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US$ Waiting on Fed Meeting, Market Expecting Interest Rate Cut

The US$ consolidated ranges overnight ahead of the beginning of the Fed’s two-day policy meeting to decide the direction of US interest rates. With the market widely expecting the Fed to lower interest rates 25 basis points, the US$ continues to remain under significant pressure. There does, however, remain significant jockeying around the prospect of the Fed lowering rates further after tomorrow’s action. Bill Gross, manager of PIMCO investment, the world’s largest bond fund asserted that he believes that the Fed will need to lower Fed Funds rates to 3.5% to stave off a recession. Rates currently stand at 4.75%. With the market on hold awaiting the Fed’s action and the accompanying statement, trade will likely remain in tight ranges today. Overnight US Treasury Secretary Paulson reasserted US support of a strong dollar and further stated that the US housing market will likely weaken further. Neither comment had much affect on the direction of the greenback. There is however, some economic data slated for release today, which could steer the direction of trade. At 10:00 a.m. Consumer Confidence data is to be released expected to decline to 99.0. Any signs of weakness from the US consumer, on the back of a declining housing market, could certainly weigh on the US$ further.

The euro fell modestly overnight as traders consolidate positions ahead of the Fed’s policy decision tomorrow. With the market widely expecting the Fed to push rates lower, focus remains on interest rate differentials between the US and Eurozone. As the Fed cuts rates, these differentials narrow, increasing the appeal of the euro. Add to the Fed’s rate cutting bias, the ECB and its apparent vigilance to inflation fighting. While analysts do not expect the ECB to hike rates when the Central Bank meets on November 8th, it is expected that they will reaffirm their hawkish posture. Expect this environment to continue to attract capital to the euro, boosting the currency to new highs.

The yen weakened overnight as investors continue to use the “carry trade” to finance positions in other financial markets amidst signs that Japanese interest rates will remain low at 0.5% for some time. It is expected that the Bank of Japan will lower its growth and inflation forecasts tomorrow as it keeps rates unchanged. Further supporting this view of lower rates is the environment of gaining unemployment in Japan. As Japan maintains an environment of low rates as signs of an economic slowdown materialize, the carry trade will persist, putting downward pressure on the yen. However, with uncertainty dominating equity markets and investors still hesitant about embracing significant risk, the yen’s losses will ultimately be limited. This will certainly regulate the yen to continue to trade in wide ranges.

The pound gained overnight to 26 year highs against the US$ as investors focus on high UK rates leading sterling higher. It is expected that the Bank of England will keep rates at six-year highs while the Fed continues its pattern of rate cuts. As the US economy continues to stumble, UK economic growth is proving to be surprisingly resilient. GDP expanded at a better than expected pace last quarter while consumer spending remains robust. Should any of these indicators show signs of weakness sterling could retreat, however, the pound will likely continue to remain robust as investors favor the pound, pushing it towards new highs.

Fed Meeting Wednesday Keeps Pressure on US$

The US$ weakened to new lows this morning as the market awaits the Fed’s decision on interest rates later this week. With the US economy apparently slowing as credit concerns dominate, amidst a slowing housing market, traders are speculating that the Fed will lower interest rates 25 basis points when its two-day meeting ends on Wednesday. This environment of expected lower US interest rates continues to weigh on the US$, forcing investors to liquidate positions. There is some US data slated for release ahead of Wednesday’s meeting, with Consumer Confidence scheduled for release tomorrow expected to decline to 99.0. Wednesday sees the release of GDP, the ADP employment report, Chicago PMI and Construction Spending. While this data could drive trade, it is unlikely that the market will commit to any significant direction ahead of the Fed. The week winds down with the release of the ISM Manufacturing report and the US payroll report. While there is no data expected to be released today, the market will likely weigh on the US$ as traders focus on declining US rates, surging oil prices and the overall hesitancy to own the greenback.

