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No Respite for the US$, Continues to Weaken

The US$ continues to remain under pressure, falling to new all time lows against the euro overnight, while weakening against the pound and yen as the market remains concerned about the probability of an US recession. These concerns were reiterated by former Fed Chairman Alan Greenspan in an interview overnight with BBC Radio, when he stated that he now sees the threat of recession to be significantly higher now than it was several months ago. These economic concerns have the market poised for the Fed to slash rates again at the October 31 meeting, in an effort to jumpstart economic growth. Yesterday, the market saw the release of weak US housing data, showing a sharp decline in New Home Sales, adding further evidence to the view that the US housing market’s decline is far from reaching a bottom. Expect trade to be further influenced by the slew of Fed officials poised to speak today. Lockhart, Mishkin, Yellen and Poole are all slated to speak, with the market closely monitoring their comments for any indication about their view of economic growth and US interest rate policy over the coming months. The market will further focus on the release of US economic data this morning to gauge the health of the US economy. This morning personal spending and income data were released in line with expectations with income gaining 0.3% vs. 0.4% expected and spending gaining 0.6% vs. 0.3% expected. Later this morning Chicago PMI is expected to register 53.0, when the data is released at 9:45 a.m. At 10:00 a.m. Construction Spending and U. of Michigan Confidence is to be released expected to decline 0.3% and register 84.0. With weakening data and the likelihood of further Fed rate cuts this year, the US$ will remain under pressure.

The euro remains firm as economic growth continues to expand throughout the region and all probabilities point to the ECB pushing rates higher this year. Despite lingering concerns about the effect that the global credit crunch will have on economic growth, ECB officials continue to stress their inflation-fighting prowess. A continued stream of comments from a wide range of Eurozone officials have reinforced this view, and will likely lead the ECB to hike rates again at least 25 basis points before year-end, as the lingering issues in credit markets work themselves to fruition. This view will continue to support the euro in the coming months as we see global capital flows moving more aggressively into euro positions.

The yen continues to seesaw in ranges as investors enter and exit “carry trade” positions funded with the currency. While global equity markets appear to be stabilizing as some stability is returning to credit markets, the yen has been shorted again by investors seeking cheap financing options. However, with Japanese fiscal mid-year ending overnight, Japanese exporters took the opportunity to repatriate yen at current levels, above the 114.40 level they had forecast for the year. The yen was furthered buoyed after the release of positive Japanese economic data. Industrial Production and Household Spending rose at a higher than expected pace, reinforcing the view that the Japanese economy can weather a US economic slowdown. With the Japanese Tankan survey of business confidence slated for release on October 1st, any signs of a better than expected survey can help bolster expectations of a Bank of Japan rate hike this year. With expectations of higher Japanese rates, led by a recovering economic landscape, expect the yen to be buoyed over the next several months. The “carry trade” will be gradually reentered as financing vehicle, however yen losses will ultimately be limited as Japanese exporter sales will keep a lid on US$ gains.

The pound gained overnight despite the news that Northern Rock PLC, the struggling British mortgage lender, was forced to borrow an additional 5 billion pounds from the Bank of England to meet obligations. The market has apparently exerted confidence in the Bank of England’s ability to stabilize markets, despite credit spreads widening as banks seek to obtain more cash for the balance sheets over quarter end. Yesterday, saw the release of strong UK house price data, reinforcing the view that the UK consumer remains vibrant and the economy strong. This view has led the market to speculate that as credit woes wane the Bank of England could be forced to hike rates to curb inflation pressures. These expectations will keep sterling firm in the short-term.

U.S. Housing Numbers Bear Fate for US$

The US$ fell to new all time lows this morning as measured by the Dollar Index ahead of data slated for release later today. With the market squarely focused on interest rates and the prospect for further rate cuts from the Fed, investors continue to sell the greenback. There are now concerns creeping into the market that the US economy could fall into recession as slowing consumer spending, led by a significant drop in the housing market will stymie economic growth. With this backdrop, the market continues to watch the flow of US economic data and the level of rhetoric from Fed officials. Fed Chief Bernanke is slated to open a conference later this morning and the market will closely monitor his comments to determine future policy action from the Fed while analyzing the level of concern the US Central Bank holds about credit and housing markets. In addition to Bernanke’s comments, there is some significant US economic data slated for release this morning. Earlier today, weekly jobless claims and GDP were both released in line with expectations. GDP registered 3.8% while weekly claims registered 298,000. However, the market’s main focus will be on New Home Sales slated for 10:00 a.m. release. New Home Sales are expected to decline 5.2% to 825,000. As the housing market continues to show signs of weakness, investors will likely continue to abandon the greenback en masse as the likelihood of further Fed rate cuts permeate the market.

