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US$ Slips Ahead of Fed Meeting Following Weaker than Expected U.S. Economic Data

The US$ consolidated in recent ranges overnight ahead of this afternoon’s Fed decision on interest rate policy.  While the market is still pricing in a 10% chance that the Fed will in fact hike rates by a quarter percent at today’s meeting, it is all but sure that they will keep rates constant.  The market will however be squarely focused on the commentary that accompanies the rate decision.  Should Fed Chairman Bernanke’s commentary fall in line with his recent inflation-fighting rhetoric, the dollar could see significant strengthening, as the market will begin to shift its overall view towards higher US rates as the Fed aims to curb rising prices.  However, yesterday’s worse than expected consumer confidence report, registering the fifth lowest reading in the index’s history, shows continued downward pressure on the U.S. economy, raising doubts about the extent that the Fed will be able to stem inflation through interest rate hikes throughout the remainder of the year.  This morning we saw the release of durable goods orders, released in line with expectations and registering no gain. At 10:00 a.m.  New Home Sales data is to be released expected to register 512,000 and post a month on month decline of 2.7%. Any weaker than expected data releases will help fuel negative sentiment towards the U.S. economy as a whole and will make the Fed’s case for price stabilization at the expense of growth that much less likely. This will ultimately contribute to continued US$ weakness.

 

The EUR was marginally higher overnight, bolstered by hawkish statements from key ECB members.  ECB President Jean-Claude Trichet reiterated his bias towards fighting inflation stating that, “inflation in the euro area is likely to remain high for some time, moderating only slightly in 2009.”  ECB member, Christian Noyer echoed Trichet’s statements saying that he believed that inflation was a bigger threat to growth than the sub-prime crisis and the most effective way to spur growth was through containing price increases.  And yet further bolstering the common currency, ECB council member, Nout Wellink stated, “in 2009, inflation will be near 2.5% on average” led by surging oil prices that show no signs of dropping. The market is nearly certain that the ECB will hike interest rates next week, but the question remains as to whether this will be the start of a trend towards higher rates over the course of the year. 

 

The JPY remained in recent ranges overnight as the market is focused on this afternoon’s Fed decision.  With rates expected to rise in the Eurozone, traders continue to use the yen as a vehicle for the “carry trade”.  In anticipation of the Fed’s policy statement accompanying their decision on interest rates, the market remains quiet and range bound.  While any hint at future rate hikes will lead to dollar strength, a neutral statement could also lead to a weaker yen as the U.S. equity markets could stage a “relief rally” as rates will likely remain at current levels for some time.

 

The GBP was steady overnight despite slightly weaker than expected economic data.  The U.K.’s current interest rate of 5% is the highest in Western Europe, continues to draw investors looking for higher yielding assets.  However, despite the highest inflation in over a decade, the BOE has little to no room for interest rate changes in the near term, as the UK economy continues to struggle.  BOE Deputy Governor, John Gieve, rejected using interest rates to tame soaring prices, saying to do so may, “potentially do grave damage to the rest of the economy because [the BOE] would have to move interest rates by so much” to curb the current rate of inflation.  This afternoon’s Fed decision on interest rates in the U.S. and the accompanying statements should give the market direction, as the contrast of interest rates going forward should be more clearly defined. 

US$ Gains Ahead of Fed Meeting

The US$ gained overnight ahead of this week’s Fed meeting, and on the heals of weaker than expected European economic news.  Despite it being widely expected that the US Central bank will hold rates steady, the commentary that accompanies their decision on interest rate policy will direct trading in the near term. While the market’s expectations for a hike in US interest rates continues to fall, currently with an 8% probability assigned to the likelihood of a quarter percent hike on Wednesday, traders will closely monitor the Bank’s commentary for direction. If Fed Chairman Bernanke continues with his newly found hawkish tone on inflation, increased prospects for rate hikes in the near term will certainly bolster the dollar.  However, with the recent release of weaker than anticipated US economic data, led by continued declines in housing, the overall view of the US economy is not overtly positive.  Further weighing on the US economy was the lack of progress at this past weekend’s summit of oil producing and major oil consuming nations in Saudi Arabia.  While Saudi Arabia did agree to increase output, the pledge was not enough to curb further gains in price per barrel overnight.  Similar to the recent G-8 meeting, participants of the Saudi summit only voiced concern over high-oil prices, and stopped short of calling for a stronger US dollar.  There is no economic data slated for release today and the market will be squarely focused on Wednesday’s Fed decision.  Tuesday sees the release of Consumer Confidence, Richmond Fed and House Price Index.  Wednesday sees the release of Durable Goods Orders, New Home Sales data, and the all-important Fed decision on interest rates.  The week wraps up with Personal Consumption, GDP, Initial Jobless Claims and Existing Home Sales on Thursday and Personal Income and U. of Michigan Confidence on Friday. 