The euro gained overnight, to new all-time highs as traders focus on the probability of lower US interest rates later this week. With interest rate differentials the primary driving force behind the direction of this currency pair, the market continues to favor the euro. Despite the market speculating that the ECB will hold rates steady when it meets on November 11th, the euro’s appeal as a reserve currency continues to dominate capital flows. With many Middle Eastern nations, in addition to India and China adding significantly to their US$ holdings, the euro continues to gain. However, the strong euro has had some positives for the US economy that seemingly are being addressed with some Eurozone disdain. The US$’s 8.5% decline against the euro this year has helped narrow the US trade deficit to $57.6 billion in August, the lowest since January. With this background of a stronger euro, French President Sarkozy has stated his concerns that the euro’s strength will harm exports. This environment of some discord amongst Eurozone officials about euro strength is unlikely to limit the currency’s advance, until officials speak with a common voice. Until such a time expect the euro to gain to new highs.

The yen fell this weekend as stability returning to equity markets, has prompted traders to renter “carry trades” financed with the yen. As the yen continues to act as a proxy for market risk, traders short the currency and take the proceeds to finance positions in other markets. In addition to financing equity market positions, the short yen “carry trade” has helped prop the higher yielding currencies of Australia, New Zealand and the UK. Expect the “carry trade” to continue to steer yen direction, pushing the currency lower in times of seeming market stability, while leading to yen gains as traders quickly exit positions, once risk remerges.

The pound gained overnight as US$ weakness pervades the market as speculation mounts that the US Fed will lower rates later this week. With the Bank of England likely holding rates steady for the remainder of this year, the market will focus on this widening of interest rate differences between the US and UK. This differential will all but certainly favor the pound as evidenced by sterling purchases overnight fueled by “carry trade” positions. This environment of higher UK rates will lead investors to buy sterling on dips through the remainder of the year keeping the pound firm.

Euro Makes Another High Against US$

The US$ fell yet again overnight as analysts focus on the slew of negatives that continue to line up against the greenback. With the continued release of data showing declines in the housing sector, weakening corporate and consumer spending, and strains weighing on credit markets, traders continue to speculate that the Fed will lower rates when they meet next week. It is currently forecast with a 90.0% certainty that the Fed will lower rates 25 b.p. when they meet next week. With this rate cut all but priced in, traders continue to sell the US$ in favor of the euro. At 10:00 U. Of Michigan Confidence is to be released, expected to register 82.0, a sharp decline from last month. Consumer confidence appears to be ebbing as defaults in subprime lending markets have translated into extended weakness in the housing sector. Add to these housing woes, the continued spike in oil prices, setting new highs near $93 per barrel overnight, and the US economy seems poised to slow significantly over the next few quarters if not move into recession. With this continual flow of negative data overtaking the market, traders seem undeterred in selling the US$.

The euro continues to gain as negatives surrounding the US economy continue to build and provide a sharp contrast to the somewhat robust environment in the Eurozone. With strong economic growth supporting the euro, the market continues to speculate that inflation pressures will build, leading the ECB to hike rates before year-end. This environment of higher rates in the Eurozone, clearly differentiates the region from the US. Higher rates within the Eurozone will continue to attract investors to the euro, likely pushing the currency to new highs.

The yen remain rangebound as volatility in equity markets keep traders sidelined as they gauge the amount of risk they are willing to adopt on their balance sheets. Expect these ranges to dominate trade over the next several weeks as concerns about credit markets keep equities relegated to wide trading ranges. Overall, with the “carry trade” still being used to finance equity positions, as uncertainty pervades markets the yen will gyrate in wide ranges. Expect this pattern to continue for some time.

