Euro Surges vs. Dollar, Here’s Why
US Dollar
The dollar has lost ground against the euro, which comes as no surprise to those
of us that are watching the markets with only a mild interest. Last week the
markets were very quiet with range trading being the predominant theme. We
expect this week to be no different. With not much to talk about, economists and
market watchers have only 2 things on their mind – which is oil and real estate.
There continues to be more signs of a housing market slowdown in the hot areas
such as California and Florida. No one is really calling for a widespread
collapse, but a collapse is not necessarily needed to have a big impact on US
consumption. It is the mere realization that the housing market may have topped
out by the average consumer that can cause homeowners or real estate investors
to want to sell now, possibly even cut prices before things get even worse. This
sort of anxiety mentality could be all the market needs to scare consumers from
being too lax with their spending habits. Oil is the other story. It seems as if
every day brings us a new high in oil prices and there is no sign of relief
anytime soon. One of our favorite economists Nouriel Roubini postulated about
whether the latest oil price shock could lead to a recession. He says that US
consumers have so far treated the rise in oil prices as nothing but temporary
and have continued to spend, dipping into their rising household wealth,
borrowed more and more against it and reducing their savings rate to zero. Yet
with this being a demand based shock rather than a supply based shock, there is
no abnormal factor such as weather or geopolitically uncertainly that can later
be corrected to make this a temporary phenomenon. This means that the 2 year
rise in oil that we have seen thus far could be far from temporary. In fact,
although Roubini and most of the world doesn’t believe that the latest oil shock
will cause a recession, there is a near consensus that if prices stay at current
levels or continue to rise, there could be a sharp contraction in growth.
Roubini said, “this last installment of the oil shock may be the tipping factor
that could trigger a consumption retrenchment, a bursting of the housing bubble
and a significant economic slowdown.” If this really unfolds, it could spell
disaster for the dollar in the second half of the year and this is not even
considering the potentially negative implications of the end to the tightening
cycle or Greenspan’s departure.
Euro
The Euro rebounded against the dollar today with a sharp break higher in the
early European session with little follow through afterwards. The Eurozone
current account balance came in much weaker than expected, dipping into negative
territory, but the market wrote off the weaker headline number after they saw
net capital flows increase by 400% in the month of June. The seasonally adjusted
current account balance fell from a surplus of 1.9B to a deficit of 2.5B in
June. With the deficit accounting for only 0.3% of GDP, it is of nominal
consequence. Instead, capital inflows increased from EUR25.9 billion in May to
EUR96.3 billion in June. If this isn’t evidence of possible global
diversification in Euro-denominated assets, we do not know what is. Equity
inflows increased from EUR22.4 billion in May to EUR61.5 billion in June. The
bigger change though was in bond inflows, which increased from EUR7.2 billion to
EUR47.5billion. As a percentage of GDP, this is a much more significant change
and certainly a number of consequence.
British Pound
With no economic news on tap, traders pushed pound sterling higher after a brief
pause on profit taking over the past four sessions. Momentum remains strong on
the belief that the Bank of England will leave interest rates unchanged at
4.50%, bucking previous expectations of a wild decline. However, traders will,
as a result, be scrutinizing economic data even more so in confirming this
notion, lest any surprises turn the tide. With a slew of data this week, traders
look to place special focus on two notables, the CBI industrial trends monthly
survey and the gross domestic product for the second quarter. With economic
growth slumping since the first quarter, economists and investors will look to
see if consumer sentiment did indeed change on the most recent rate cuts,
although effects may still be early. Most recently, housing price depreciation
has actually bottomed as consumer prices have also increased, indicative of
previous warnings that inflation remains a concern. However, with consumer
consumption representing a large portion of the economy’s growth, pick-ups in
domestic demand would ultimately be the nail in coffin, confirming a domestic
turnaround and steady rates. Until then, traders will be left with some
uncertainty until policy makers next convene in September as futures traders are
siding with the overwhelming positive.
Japanese Yen
The Japanese yen cast aside the disappointing convenience store sales data and
instead rose on subsequent financial and political factors. For one, Prime
Minister Koizumi and his reform plan have garnered a good amount of positive
public support according to a local survey. Even after the previous Japanese
postal service reform debacle, Koizumi’s popularity has ballooned to 53%, with
plenty of upside potential. Subsequently adding to this, the prime minister’s
political party released its manifesto and stated its intent to fully back the
passing of the reform bill, calming any further speculation of future lower
house contention. As a result, not only can market participants bank on a
political win in September, but further economic reform is sure to follow. With
the political picture a bit more optimistic and grounded, investors additionally
turned their focus to the rising equity markets. Continuing to close above the
12,000 psychological mark, the Nikkei 225 has remained above the figure, even
rising to fresh four-year highs last night. Bolstered by positive future growth
potential, foreign investors purchased the largest amount of Japanese equities
in 17 months, $6.5 billion, last week. Ultimately, with both factors in favor of
yen appreciation, a lot of pressure is being placed on future economic data,
especially inflationary figures. Any rise in prices may ultimately warrant
speculation on short-term rate considerations.
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. Kathy has vast experience within the
interbank market using both technical and fundamental analysis to trade FX spot
and options. She also has experience trading a number of products outside of FX,
including interest rate derivatives, bonds, equities, and futures. She has a
Bachelors degree in Finance from New York University. Kathy has written for
Stocks and Commodities, CBS Market Watch, ActiveTrader, Futures and SFO
Magazine. She is frequently quoted on Bloomberg and Reuters and has taught
seminars across the country. She has also hosted trader chats on EliteTrader,
eSignal, and FXStreet, sharing her expertise in both technical and fundamental
analysis.