The dollar fell against all the majors in a week that saw little evidence to support Ben Bernanke’s statement that the risk of a downturn had diminished. “What can the Fed do about inflation if the economy is slowing down?” was the question on everyone’s lips as speculation mounted that an increase in interest rates is unlikely on Wednesday.

 

 

 

The first few hours of the week (chart 1) were quiet with the dollar trading in a narrow range during the Asian session. Europe woke up to a higher than expected European Consumer Price Index (CPI) which gave the euro an upside boost. The US Empire State Business Index is the first in a series of US economic activity indicators. It came in worse than expected and perhaps sets the tone for US manufacturing indicators in the coming weeks. Monday’s US TIC numbers stuck a positive note for the States as they showed that over-seas’ demand for US long-term securities remains strong. However, they were not sufficient to turn the tide as oil hit new all-time highs on Monday afternoon and the euro tested and finally found support at 1.55.

Tuesday’s weak ZEW numbers put a dampener on euro sentiment. Over in the US, Housing Starts fell to their lowest level since 1991 offering no convincing signs that US housing has found a bottom yet and US Producer Price Index surveyed prices rising faster than expected and underlined the problems facing the developed economies. In the old days, high prices for commodities in the US and Europe triggered a global fall in demand which in turn caused prices to fall. However, globalization has created millions of new consumers in China, India and Russia etc who are richer than they have ever been before and who may well be prepared to pay prices that Americans and Europeans can’t stomach. 

Wednesday was pretty non-descript in trading terms with very few news releases were scheduled. ECB executive board member and leading hawk, Jurgen Stark, was reported as telling an audience in Cologne that he was alarmed at the rate of inflation and said the time was right to look at interest rates.

Thursday saw euro/dollar fall once more below 1.55 as China announced plans to raise energy prices across the board the following day. The Chinese authorities had been under pressure from the international community to slash energy subsidies for some time. However, most commentators had believed they would forgo a price hike until after the Olympic Games in August.

Friday saw the Euro regain support at 1.55 and start climbing to 1.56 as oil prices rose again and speculation mounted that the Fed was increasingly unlikely to raise rates next week. Euro/dollar closed the week a touch above 1.56.

 

 

 

Monday saw Sterling (chart 2) rise against the greenback as oil prices rose. The pair hit strong resistance at 1.97 and the release of the UK’s Consumer Price Index (CPI) on Tuesday morning saw the pound lose all the gains it had made the day before. The CPI numbers had inflation running at 3.3%, over 1% above target and this would usually boost the currency. However, in his letter to the Chancellor of the Exchequer, the Bank of England’s Govenor, Mervyn King, threw cold water on the idea that the Bank was going to hike interest rates anytime soon. Investors sold the pound, which fell below 1.95 and didn’t start rising until the release of the US’s housing and inflation numbers. It fell back to 1.95 overnight but firmed once again when the Monetary Policy Committee (MPC) meeting minutes were released. The minutes showed that only arch-dove Danny Blanchflower had supported a rate cut, with a rate hike being discussed before an 8-1 vote to hold. Cable then started rising to 1.96 where Mervyn King gave it support when promised to do whatever was necessary to reduce inflation. This hawkish tone was tempered somewhat when he went on to advise the British to learn to live with higher prices without increased wages. It seems the Bank wants to tough it out against inflation and wait for falling demand to bring prices down.

The pound got a real boost on Thursday’s release of UK retail sales which surveyed a totally unexpected boost in consumer spending. The pound broke through 1.97 and continued rising on a worse than expected Philadelphia Manufacturing Index.

Friday saw cable testing support at 1.97, until rising oil prices and a bearish dollar tone lifted the pair to close a little above 1.9750.

 

The week’s big event (chart 3) is of course the Fed’s interest rate announcement on Wednesday and the run-up to this is always pretty fraught. A week or so ago Ben Bernanke said that it appeared that the US economy had turned the corner. If this is the case then the Fed could have room for interest rate rises. You can check for signs of cornering in the US housing market on Tuesday with the influential S&P/Case SchillerComposite 20 index, Wednesday’s New Home Sales and Thursday’s Existing Home Sales

 

 

Durable Goods Orders released a few hours before the Fed statement will give a further opportunity for insight into US economic health. Touch base with the US consumer on Tuesday and Friday.