The pound gained slightly overnight shadowing the euro’s movements against the US$, however further gains could be ultimately limited following the release of a downbeat economic report overnight. The National Institute of Economic and Social research stated that they believe that the UK economy will grow at a slower pace next year, widening the Treasury’s budget deficit. This report follows comments from the Bank of England yesterday stating that they believe that the commercial property and financial sectors could be vulnerable to future shocks. With both of these factors as a backdrop, the market has begun to speculate that the Bank of England could soon shift gears from is current neutral policy position to pushing rates lower. Should this happen, expect sterling to decline.

US$ Falls Near All-Time Low Against the Euro Again

The US$ has come under pressure yet again as the market has shifted its concerns to the apparent slowdown in the US housing market and the prospects for the economy to shift into recession. Yesterday’s release of disappointing Existing Home Sales data, coupled with the announcement by Merrill Lynch that it was writing off some $4.0 billion in under performing loans fueled by defaults in sub prime lending, led to a sharp drop in the US$. These concerns have led the market to price in a 86.0% chance that the Fed will lower the Funds rate 25 basis points when it meets next week. There has also been speculation swirling in the market that the Fed could act before next week and look to lower the discount rate, as credit markets again tighten up. The US released worse than expected data this morning, with durable goods posting a decline of 1.7% vs. expectations of a 1.5% gain. Weekly jobless claims rose to 331,000 vs. 320,000 expected. However, the market’s attention is clearly focused on New Home Sales slated for release at 10:00 a.m. and expected to register 770,000. Any signs of significant weakness in this figure could prompt the market to speculate further about Fed action in excess of the 25 basis points in rate reductions already priced into trade. With credit markets tightening yet again, the Fed all but certain to lower rates 25 basis points next week and the US economy on the brink of recession, the US$ will likely come under a period of renewed pressure.

The euro surged to levels near its all-time highs against the US$, as investors focus on the growing economic divide between the US and Eurozone. With the major economies in the Eurozone showing signs of significant economic expansion, members of the ECB continue to discuss their concerns about mounting inflation pressures. This has led some traders to speculate that the ECB will push rates higher this year, in an effort to curb these inflation tendencies. With the prospect of higher Eurozone rates in stark contrast to the US landscape, which will position the Fed to cut rates next week, US$ deposits are becoming less attractive. This trend continues to support global capital shifts into the euro and away from the greenback. Expect this to continue for some time as the euro pushed to new all-time highs.

The yen continues to grind higher, albeit in ranges, as investors continue to use the Japanese currency as a strong proxy for market risk. With global equity markets continuing to gyrate in wide volatile ranges, investors are tepidly entering and exiting “carry trade” positions. With the increase in volatility and uncertainty surrounding the US economic landscape, investors are exiting these yen financed positions, leading the currency to post some significant gains against the US$. Expect this trend of wide ranges to continue for some time, with the yen ultimately having an upward bias as “carry trade” positions ultimately all but exit the market.

The pound gained modestly overnight, on the back of overall US$ weakness, despite the release of some disappointing data from the UK. Overnight, a report was released showing mortgage approvals fell by almost 25.0% in September as credit concerns, highlighted by they default of Northern Rock, have led housing lenders to tighten standards. This has led to a significant drop in approvals, which could translate directly to a slowdown in UK housing. Whether this slowdown in housing spills over to the consumer, remains to be seen, however, any signs of weakness could quickly shift the market’s view about Bank of England rate policy. Weakness in the UK economy, highlighted by the consumer segment, could prompt the BOE to shift rates lower. With the BOE the most proactive of the G7 Central Banks, policy action could come quickly should signs of a slowdown materialize. Sterling weakness will likely ensue should a rate cut occur otherwise expect the pound to trade counter to the overall direction of the US$.