The euro continues to remain firm as global investors continue to shift US$ holdings into the Eurozone currency. With the backdrop of robust Eurozone growth, coupled with the probability of the ECB hiking rates later this year, the euro remains firm. However, there are still some lingering concerns about a global credit crunch, which could inhibit further significant euro gains. The ECB loaned 3.9 billion euros to banks overnight at the emergency lending rate, as credit conditions remain tight amongst Eurozone banks. This is the largest cash injection into the market since October 2004. However, despite these tightening credit conditions, M3 money supply continues to hold near 28-year highs. M3 is used as a gauge for inflation pressures by the ECB, and at current levels, all but guarantees a further rate hike from the Bank this year. ECB Chief Trichet secured these interest rate expectations when he stated that he believes that it is too soon to determine if economic growth will be hurt by recent credit market conditions, however the Bank is determined to anchor inflation at 2.0%. This backdrop of higher Eurozone rates should continue to drive the euro higher.

The yen continues to range trade, dropping modestly overnight as investors tepidly reenter the carry trade. With news emerging in the market yesterday that Bear Sterns was selling a portion of its losing mortgage portfolio to Warren Buffett, some stability returned to markets allowing equities to rally. With yen still remaining the preferred financing vehicle for equity purchases, investors shorted the Japanese currency overnight as more risk was shifted to investor balance sheets. Expect this correlated relationship between risk and the direction of the yen to prevail for the next several months until global markets calm and/or there is some indication of an interest rate policy shift from the Bank of Japan.

The pound rallied overnight after the release of data showing that UK house prices rose at the quickest pace in three months. This data helped ease market fears that the UK housing market was declining at a pace similar to the US. With the Bank of England under pressure as credit fears eclipse the UK market, it appears the Central Bank’s policy of guaranteeing deposits coupled with large cash infusions to the market have appeared to calm both jittery investors and consumers. As stability returns to markets, investors will quickly refocus on the strong UK economy and the likelihood of a further rate hikes from the Bank of England. These expectations should buoy the pound.

US$ Flat Ahead of Housing Numbers Tomorrow

The US$ was flat overnight after weakening yesterday in response to economic data that continues to disappoint the market. Yesterday, the Conference Board’s index of consumer confidence fell to 99.8 from 105.6 last month. The decline was larger than expected, helping to prompt increased market expectations that the Federal Reserve will lower interest rates further this year. The US$ index fell to its lowest level since it was created in 1973. Today, the change in durable goods orders was released at 8:30 a.m. The number was expected to show a decline of 4.0%, but actually showed a decline of 4.9%. Excluding transportation, durable goods orders declined 1.8%, larger than the expected decline of 1.0%. Tomorrow, the US$ may receive a very slight reprieve from the negative news with the release of final second quarter GDP. GDP is expected to have grown 3.8%, up significantly from first quarter growth. It is likely, however, that the market will focus on the release of new home sales at 10:00 a.m. tomorrow. Home sales are expected to decline 5.2%. In the current environment – with consumers losing confidence and rates moving lower – it is difficult to imagine that home sales will show impressive gains over estimates. With the negative news seeming to pervade the market, the US$ is likely to fall further, particularly if the Fed continues to lean towards cutting interest rates. Any gains will be seen by the market as good opportunities to further liquidate US$ holdings.

The euro fell slightly overnight, but remains very close to its all time high against the US$. Despite a disappointing IFO business climate survey yesterday, the euro rose against the US$. The focus within the market continues to point to a narrowing of interest rates between Europe and the United States that helps boost euro holdings. The ECB continues to make statements that support the notion of at least one more interest rate increase this year. However, the ECB could potentially come under increased political pressure if more countries begin to feel the euros appreciation is too significant.

The yen fell overnight as equity markets rally. The yen remains the market’s proxy for risk, falling against the US$ when the market assumes more risk and rising when it pares these positions. The Federal Reserve interest rate cut has done well to steady the market and decrease volatility, which should be supportive of more carry trades. As interest rates in Japan remain low, the market will look to sell the currency and enter higher yielding currencies.