RightMove reported that UK house prices fell in June by 1.2%. This is the first June fall since records began. More important UK news expected this week includes the UK’s GDP on Friday and the Bank of England’s Monetary Policy Committee testimony to Parliament on Thursday. Look for clues to future policy.

Monday’s German Ifo surveys came in much weaker than expected (Business Climate: 101.4 and Business Expectations: 94.7. The Euro zone’s Purchasing Managers Index (PMI) came in at the same time with both the manufacturing and service sectors recording contractions. The euro dropped like a stone to 1.55. As I write this it seems to be finding support at this level and we’ll have to see what the rest of the week brings. On Friday we’ve got Euro zone consumer confidence. ECB President Jean-Claude Trichet will be speaking on Wednesday in Brussels and on Friday in Rome. Our full economic calendar is available.

Recent US data and continuing problems in the financial sector cast doubts on the Fed’s room to hike rates and we can’t see them raising rates on Wednesday. However, there seems to be a lot of desire for a US turnaround on the market and the run up to Wednesday could well see some dollar strengthening in anticipation. Oil is another key factor at the moment, buy the dollar when oil falls and sell it when it rises should be your mantra. As Bloomberg noted, oil and the dollar had moved in opposite directions 93% of the time in the last 12 months.

This weekend’s emergency summit in Jeddah, Saudi Arabia, seemed short on solutions. The communiqué issued at the end of the summit touched on all the major issues of both producers and consumers, but was had little real substance. As I write, NYMEX crude is over $137 a barrel, up $1.71 on the day so far.

However, it is not unlikely that the bad numbers out of Europe this morning could continue to bring downside pressure on the euro, while sterling should find it difficult to build on last week’s run as the UK’s economy as a whole and housing market in particular are in a fragile state.

All in all, we favor euro/dollar shorts this week and see EUR/USD finding support at 1.5300 with resistance at 1.5700. If the pair should overcome this resistance, 1.5775 will provide the next target. GBP/USD will trade within 1.9560 and 1.9800. UK fundamentals make a break of 1.98 unlikely. USD/JPY could test support at 106.00 in the first part of the week. However, we still believe the pair has the legs to make 109.80

 

The latest Forex Focus video

 

The carry trader takes advantage of interest rate differentials by buying the currency in a pair which has the higher interest rate. This enables the trader to benefit from swap as well as changes in the price of each pair.

EUR / CHF
The Swiss National Bank (SNB) held rates at 2.75% for the third consecutive time last week which had a positive impact on EUR/CHF. The week’s high of 1.622 was hit on Thursday. If the pair drops to 1.5930, we intend to go long (target within 1.611 - 1.612).

EUR / JPY
High inflation in the Euro zone and moderate economic growth in Japan saw the Euro make significant gains against the yen. The pair rate reached the key level of 168, the highest level since July 2007.

EUR / GBP
The reluctance of BoE’s Monetary Policy Committee to cut base interest rates and high inflation in the UK saw this pair fall last week to a low of 0.785. Our target stands at 0.763, a significant correction level.

GBP / JPY
Our GBP/JPY long continues to earn solid income for the sixth week in a row and should continue to do so if UK rates stay firm. The pair had hit 213.8 by the end of last week. Our medium term target is 216.7, the mid-point of the recent downtrend. 200.9 is a good level to load a long.

GBP / CHF
The British pound gained slightly against the Swiss franc thanks to the SNB statement. Nevertheless, the volatility of this currency pair remains low. We forecast an appreciation in GBP/CHF rate to 2.117 in the second half of this year. Only the refinancing rate hike by ECB could cause a further decline of GBP/CHF.

USD / JPY
The pair rose to 108.6. Our medium term target is on 109.7. We think that 103.3 is a good level for buying.

AUD / JPY
The growth rate of the Australian dollar against the yen accelerated again. Last week saw a new high of 102.8. This appreciation has obliged us to raise the level we will load a long by 100 pips to 97.3

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That wraps it up for this week. Thank you for reading this far. Have a great week and I hope to see you at www.coltfx.com

 

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