US$ Slightly Better Ahead of Existing Home Sales Data

The US$ gained moderately in overnight trading ahead of housing data released at 10:00 a.m. this morning. Sales of existing homes in September are expected to fall once to 5.25 million, down from 5.50 million in August. Sentiment toward the U.S. housing market continues to be negative as the remnants of the subprime market fallout continue to plague the market. Merrill Lynch reported today a greater-than-expected writedown of $7.9 billion in its subprime mortgages and asset backed bonds. The re-evaluation of the firm’s holdings accompanied Merrill’s first quarterly loss in six years. Expectations for the Federal Reserve to cut interest rates by 25 basis points at their meeting next Wednesday have since risen to 96%, boosted by recent comments from a wide array of corporations that emphasize a slowdown in the consumer sector. It is likely, particularly ahead of the Christmas shopping season, that the Fed will want to bolster the consumer to prevent a significant economic slowdown in the final quarter of 2007. These current expectations have been largely factored into the US$’s recent decline; however, the further erosion of an interest rate advantage is surely to cause precipitous declines in the currency.

Comments overnight from an ECB Executive Board Member helped the euro to fall slightly against the US$. The member suggested that the ECB might ignore a short-term spike in inflation should it be contained and not impacting the broad economic outlook. This continues to point to muddled evidence of the ECB’s next move, which is now considered to be pointed toward further interest rate increases. In September, inflation jumped to 2.1%, above the ECB’s 2% target for the first time in a year. However, the comments from the ECB suggest that they might need a series of readings and projections that point to continued inflation before raising interest rates further.

The yen gained overnight as the news from Merrill Lynch spurred slight risk aversion. The $7.9 billion writedown was the largest to date by one of the main U.S. investment houses. Investors are still using the yen as a near perfect hedge against risk, as indicated by equity markets. With U.S. equity markets suggesting a lower open this morning, the yen will likely be supported further. In the longer term, however, particularly as interest rates in Japan remain at historically low levels, the yen will continue to be the preferred tool of the carry trade, keeping it weak as long as overall market volatility stays low.

Sterling remains firm against the US$ on broad US$ weakness and a widening interest rate differential. Interest rates in the U.K. are a percent higher than the current Fed funds rate, which is likely to increase to a total of 1.25% higher when the Fed lowers rates next week. This position will keep sterling favorable in the near term, as it is likely to attract interest by central banks looking to diversify from US$. Currently, sterling is the third most commonly held asset on reserve, which is likely to only increase as the US$ loses more of its share.

Euro, Sterling, Commodity Currencies Continue to Find Support

The US$ fell overnight, following yesterday’s post G7 rally, as the market has refocused on a weakening US economy and the prospect for lower interest rates. The market will watch the flow of US data the remainder of this week, to verify its view that the US economy has turned lower. At 10:00 a.m. the Richmond Fed releases its index of manufacturing expected to post a decline to register 8. However, the data that will draw the markets’ attention is slated for release tomorrow. Existing Home Sales are expected to decline to 5.25 million from 5.50 million last month when they are released at 10:00 a.m. Thursday sees the release of New Home Sales and Durable Goods, both also expected to register declines. This expectation of weak US data, has led futures markets to sharply increase its expectations that the Fed will cut rates when it meets next week. Last week futures markets had predicted a 32.0% chance of the Fed cutting rates at its October 31 meeting. These markets are now predicting an 86.0% chance that the Fed will lower rates 25 basis points next week. This combination of slowing US economic growth and the prospect for lower rates will continue to weigh on the US$.

The euro gained overnight, recapturing most of its post G7 losses, as the market has refocused on strong Eurozone economic growth and the prospect of the ECB pushing rates higher in the near-term. Overnight a report released showed that industrial orders in the Eurozone rose 0.3% in August after falling 2.6% in July. This environment of strong growth has helped reinforce the argument for the ECB to hike rates again this year. ECB Council member Weber asserted overnight that he still sees medium term inflation risks and that the Central bank must be prepared to act. With this environment of strong growth and increased hawkish rhetoric from ECB officials, the market has forecast that the ECB will hike rates at least once more this year, with futures markets now showing indication that 50 basis points in hikes are possible by year-end. This environment of higher Eurozone rates will almost certainly continue to support the euro as it pushes to new highs by year-end.