Sterling continues to oscillate in wide ranges as the market is concerned with potential fallout in the U.K. banking sector. If the banking sector were to come under a crunch, it could potentially impact the strong housing sector in the U.K. Much like the U.S., the housing sector in the U.K. has been supportive of strong economic growth and increasing inflation pressures, causing the Bank of England to raise rates. If the bubble were to burst in the U.K. housing sector, sterling would suffer. However, as long as the housing sector remains buoyant, rates will stay firm and sterling will remain a favorite among investors.

US$ Steady, But Weak Ahead of Housing Data

The US$ diverged in direction against the yen and pound overnight, while steadying against the euro, as market aversion to risk appears to driving trade. The focus of trade still remains on the evolving global credit crisis and the risk this has to economic growth rates. With the Federal Reserve slashing interest rates an aggressive 50 basis points last week, the market remains wary that the US economy is slowing and the Fed seems to be adopting a proactive posture. Concerns about the recent credit market problems were reiterated in an IMF report released overnight. They stated that they believe that the turmoil in credit market will likely be protracted, reinforcing views that the Fed will have to remain in a proactive, dovish posture. Data to be released later this morning will help the market gauge whether the Fed will act to cut rates further later this year. At 10:00 a.m. the US releases Consumer Confidence expected to decline to 104.3 and in addition, Existing Home Sales will be released expected to decline 4.6% to 5.48 million. Any indication that the US consumer is losing confidence coupled with signs of further weakness in the US housing sector, will almost certainly contribute to a further US$ drop.

The euro steadied in recent ranges ahead of the release of US economic data this morning and after comments from ECB officials overnight. Despite the release of a weaker than expected German Ifo survey showing that the confidence dropped to a 19-month low of 104.2 from a previous reading of 105.8, the euro failed to decline. It appears that the market has placed significant weight on interest rate differentials and the expectations around Central Bank policy. With the US Fed all but certain to cut rates again this year, the market has shifted its attention to the ECB. The recent slew of comments from various officials seem to suggest that the Central Bank will hike rates again this year. This view was reinforced by comments from ECB member Nicholas Gargans overnight, who stated that he believes that the euros’ recent rally will not be enough to “diminish” price pressures, suggesting he supports a further interest rate hike. In addition, he stated that he believes that the recent turmoil in credit markets will have a “marginal effect” on economic growth. Expectations of higher Eurozone rates will continue to drive the euro higher.

The yen gained overnight as risk appears to be reentering credit markets following news from the Bank of England that it might be unable to support policy action announced several weeks ago. The “carry trade” still remains an integral part of trade finance, with many investors opting to use the short yen as a preferred financing vehicle. The “carry trade” is certainly less entrenched than it was several months ago; however, any reemergence of risk in markets has new positions quickly being liquidated. This sharp correction in yen positions has led to significant drops in both the Aussie and Kiwi overnight as these currencies had again become favored counters to the short yen trades. Yesterday, the government of Shinzo Abe resigned making way for his successor Fukuda. The market remains uncertain about the pace of reforms Fukuda’s government will institute, keeping the Bank of Japan likely in limbo about policy direction. With theses dueling factors overhanging the market, expect ranges to prevail for some time.

The pound dropped overnight after the UK newspaper, the Independent, reported that the deposit protection plan announced by the Bank of England on September 14th remains under capitalized. As it was reported that the UK Financial Services Compensation Scheme holds only 4.4 million pounds (while compared with a similar US fund holding some $49 billion) there is mounting concern that the UK government will be unable to bailout institutions like Northern Rock Plc. Any such concerns about the viability of the UK government to bailout faltering institutions could lead to further turmoil in credit markets and ultimately sterling declines. However, should the Bank of England report some other financing vehicle for proposed bailouts, the pound could quickly stabilize.

US$ Weighed Down by Fed Expectations

The US$ slumped across the board overnight as speculation mounts that weakness in the US economy will lead the Fed to cut rates further this year. Last week the Fed surprised the market with a 50 basis point rate cut as they signaled to the market their concerns about the ensuing credit crunch and the affect it could have on US economic growth. With the US housing market already in a downturn as defaults rise on subprime mortgages, the Fed is walking a careful line not to cause further harm to the consumer and ultimately lead the US economy into recession. As these expectations about slowing US economic growth and further Fed rate cuts overhang the market, the US$ continues to set new lows. The US$ fell to its lowest levels on a trade weighted basis, since September of 1992 as investors flee the currency en masse. This US$ weakness has led many country’s to shift their reserve mix away from significant US$ holdings in favor of other currencies. Furthermore, the market is speculating that the Saudis could abandon the US$ peg that the riyal has long held, should the US$ decline further. A Saudi desertion of the peg could lead other nations to further ease their reliance upon the US$ as a guide for monetary policy. This would further tarnish the US$’s reputation and ultimately lead to further declines. The market will be watching the flow of economic data this week to see if fears about a US economic slowdown are coming to fruition. There is no significant data to be released today, however, the market will focus on releases tomorrow. Tuesday sees the release of Consumer Confidence and Existing Home Sales. Wednesday sees the release of Durable Goods. On Thursday, GDP, New Home Sales, and Weekly Claims are to be released. The week ends with Personal Income and Consumption, Chicago PMI, Construction Spending and U. of Michigan Confidence. Any signs of weakness in this data could lead the US$ lower.