 

The EUR fell overnight following the release of a worse than expecetd report measuring German business confidence.  The Ifo Institute said it’s survey of business confidence in Germany declined to 101.3 from 103.5, the lowest level in over two years.  With expectations that the ECB will hike interest rates at its July 3^rd meeting to curb inflation, policy makers remain divided as to weather this hike will be enough to contain prices that have accelerated at the quickest pace in 16 years.  While it does not appear that this weak economic data will be enough to deter the ECB from hiking rates next week, it does strengthen the argument and that further rate hikes this year will not be necessary.  With the Fed’s decision scheduled for this Wednesday, trade will remain in current wide ranges as the market waits for any signs of direction in interest rate policy in the near-term.

 

The JPY traded within recent ranges, albeit towards the bottom, as the US$ lacks any apparent direction ahead of this weeks Fed decision on interest rates.  While it is all but sure that the Fed will leave rates unchanged at this meeting, the commentary following the decision will be reflective of future interest policy direction.  It is expected that with inflation seemingly accelerating, the Fed will move to hike interest rates in the near term to stem these gains.  If this hawkish stance does prevail, expect gains for the US$.

 

The GBP was down sharply overnight following the release of a report showing that U.K. house prices fell in June by the most this year.  This data led traders to cut bets that the BOE will hike interest rates to curb inflation in the near-term.  Andrew Sentance, a member of the central bank’s Monetary Policy Committee, wrote that economic growth will be “much slower” over the coming year and that the BOE will bring inflation back to the 2% target “over a reasonable timeframe”.  With further declines in housing prices expected within the U.K., the GBP will remain under pressure for the time being, as interest rate expectations continue to scale back.

 

US$ Falls Across the Board on Waning Expectations of Fed Rate Hike

The US$ fell across the board overnight as traders scaled back positions speculating that the Fed will hike interest rates over the next several months.  Recent releases of consistently weak US economic data, particularly in the housing sector, has led to the reemergence of an overall negative outlook for the US economy. Adding to this pessimistic sentiment, Moody’s Investor Service stripped MBIA Inc. and Ambac Financial Corporation of their top investment-grade rankings late yesterday afternoon, further raising concern about future credit related writedowns. Both of these companies are critical in insuring bond deals against losses. This renewed sense of financial market trouble is weighing on the greenback.  Further weighing on the dollar, crude oil spiked $2 overnight, as the prospect of an impending strike by Nigerian oil workers hit the market. This rebound comes after a $5.00 drop in prices yesterday fueled by the announcement by the Saudis of increased production. With the Fed scheduled to meet next Wednesday, June 25^th, traders have significantly scaled back expectations of a policy shift from the US Central Bank. The market is currently pricing in a 12% chance that the Fed will hike interest rates by a quarter point at their June 25^th meeting, down from a 22% probability one week ago.  There is no economic data scheduled for release today, leading the market to be squarely focused on the Fed’s commentary next Wednesday and the overall negative tone of markets in general to steer the US$.

 

The euro gained significantly overnight as contrasting interest rate policies between the ECB and Fed prevail.  It is all but certain that the ECB will hike interest rates by a quarter of a percent at its July 5^th meeting as ECB President Trichet continues to voice his hawkish stance.  Overnight Trichet stated,  “Experience has shown that if inflation is left to creep up, the cost of bringing it down later will be even higher.  The central bank must ultimately act if this what is needed to maintain price stability.”  This succinct message underscores the ECB’s will to fight inflation, no matter the costs top economic growth. In addition, to underscore this growing inflation threat, Germany released PPI data overnight accelerating at the fastest pace in almost two years. With inflation pressures continuing throughout the Eurozone, higher rates will almost certainly continue to attract capital to the common currency.

 

The yen gained within recent ranges overnight as traders exited the “carry trade” overnight.  Moodys Investors Service’s downgrade of both MBIA Inc. and Ambac Financial Corp. spurred fear of future writedowns in the financial sector and resulting turmoil in the financial markets. This has led to the prospect of a weak opening on Wall Street this morning, leading to further unwinding of the “carry trade.” The Japanese currency’s marginal gains were sustained by expectations that the Fed will be unable to hike interest rates in the near term, certainly to be reinforced by the US Central Bank’s commentary next week. In the interim, expect some modest yen strength within current ranges.