The yen continues to consolidate in recent ranges, falling overnight as investors again cautiously reentered the “carry trade” to finance positions in higher yielding assets. With stability seemingly returning to global equity markets overnight, investors again showed signs of borrowing in yen. There is currently a very strong correlation between the direction of the yen and the overall performance of global equity markets. With the yen also being used to finance positions in other markets as borrowing costs remain at 0.5%, higher yielding currencies are also seemingly benefiting from this “carry trade. The Aussie, Kiwi and South African Rand all rallied overnight as investors use the yen to finance positions in these high yielding currencies. Expect ranges to prevail with the yen as its continued use as a proxy for market risk defines trade direction.

The pound gained overnight as interest rate expectations dominate trade. With the likelihood of the Fed cutting rates next week, the market continues to speculate about the direction of UK rates. It is likely that the Bank of England will hold rate steady for the remainder of the year, as the flow of UK data remains inconsistent. Consumer spending remains robust, however, there are some signs of weakness now appearing in the UK housing market. Until there is some more definitive data reinforcing the view that growth or slowdown is at hand, the Bank of England will hold interest rate policy steady. This will continue to keep the pound in ranges, with its fortunes tied ultimately to overall US$ direction.

US$ Gains as G7 Spurs Carry Trade Unwind

The US$ gained overnight despite any lack of significant conviction from the G7 about the recent trend of overall US$ weakness and after comments from former Fed Chief Alan Greenspan. The G7, comprised of Italy, France, Germany, the US, the UK, Canada and Japan issued a statement expressing their concern about “excess volatility” in currencies and that this volatility was “undesirable,” They also stated that currencies should trade in line with fundamentals. The G7 failed to mention any currency in particular other than the Chinese yuan in its statement. Without any commentary supporting the US$ or expressing concerns that the greenback has declined to unwarranted levels, the market sold the US$ initially. However, the market soon took profits from these new all-time US$ lows, as rumors swirled that Central Banks had placed some limited buy orders. Also weighing on the US$ overnight were comments from former Federal Reserve Chief Alan Greenspan. Greenspan asserted that US$ weakness could lead to the US government having difficulty funding debt obligations in the future. With a declining US$, US debt becomes less appealing to foreign investors as the return diminishes significantly. Despite this bout of a US$ recovery overnight, ranges will likely persist today as the market focuses on the course of equity trade and US economic data slated for release later this week. On Wednesday Existing Home Sales are to be released, while Thursday sees the release of Durable Goods, Weekly Claims and New Home Sales. As the course of US interest rates continues to steer trade, the release of housing data this week will be closely monitored. Any signs of weakness in this data could lead the market to speculate further that the Fed will cut rates 25 basis points when it meets next week. The overall trend of US$ weakness will likely persist this week, as interest rate expectations and the failure of support from global finance ministers ultimately weigh on the US$.

The euro declined overnight despite some very supportive comments from ECB members and finance officials. With the G7 failing to reach any conclusive position about euro strength, some analysts viewed this lack of coordination as a lack of concern about the euro’s gains. The only country that offered limited resistance to the euro’s gains was France, however, they were soon drowned out by the remainder of the G7, who seem to have little concern about recent movement. Further helping support the euro were comments from the ECB stating that recent gains in oil and food prices are fanning inflation pressures. Germany’s ECB Board Member, Axel Weber, stated that the ECB “will counter inflation risks” as they materialize. These comments certainly support additional policy action from the Bank by year-end. The only action which could temper the pace of rate hikes from the ECB is a stronger euro. A robust currency contains inflationary pressures. However, with this very euro supportive backdrop, the currency declined overnight after setting fresh all-time highs against the US$. These declines were triggered as the market took profits following rumors of Central Bank sell orders. Overall, however, the trend for euro strength will continue for some time.