The euro continues to remain firm as strong Eurozone economic growth coupled with the prospect of higher Eurozone rates continue to support the currency. These factors continue to push the euro higher, however gains might begin to temper as some commentary about excessive US$ weakness begins to be voiced from a slew of Eurozone officials. Overnight ECB Board Noyer stated that the ECB supports the G7 commentary that excessive currency volatility is “undesirable.” Furthermore, he stated that any “abrupt change” in US$ value could seriously hamper world economic growth. Furthermore, concerns about euro strength were echoed by the German Ministry of Finance last week, when they asserted that the currency’s climb could hamper economic growth. As vocal opposition rises to the euro’s recent gains, look for the currency to soon form a short-term top. However, euro gains will likely continue for the remainder of the year albeit at a tempered pace, as strong euro positives support the currency.

The yen gained modestly overnight as US$ weakness pervades all markets. Expectations that the Fed will continue to lower rates have tempered investors desire to hold the greenback, however, political uncertainty in Japan could ultimately push the yen lower. It is expected that Japan will name Yasoa Fukuda, the new Prime Minister tomorrow. However, Fakuda will likely ease on structural reforms within Japan as his ruling LDP struggles in the polls and he is unlikely to press any hardship on already disheartened voters. In this environment, uncertainty remains about the course of Japanese interest rates. Despite comments last week from BOJ Chief Fukui asserting that rates could be soon rising, it is uncertain given the Bank’s political sensitivity. In the interim expect ranges to prevail and the yen to seesaw as both yen and US$ weakness steer the currency.

The pound gained overnight as investors are again cautiously entering long sterling positions. With the Bank of England seemingly settling investor concerns about a further spread of the mortgage default contagion and helped ease worries about a continued credit crunch, the market is refocusing on UK economic fundamentals. With surprisingly good data released last week showing a resilient UK consumer, the market remains bullish about the outlook for the economy. This has led some to speculate that once the current mortgage and banking crisis eases, the focus could resift to the Bank of England who could again hike rates to ease inflation concerns. In the interim, however, expect ranges to dominate, with the pound trading in tandem with credit market expectations.

US$ Under Pressure, Reaches Lowest in 15 Years on Trade Weighted Basis

The US$ is under pressure, falling against the euro and pound as the market remains focused squarely on the declining economic situation in the US and the prospect for the Federal Reserve to continue cutting rates. After the Fed surprised the market with an aggressive 50 basis point cut on Tuesday, their accompanying commentary seemed to suggest that other rate cuts would be forthcoming this year. Currently the market is forecasting a 75.0% probability that the Fed will cut at its next meeting. This view was reinforced by comments yesterday from Fed Chief Bernanke who suggested that the continued crisis in credit markets could lead the recent housing recession to be more severe. In addition, Bernanke told lawmakers yesterday that the US central bank is “actively working” to prevent a repeat of the sub-prime rout of earlier this month. As the US Central Bank is seemingly moving into an accommodative posture, the market will look for further signals that the Fed will cut again when the Bank meets again on October 31. A slew of voting Fed officials are slated to speak today including Mishkin, Kohn and Warsh. As the market awaits comments from these Fed officials, expectations for lower rates have helped push the US$ lower as evidenced by the Fed’s trade weighted index falling to it’s lowest level since 1971 when the index was introduced. Further weighing on the US$ has been the recent surge in oil and gold prices. As these commodities spike, overall US$ weakness continues to permeate the market. With no US economic data to be released today, look for the backdrop of credit market turmoil, a weak housing market and the prospect of lower US interest rates to all weigh on the US$ in the coming months.

