.  Therefore we would not be
surprised to see an extension move over the next few days.  

Japanese Yen

With the Japanese government giving their blessing to the Bank of Japan to do as
they please, the Japanese Yen has rallied for the fifth consecutive day. 
Economic data is also supportive of the move with retail sales rising 3.1
percent in January and the manufacturing sector PMI index holding near record
highs.  Industrial production fell short of expectations, but still increased
0.3 percent last month. 

The market is touting the end of the USD/JPY carry trade story
which may be the correct belief in the short term as some speculators unwind
their short Yen trades ahead of a possible shift in policy at the Bank of
Japan’s meeting next week.  However, even if the BoJ did remove quantitative
easing, at best, they would only deliver a quarter point rate hike, which still
leaves Japan with the lowest interest rate in the world.  According to a Reuters
report, Bank of Japan officials have already said that the central bank would
keep short term rates low even after scrapping the policy.

Kathy Lien

Kathy Lien is the Chief Currency Strategist at

Forex Capital Markets. Kathy is responsible for providing research and analysis
for
DailyFX, including technical and fundamental research reports, market
commentaries and trading strategies. A seasoned FX analyst and trader, prior to
joining FXCM, Kathy was an Associate at JPMorgan Chase where she worked in Cross
Markets and Foreign Exchange Trading.