The yen gained again overnight as weakness in equity markets led traders to abandon the “carry trade” financed with short positions in the Japanese currency. This selloff in global equity markets was prompted by comments from the G7 asserting that weakness in the US housing market coupled with the recent surge in oil prices will slow global growth. Asian stocks fell the most in over two weeks as these comments reverberated through markets. Expect this pattern of yen strength to continue for some time as equity markets remain under duress. This will ultimately push the US$ lower against the Japanese currency albeit with a pattern of wide orderly ranges.

The pound fell overnight as investors unwound the carry trade amidst profit taking and speculation about the course of UK interest rates. Following comments from the G7 expressing concerns about the course of global economic growth, investors unwound the “carry trade” overnight, selling sterling, a preferred investment vehicle for short yen positions. Further weighing on sterling is the environment of uncertainty surrounding the UK economic landscape. With the UK consumer continuing to spend aggressively, there are signs that the housing market could be showing some signs of weakness. This uncertain environment has analysts speculating about UK rates, keeping the fortunes of the pound tied to overall US$ direction. Expect ranges to dominate until some clear view of UK interest rate policy emerges.

US$ Stays Weak as G-7 Statement Looms

The US$ remains weak, trading near all-time lows ahead of this weekend’s G7 summit in Washington DC. Despite the market remaining uncertain about the resulting commentary from this meeting, a continual selling of the greenback dominates. There is a belief that the statement arising from this meeting will do little to offer the US$ any respite. As there appears to be no unified view amongst Finance Ministers about the US$’s decline over the past year, it is unlikely any sharply worded statement supporting the greenback will originate from this meeting. It more likely finance ministers will address the recent problems in credit markets and the need for a unified stance concerning global market liquidity. This lack of a supporting statement will almost certainly contribute to renewed US$ declines. Following yesterday’s announcement by US banking giant Bank of America that earnings fell significantly last quarter, market speculation has been renewed that the US Fed will be forced to cut rates this year. With a slowdown in housing, coupled with US credit markets far from recovered from the shocks of August, the market believes that the Fed will lower rates to prevent a recession next year. After yesterday’s earnings news, futures markets jumped to reflect a 75.0% probability that the Fed will lower rates by year-end. There is no economic data slated for release today that could alter the market’s perception about rates. However, Existing and New Home Sales, both slated for release next week, will be closely monitored by the market to gauge the overall health of housing. Ultimately, this environment of lower rates will almost all but certainly contribute to US$ weakness as this quarter progresses.

The euro continues to remain firm as the market focuses on diverging growth and interest rates between the US and Eurozone. With it unexpected that the G7 will release any statement supporting the US$, prompting a reversal in the market’s current trend, the euro will likely continue to remain well supported in the near-term. There seems to be little unified concern amongst Eurozone finance ministers about the euro’s strength, with French officials expressing some discomfort, while Germany seems to support a “strong euro.” As this trend of a strong euro continues to dominate the market, capital will likely continue to flow to the Eurozone, pushing the euro to new highs.

The yen continues to remain firm as uncertainty in equity markets, prompts investors to unwind the “carry trade.” As the yen’s direction continues to be determined by investor’s appetite for risk, the yen remains in wide volatile ranges. However, the overall trend for the yen, will likely see the currency strengthen further in the coming months as the Bank of Japan will likely soon be hiking interest rates and as the Chinese yuan moves closer to convertibility. As Chinese and Japanese goods remain economic substitutes, and as the yuan moves towards convertibility and ultimately strengthens, the yen will likely follow suit and firm. However, in the interim, expect ranges to dominate trade.

The pound firmed again overnight as data released in the UK pointed to a robust economic landscape. GDP rose 0.8% in the second quarter vs. 0.7% expected, as an expansion in services drove economic growth. With this better than expected growth, the Bank of England will likely hold interest rates steady for time, helping bolster the pound. As interest rate differentials widen, as the US Fed is expected to cut rates, the pound will continue to firm. This pattern will push the pound higher for the remainder of the year.