The euro remains firm as the market remains steadfastly focused on both diverging economic growth rates and differing interest rate policy between the US and Eurozone. However, recent gains may soon consolidate at these levels, as it appears that some of the recent crisis in credit markets and the euro’s strength is beginning to take its toll on the Eurozone economy. Overnight the RBS Index of Eurozone Manufacturing and Services fell to 54.5 in September from 57.4 in August. This is the lowest reading since in over two years, suggesting that recent credit turmoil could be spilling into other areas of the economy. In addition, two Italian executives voiced some disapproval of recent euro strength. Fiat Chairman Luca Cordero and Eni SPA Chairman Paulo Scaroni both asserted that the euro’s recent strength is beginning to curtail exports and hurting the Italian economy. They both urged the ECB to take action. However, any such action from the ECB is unlikely as comments overnight from ECB council member Vito Constacio suggest. Constacio stated that he believes recent euro gains are helping control price pressures, reinforcing the Banks’ strong focus on inflation fighting. Expect there to be little action by the ECB towards euro strength at current levels, while the currency remains buoyed by expectations of higher rates and robust growth.

The yen continues to seesaw in ranges as the market jockeys around the “carry trade.” With global equity markets gyrating between posting strong gains and declines, the yen is being used as a preferred vehicle to finance these equity purchases. As equity markets stabilize the yen will weaken in ranges, however, these declines will ultimately be limited as Japanese exporters continue to take advantage of a weak yen to repatriate profits. Adding to these yen purchases providing strength to the currency, has been the reemerging prospect of a Japanese interest rate hike by year-end. Recent comments from various Bank of Japan officials suggest tht the Bank will soon hike rates as it attempts to normalize borrowing levels with the rest of the G7. These conflicting factors will likely keep the yen in ranges for some time.

The pound gained overnight as the market remains focused on credit markets and a restoration of stability to the UK banking system. After concerns last week about spillover from the failure of British mortgage lender Northern Rock to other financial institutions, the pound came under significant pressure. As a run on the UK banking system pushed to the forefront, the BOE stepped in to guarantee deposits and inject liquidity into money markets. As stability returns, the market can shift its focus to the strong economic fundamentals in the UK. Robust retail sales coupled with the prospect that inflation pressures are mounting, will help keep sterling firm as the Bank of England might soon shift gears back into a rate hiking posture.

US$ Continues to Fall Ahead of Bernanke Testimony to Congress

he US$ fell across the board overnight, dropping to new all-time lows against the euro and fresh 30-year lows against the Canadian Dollar, ahead of Congressional testimony by Fed Chief Bernanke. Bernanke along with Treasury Secretary Paulson is slated to discuss the mortgage market and the affect continued sub prime delinquencies will ultimately have on US economic growth, at 10:00 a.m. before the House Financial Services Committee. It is unlikely that this testimony will do anything to help the US$, but rather it will draw further focus on the weakening economic conditions in the US. Following today’s testimony, there will likely be little doubt that the Fed will continue to push US interest rates lower this year, further weighing on the US$. The US$ also received a further downward push after it was reported in London’s Daily Telegraph that Saudi Arabia is poised to drop the country’s dollar peg. This speculation was fueled after the Saudi Central Bank did not cut rates in line with the Fed. US$ weakness continues to stoke inflation pressures within the desert kingdom and this action could be the first step prior to other Middle Eastern and OPEC nations exiting the strong reliance their currencies and reserve mix have had on the US$. Any such action would be a strong blow to the credibility of the US$ in the global market. The US released better than expected weekly claims data this morning registering 311,00 vs. expectations of a 321,000 reading. At 10:00 a.m. Leading Indicators are to be released expected to decline 0.4%. It is unlikely that any of this data will have a significant affect on US$ direction. The market’s attention remains transfixed on Bernanke, the Fed, the prospect for lower US interest rates and the probability of a prolonged US economic slowdown. With so many negatives lining up against the US$, it is all but certain the US currency will continue to set new lows.

The euro continues to gain against the US$, trading to new all-time highs as investors shun the US$ en masse in favor of the Eurozone currency. With the Fed poised to cut rates further amidst a continued crisis in the housing sector, interest rate differentials between both the Eurozone and US have come sharply into focus. As the Fed is backed further against the wall, and forced into a reactionary posture to declining US economic conditions by cutting rates, the market is drawn to the seemingly converse proactive posture of the ECB. With the Eurozone’s Central Bankers seemingly dealing with the mortgage crisis in an aggressive, successful manner and Eurozone economic growth still on track, the market has remained focused on the prospect that interest rates will be rising. A slew of comments over the past several weeks from a range of ECB officials all but signal these higher rates. Also helping the euro higher is the apparent appeal that the currency continues to adopt as a substitute for the greenback. As the reserve mix of global central banks shifts into a greater euro weight, coupled with the likelihood that several countries will soon exit their monetary peg to the US$, the euro has stepped in as a strong alternative. Look for this trend to continue, as the euro advance will likely go unimpeded for the remainder of the year.

