Dollar set to react to Q4 GDP

• February 28, 2006
• Kathy Lien

US Dollar

The US dollar gained strength against the Euro and British Pound, but its
weakness against the Japanese Yen and Canadian Dollar completely overshadowed
its performance against the two more liquid currencies.  Starting off what is
expected to be a very busy week, we had weaker new home sales reported this
morning.  Falling 5 percent on the month, new home sales were 1.233 million
versus the market’s forecast of 1.265 million.  Inventories hit a record high,
raising continued concerns that the housing market may be floundering. 

With new condo developments still springing up left and right
in New York, California, and Florida, the slowing sales of new homes is
particularly concerning.  We have always said that the first indication of
waning demand is a buildup of inventory and according to today’s report that is
exactly what we have been seeing.  There is also word that home sales were able
to increase only because of additional free add-ons that builders are providing
such as flat screen TVs and upgraded floors.  CNN Money reported Friday that
more people are canceling their purchases of new homes due to an inability to
sell their previous homes.  If the housing market continues to show signs of
slowing, people may just give up on their down payments rather than get stuck in
a losing investment. 

Yet even though housing is fading, the low level of jobless
claims should be very good news for consumer spending, confidence and ISM
reports.  Today’s fourth quarter GDP figure is also up for revision.  As
signaled shortly after the advance release by the government, the number was
somewhat distorting and expected to be notched higher at the next release.  The
market is forecasting an upward revision from 1.1 percent to 1.6 percent.  

Euro

The Euro extended Friday’s weakness despite faster than expected money supply
growth last month.  M3, the broadest definition of money supply grew by 7.6
percent compared to the market’s forecast for 7.3 percent growth.  Household
borrowing also grew by 9.4 percent, which was the fastest pace of growth in
close to six years.  With such a rapid rise of borrowing, there is no wonder
that the European Central Bank will be looking to raise interest rates on
Thursday.   A quarter point interest rate hike has been completely priced into
the market, which is part of the reason why the Euro is not rallying into the
meeting. 

However, what the market is not anticipating is significantly
hawkish comments from the central bank.  Everyone expects the ECB to continue
raising rates conservatively since they rarely have a vested interest in seeing
the Euro increase significantly in value. As an export dependent region, the
Eurozone should have benefited significantly from the Euro’s sub 1.20 value over
the past month.  There are a lot of economic data due for release from the
Eurozone tomorrow including German and French unemployment figures, Eurozone
CPI, and consumer confidence.  With most releases being for the month of January
or February, we expect the figures to show improvements in the economy.   

British Pound

The British pound tumbled for the second consecutive day in the face of mixed
economic data.  The narrowest measure of money supply growth, M0 fell 0.1
percent this month after strong growth last month.  The weaker pace of growth
dragged annualized acceleration down from an upwardly revised 6.6 percent to 6.2
percent.  Meanwhile housing market reports mixed.  House prices as measured by
hometrack accelerated by the fastest pace in 20 months in February but mortgage
approvals according to the British Bankers Association fell by 12.1 percent last
month. 

Today we are expecting more housing market figures with
Nationwide House prices due for release along with the Gfk Consumer Confidence
survey and the CBI Distributive Trades report.  More weakness or mixed data
should not be surprising as the UK economy continues to struggle to recover. 
Compared to the rest of the world, the UK calendar is relatively light, which
means that the British pound’s value against the Euro and US dollar will most
likely be determined by Eurozone and US developments.  

Japanese Yen

The big winner today and in fact over the past 4 trading sessions has
undoubtedly been the Japanese Yen.  Having first rallied on hawkish comments
from Bank of Japan Governor Fukui and then a subtle announcement by the People’s
Bank of China, the Yen is now soaring on the latest endorsement by the Japanese
government.  If you recall, we had said that the one thing standing in the BoJ’s
way is the Japanese government, who adamantly opposed the removal of
quantitative easing. 

Last night however, we saw the first and rather clear sign of
the Japanese governing shifting sides.  The Prime Minister himself said that the
final decision on monetary policy is “up to the central bank.”   An article in a
Japanese paper (Yomiuri Shimbun) quoted “sources” as saying that the government
would be fine if the BoJ decided to end quantitative easing at the March 8-9
meeting.  With the Japanese government now backing the BoJ’s stance, a move in
the next two months now becomes very likely since we have the endorsement that
we have been waiting for and the barrier that has been blocking such a move is
now dissipating. 

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.