The commodity based currencies rose overnight as a surge in prices helped bolster these currencies. With oil trading near $100 per barrel and gold pushing to the highest levels since the US inflation crisis of the mid-1980s, the Canadian Dollar, Aussie, Kiwi, South African Rand and to a lesser extent the Mexican Peso all continue to gain against the US$. As long as commodity prices continue to rise, investors will drive investment to the haven these currencies offer and away from the US$.

US$ Falls to New Lows Amid Renewed Concerns Over Economic Slowdown

The US$ fell to new all-time lows overnight as the market seems to have reawakened to the risks facing the US economy surrounding housing, sub-prime lending and credit markets. Overnight Bank of America announced that earnings would seriously disappoint Wall Street, falling $0.24 below forecast. They cited significant losses in trading revenue and consumer credit as the rationale for the decline in earnings. With this “surprise” earnings disappointment, the market has refocused on the state of the US economy, paying particular attention to declines in housing and the continued overhang of weak credit markets led by sub-prime woes. It important to note that over $10 billion in “teaser rate” ARM mortgages reset at significantly higher rates at the end of this month. This will likely lead to a further drop in the housing market. This refocusing on weak fundamentals has led the market to up the prospects of the Fed cutting rates by year-end. There is now a 76.0% chance that the Fed will lower rates 25 basis points by year-end, with odds increasing to close to 50.0% that a rate cut will come at the end of this month. The expectation of lower US rates has led the dollar to sell off significantly overnight. Further weighing on the US$ and overall market confidence has been the lack of soothing words from any US officials either at the Treasury or the Fed. On Tuesday, US Treasury Secretary Paulson asserted that the US housing crisis would likely worsen without offering any words of respite. Meanwhile officials at the Fed continue to tiptoe around the US credit market problems, with some officials still stressing their concerns about inflation. Couple this environment with mounting problems in the Middle East as Turkey masses troops on the Iraqi border, adding a further element of geopolitical risk to the market, and further pressuring the US$. Weekly jobless claims were released at a higher than expected 337,000 vs. expectations of a 312,000 reading. Leading Indicators are slated for release at 10:00 a.m. and expected to register 0.3%. While this data is unlikely to steer the course of trade today, the market be watching the course of equity markets for an indication of direction. Expect opening losses to weigh on the greenback, however, this overall trend could be tempered today as the market might remain wary about pushing the US$ to fresh losses ahead of this weekend’s G7 meeting.

The euro surged to new all-time highs overnight following disappointing news from US banking giant Bank of America and as the market refocuses on the weak US economic landscape. With the US consumer likely facing further hardship in the coming months, the US Fed will almost certainly be slashing rates by year-end. This is in stark contrast to the ECB. Officials at the Eurozone Central Bank continue to assert that growth remains robust, igniting inflation pressures and likely leading the Bank to hiking rates again this year. This environment of diverging growth rates and narrowing interest rate differentials has led investors to continue to shift capital into the euro. This trend will likely continue for some time, barring any statement from the G7 this weekend, asserting Finance Ministers intention to reverse this trend. With such a strongly worded statement unlikely, the euro will likely continue to gain.

The yen gained overnight as investors purchased yen aggressively as they unwound carry trade positions following the announcement by Bank of America concerning earnings. This negative announcement by BOA led traders to sell equity positions, some of which were financed through the “carry trade” using cheap yen. While most of these positions seem to have been unwound over the last 48 hours, the yen could post further gains, should Wall Street sell off aggressively today. Expect the yen to continue to trade in a tightly correlated pattern with the direction of global equity markets, as the currency remains a preferred financing vehicle. This pattern of the yen trading in wide ranges will likely persist for some time.