The yen gained overnight as investor risk appears to be resurfacing in the market amidst a continued shakeout in equity markets. As the US housing situation appears to be worsening and it all but certain that Fed Chief Bernanke will sound some strong warnings this morning, global equity markets slumped overnight. This slump in equity markets led to a cover of weak “carry trade” positions used to finance these recent stock purchases. Also weighing on the yen is the continued repatriation of profits by Japanese exporters as their currency weakens to levels above 116.00. These yen purchases by Japanese corporates have been predicated by the Bank of Japan signaling that it is poised to raise rates as soon as next month, as it attempts to normalize the Japanese lending market with other G7 nations. In the interim, expect the yen to trade in wide ranges against the US$, weakening when equity markets gain, however ultimately regaining its footing as Japanese exporters repatriate profits and the prospect of higher Japanese rates loom.

The pound gained overnight as investors look past the fallout from the recent banking crisis and refocus on strong UK economic fundamentals. Recent actions by the Bank of England to bolster liquidity in money markets, while guaranteeing the deposits of failed mortgage lender Northern Rock have appeared to calm the recent turmoil ensuing the UK banking sector. With this calm apparently emerging, the market has refocused on strong UK economic fundamentals. Retail Sales unexpectedly rose in August, a sign that higher UK borrowing costs have done little to curb consumer spending. This has led the market to speculate that the Bank of England could again be forced to hike rates to curb inflation, once the turmoil in banking and credit markets ease. Such speculation could continue to further support the pound in the short-term.

The Canadian Dollar surged overnight to new thirty year highs against the US$, as a recent surge in global commodity prices and overall weakness in the US economy has forced investors to look for alternatives. With Canadian GDP likely to expand as commodity prices rise and the threat of inflation looming, the Bank of Canada could hike rates as soon as it’s next meeting. This backdrop will continue to support the loony’s appeal.

Fed Cut of 50 Basis Points Pushes US$ Lower Against Euro

The US$ fell overnight, trading near all time lows against the euro, however gaining against the pound. Yesterday, the US Fed took aggressive steps to lower US interest rates, slashing both the Fed Funds rate and Discount rate 50 basis points in an effort to calm the recent credit crisis and offset the prospect of the US economy moving towards recession later this year. While lowering the Fed Funds rate to 4.75% and the discount rate to 5.25% the Fed issued a sternly worded statement warning about the risks to slowdown in US economic growth from declines in housing markets and recent credit market turmoil. This move came as a surprise to markets as it is indicative that the Fed remains very concerned about the course and pace of the US economy in the coming months. Adding to these market concerns about a slowdown in US economic growth was the release of weaker than expected housing data this morning. Housing Starts registered 1.33 million vs. 1.35 expected. Also, Building permits fell to 1.307 million vs. 1.348 forecast. While this data points to continued declines in housing, the risk of inflation continues to ebb despite the recent surge in oil prices to levels now above $82 per barrel. CPI registered a decline of 0.1% month on month and dropped to a 2.0% annual reading, as inflation pressures appear to be declining. With inflation moderating and economic growth likely to slow, led lower by declines in housing the market is now predicting that the Fed will lower interest rates by at least 25 additional basis points this year. This backdrop of US economic declines and lower interest rates should weigh on the US$ for the remainder of the year.

The euro continues to gain as yesterday’s action by the US Fed to slash interest rates 50 basis points helped highlight the narrowing of interest rate differentials between the US and the Eurozone. The ECB continues to clarify to the market its intent to hike rates as evidenced by a slew of comments from various officials over the past week. Adding to this choir of comments was ECB member Juergen Liebscher this morning. Liebscher stated that he sees “limited effect” to the Eurozone economy from the US economic slowdown and that he believes current market turmoil will likely last “several more months.” He also stated that he believes that inflation risks “remain to the upside” asserting that the ECB will likely push rates higher again at least one more time this year. Higher Euro zone rates coupled with a strong economy will likely push the euro to fresh new highs in the coming weeks.