The pound gained overnight as US$ weakness permeated the market and following the release of better than expected retail sales data in the UK. With the market concerned about a prolonged slowdown in the US economy led by a weakened housing market, expectations are that the Fed will be forced to cut rates. The UK economy, on the other hand, continues to provide an uncertain outlook. Housing markets in the UK continue to reveal an uncertain outlook about the direction of prices and the overall health of the market. However, the UK consumer continues to remain healthy as evidenced by the retail sales data released overnight showing a gain of 0.6 in September, and registering a 6.3% gain fro the year, the quickest pace in almost three years. This environment of vibrant consumer spending coupled with a strong housing market, will likely keep the Bank of England sidelined on interest rate policy for the next several months. With the Fed cutting rates and the BOE sidelined, widening interest rate differentials between the US and UK will continue to support the pound.

U.S. Housing Data Continues to Disappoint

The US$ weakened overnight ahead of US data this morning. Look for this trend of overall US$ weakness to likely continue to through the remainder of the day, as the data released was worse than expected. CPI rose 0.3% month on month vs. expectations of a 0.2% gain. The measure registered as forecast year on year at 2.8%. This data will likely have little affect on the direction of trade. Housing Starts, however, fell over 10.2% last month registering 1.191 million vs. a forecast reading of 1.280 million, falling to a 14 year low. This data reinforces comments from US Treasury Secretary Paulson yesterday asserting that the housing market remains a significant drain on the US economy. This weakness in housing markets will almost certainly keep US rates on hold, if not push the Fed to move rates lower later this year. While the recent weakness in US data has weighed on the greenback, traders seem unwilling to push the US$ to new lows before the G7 meeting this coming weekend. While no clear unified position about the US$ has emerged amongst global Finance Ministers, there is some speculation that a strongly worded communiqué could emerge from the weekend meetings. This communiqué could center on the G7’s support of a strong dollar and perhaps go as far as to state their intention of supporting this stance through market action. While such a strongly worded statement is unlikely, the market seems unwilling to sell the US$ significantly before the weekend summit.

The euro continues to remain firm as the market speculates about commentary from the G7 this weekend and overall interest rate policy from the ECB. While Eurozone finance ministers seem to be grumbling about the euro’s recent strength, there is little consensus as to whether any strong shift in policy will emerge form this weekend’s meeting. Officials both at the ECB and within the US Treasury seem to share less of these concerns about euro strength. Treasury officials have relied on the weak dollar to boost exports and help attract capital to pay off the growing US deficit. ECB officials have looked to the strong euro as a counterbalance to the inflationary effects of surging oil prices and the recent rise in Eurozone food prices. Without this clear consensus emerging, the market has looked to diverging interest rate policies between the US and Eurozone. While the Fed seems likely to keep a soft posture towards interest rates, several ECB officials continue to voice a hawkish tone surrounding interest rates. These comments have led several analysts to speculate that the ECB could hike rates as soon as it’s meeting next month. With this backdrop of higher Eurozone rates the euro remains well supported, however it seems to be pausing as traders are unwilling to set new highs before the G7 meeting.

The yen continues to seesaw in ranges as the market uses the “carry trade” to finance equity and commodity market positions. With signs that US equity markets will rebound this morning following the release of better than expected earning at US banking giant JP Morgan, traders again entered the yen “carry trade” to drive equity purchases. This push higher in equity prices coupled with the gains in oil to new all-time highs; has investors continuing to look for cheap financing options and turning to the yen. Expect range trading in the yen to continue for some time as interest rates in Japan remain at 0.5% and investors continue to use the currency as a proxy for risk in their portfolios.

The pound continues to push higher as the market has focused on weakening US data and the diverging interest rates views between the US and UK. With US data pointing to continual weakness in the housing market coupled with slowing economic growth, the market speculation that the Fed will cut rates again by year-end dominates trade. This view is in contrast to the approach the Bank of England seems to be adopting. An uncertain outlook concerning UK housing coupled with robust UK consumer spending has led the pound to stabilize in ranges. With the backdrop of stability seemingly returning to UK credit markets, the pound appears to again be poised to push higher.