The yen continues to seesaw in ranges as the currency continues to remain a proxy for investor risk. With low Japanese interest rates keeping the yen a preferred financing vehicle for investors, any rally in global equity markets will contribute to some yen weakness, as we saw evidenced yesterday. However, this weakness was tempered overnight following market rumors that Japanese exporters are choosing current levels to repatriate profits and after comments from Bank of Japan Governor Fukui. Fukui reiterated that Japanese rates remain low and implied that they need to rise. These comments could be the early promptings from the Central Bank ahead of a rate hike next month. In the interim, expect ranges to prevail, with further yen losses ultimately limited.

The pound fell overnight after the Bank of England reversed its opposition to emergency lending to three-month auctions, despite comments last week that any such action from the BOE promotes “risky” investor behavior. This decision from the BOE is in stark contrast to comments made earlier this month, as the Bank now aims to stem “fear and panic” in the banking system. With a liquidity crisis now in full swing and the apparent failure of UK mortgage lender Northern Rock Plc, the BOE now seems committed to maintaining the integrity of the UK banking system. In addition to emergency lending the BOE has taken the unusual step of guaranteeing all individual bank deposits to prevent any further runs on additional UK financial institutions. As this liquidity crisis continues and the BOE looks to restore stability and credibility to the banking system, sterling gains will ultimately be limited. However, an overall strong UK economy and interest rates still remaining at levels significantly higher than those of the US, sterling should remain well supported.

Bernanke and Co Holds Fate Today for US$ and U.S. Economic Growth

The US$ traded in steady ranges overnight ahead of this afternoon’s policy announcement by the Fed concerning interest rates. While the market has leveraged a 50.0% chance that the Fed will lower interest rates 50 basis points, the Street still remains divided as to the extent of this rate cut. The ranges of forecasts vary from a 25 basis point action to a full 100 basis point cut. With the Fed providing little verbal direction concerning the extent of any cut, the market has been left guessing about the Bank’s action. There is a slew of data to be released today, all of which will have little effect in influencing Fed policy. The US released PPI data this morning showing a sharp decline of 1.4% vs. expectations of a 0.3% drop. Year on year PPI registered an as expected 2.2% gain. At 9:00 a.m. TICS data is to be released expected to register a modest decline to $85.0 billion. There was, however, the release of a report overnight showing that home foreclosures surged in August as Adjustable Rate Mortgages reset to higher rates. Mortgage defaults rose 36.0% last month as foreclosures surged. As a worrying point there are $50 billion in additional ARMs that are poised to reset higher in October. This will all but certainly contribute to an additional surge in foreclosures. With the current woes in housing prompting a surge in defaults and ultimately a tightening in global credit, the Fed could be forced to take aggressive action this afternoon and throughout the remainder of the year. As the Fed shifts policy at 2:15 p.m. this afternoon the market will also be closely watching the statement that accompanies this policy action. Should the Fed signal considerable discomfort about the direction of housing and express worries about the economy moving into recession, the market will interpret these comments as a signal of lower rates throughout this year. This will certainly weigh on the US$.

The euro continues to consolidate in ranges near the all-time highs against the US$ ahead of this afternoon’s Fed policy announcement. The market remains focused on the divergence in policy between the ECB and the Fed. While the US Fed has shifted into a rate cutting bias, the ECB continues to express its vigilance towards containing inflation pressures. Overnight, Miguel Ordonez, the ECB member from Spain, continued to voice the Bank’s commitment to battling inflation, however, he added the caveat concerning current credit market conditions. Much like other ECB members, Ordonez expressed the need to evaluate current credit market conditions before the Bank takes further actions. These comments accompanying the diverging biases between the Fed and ECB should keep the euro well supported.

The yen fell this morning as the currency continues to act as a market proxy for risk. As the current credit crisis appeared to spread to the UK last week, the yen gained as investors exited all positions of risk. With the apparent easing of credit concerns in the UK, the yen again weakened overnight. Look for this pattern of wide looping ranges in the yen to dominate the markets for the next several weeks as credit concerns work themselves out. As it is unlikely that investors will again enter the “carry trade” in as aggressive a pattern as they had earlier this year, look for the continued use of the yen as a gauge of risk. This will result in ranges dominating trade.

The pound recovered slightly from its lows of yesterday following the announcement by the Bank of England overnight that it was making emergency loans to UK banks in an effort to bolster the banking system with additional liquidity. This action comes as a credit crunch overtakes the UK financial sector as worries about mortgage defaults rise following the announcement by Northern Rock PLC, a large UK mortgage lender, that it had become insolvent. While the Bank of England had originally opted to take hands off approach to financial markets and the apparent liquidity squeeze, the extent of the problem has forced the Bank to action. Bank of England Governor Mervyn King is aiming to battle a collapse in confidence in the banking system following fallout from the Northern Rock default. His actions to bailout Northern Rock and flood the system with cash has thus far appeared to have the desired effect of stabilizing conditions. However, as continued worries overhang markets, the pound will remain under pressure as attention remains on the solvency of the banking system as opposed to economic growth and mounting inflation pressures.

The Canadian Dollar continues to surge as strong economic growth and mounting inflation pressures will likely prompt the Bank of Canada to soon hike rates. These expectations have prompted the Canadian Dollar to surge to fresh 30-year highs.

US$ Near Lows But Steady Ahead of Fed Meeting

The US$ has all but steadied in current ranges against the yen and euro, while gaining against the pound as the market continues to digest the fallout from the sub-prime mortgage meltdown, while jockeying positions ahead of tomorrow’s Fed meeting. The market has forecast a 58.0% chance that the Fed will cut rates 50 basis points when they meet tomorrow. This has led the US$ lower over the past few weeks as there is a perceived narrowing of global interest rate differentials pushing the greenback down. Also weighing on the US$ was the announcement overnight by Venezuelan President Hugo Chavez, ordering Petroleos de Venezuela, the state oil company, to convert all of its investments to euros and Asian currencies to reduce risk. Although Chavez has long been at odds with the US, this announcement is a strong step by an OPEC member nation to diversify oil profits away from the US$. Should this action be a signal of further global diversification away from US assets, the US$ could fall further. The US releases several pieces of economic data this week, with Empire Manufacturing registering a slightly lower than forecast 14.7 this morning. Tomorrow sees the release of PPI expected to decline 0.3% and Tics data expected to register $95.0 billion. Wednesday sees the release of CPI and Housing Starts while Thursday sees the release of Leading Indicators and the Philly Fed. Despite this slew of data slated for release, the market’s attention remains steadfastly focused on the Fed tomorrow. While the range of forecasts call for rate cuts ranging from 25-75 basis points, it will likely be the commentary accompanying the Fed’s policy shift that will steer trade. Should the Fed signal that concerns remain about slowing growth and continued fallout from increased mortgage defaults, the Central Bank could be setting the market up for further cuts this year. Any signs that the Fed is shifting gears into a cycle of prolonged rate cuts will weigh on the US$.

The euro continues to steady near all-time highs against the US$ as the market’s focus remains on the narrowing of interest rates between the US and the Eurozone. While the Fed is widely expected to cut rates tomorrow, the market’s focus has shifted to the ECB. Later today ECB Board member Likanaen is expected to announce that the Bank will continue its pledge to fight inflation, signaling the intention of the ECB to push rates higher. On Saturday ECB member Drakhi stated that the Bank is clearly focused “on inflation expectations.” With the ECB indicating its intention to hike rates to curb inflationary pressures, the Fed will come into further focus. Should the US Central Bank indicate its intention to continue pushing rates lower, the euro will certainly benefit as interest rate differentials gradually shift in the euro’s favor.

The yen continues to gain against the US$ as the “carry trade” has been all but abandoned and investors have now opted to hold long yen positions or none at all. With the yen continuing to remain a proxy fro investor risk, current market conditions have done little to whet investor appetite for the cheap financing option the yen “carry trade” affords. Expect this trend to continue for some time with investors opting to trade the yen in cautious patterns. Also helping the yen gain is mounting prospects that the Bank of Japan could hike interest rates at some point this year. After the surprise announcement last week about the government of Shinzo Abe stepping down, fresh leadership in the ruling LDP could provide the Bank of Japan with the impetus it needs to push rates higher. Higher Japanese rates should translate to a higher yen.

The pound continues to remain under pressure following the run on UK mortgage lender Northern Rock last week. As customers lined up last week to withdraw deposits from the failing mortgage lender, the pound tumbled. These declines continue this morning despite the announcement by the Bank of England to bailout the failing institution. This bailout, the largest in the UK in over 30 years, prompted further sterling declines, as the market becomes increasingly concerned that other UK mortgage lenders could come under similar stress. With these worries paramount, investors continue to shun sterling holdings and purchase less risky investments. With the continued mortgage meltdown scenario in the forefront, sterling will likely continue to remain under pressure.

The Canadian Dollar traded to new 30-year highs against the US$ as investors opt to purchase the loony in lieu of the US$. With the Canadian economy exhibiting strong economic growth and the Bank of Canada seemingly committed to higher interest rates to combat inflation pressures, the Canadian Dollar will certainly continue to benefit.