 

The pound settled into recent elevated ranges as the market looked to US$ weakness against other currencies and after sterling positive news yesterday.  Thursday’s release of a much higher than expected UK retail sales figure coupled with a hawkish statement from BOE Governor, Mervyn King, led some traders to speculate that UK rates could soon be pushing higher.  These expectations come despite weakness in the overall UK housing sector, as it seems almost certain the at the BOE will join their brothers at the ECB and adopt a staunch inflation fighting posture. This will almost certainly push sterling higher within recent ranges.

US$ Consolidates Against EUR and JPY While Slipping Against GBP on Better Than Expected British Retail Sales

The US$ was mixed overnight, falling against the GBP and consolidating in recent ranges against the EUR and JPY.  The US$ remained within these ranges even after the release of worse than expected jobless claims registering 381K vs. 375K forecast, revealing continued weakness in the labor market.  Later this morning, the Philadelphia Fed’s manufacturing report is released, expected to register –10.  Following the recent disappointing Empire Manufacturing report, any signs of continued regional weakness could support the market’s negative outlook for the US economy in the near- term. These expectations of a slowing US economy have been reflected recently in interest rate future markets.  Currently these markets reflect a 48.0% probability of a 25 basis point Fed rate hike by the Bank’s August meeting, down from 90.0% two weeks ago. These diminished interest rate expectations, coupled with the apparent sluggishness of the US economy will weigh on the US$ for some time. 

 

The euro slipped within recent ranges as the market consolidates ahead of the Fed’s June 25^th meeting. Although the US Central Bank is not expected to alter rate policy, Expectations remain in place that the ECB will hike rates at its July 3^rd meeting further lending support to the common currency. Interest rate differentials and expectations continue to remain the driving force behind the direction of the euro. This should keep the euro well bid for some time.

 

The yen continued to trade within recent ranges overnight.  The currency direction remains guided by the market’s use of the “carry trade.” As traders use the currency to finance positions in equity markets, the direction of the yen has been closely tied to these markets. Weakness in Asian and European bourses this morning contributed to some limited yen strength, however, it will be the direction of US equity markets today that ultimately contribute to the currency’s direction. Over the next several months expect ranges in the yen to prevail.

 

The pound strengthened overnight following the release of much better than expected retail spending data in the UK registering a gain of 3.5% vs. an expected 0.1% decline.  This data surprised the market as traders had expected consumer spending to slow in tandem with a weakened housing sector. In addition, BOE Governor, Mervyn King, called for the need to focus on inflation, and not growth.  The apparent resilience of the consumer, accompanied by a more hawkish stance by the Bank of England, has reintroduced the possibility that UK rates will be moving higher sooner rather than later. These shifting expectations helped bolster sterling overnight.

 

The Swiss franc fell overnight, following the Swiss National Bank’s decision to hold rates steady at 2.75%. The Bank stated that all signs pointed to recent inflationary pressures to be “temporary”.  This move surprised the market as traders had expected the SNB to adopt a posture similar to their brothers at the ECB and therefore led to a significant selling of the franc.

US$ Trends Higher as Sentiment Moves Towards Economic Slowdown Continuing for Longer than Originally Thought

The US$ trended slightly higher overnight as the market continues to try and gauge the overall direction of interest rates amongst the G8 countries and ultimately the health of the US economy. Yesterday’s failure of the overall equity market to rally after positive earnings news from investment banking giant Goldman Sachs has seemed to set a negative tone throughout market. With housing markets remaining under substantial duress, there is a new view in the market that US economic growth will not rally in the second half of this year, but rather that the current malaise will be long-lasting and spread to other facets of the economy. This period of malaise could limit the Fed from hiking rates this year, albeit as food and energy prices continue to rise. There is further disheartening news for the economy as food prices are almost certain to rise later this year. It seems that the Iowa has lost between 10.0% and 15.0% of its annual corn harvest as floods ravage the Midwest.  Expect the US$ to continue to remain weak throughout today as traders keep an eye on the overall direction of US equity markets. The only data slated for release today was Mortgage Applications registering a decline of 8.8%, signaling that the housing slump is far from over.

 

The euro remains firm against the US$ as traders continue to speculate that the ECB will hike rates when they meet on July 3^rd. The Eurozone Central Bank has made it clear that they intend to curb inflation pressures and “maintain price stability.” With Eurozone rates poised to rise, traders seemingly continue to favor the common currency on a strictly yield basis. Also helping the euro push higher is its emergence again as a “safety investment” relative to the US$. With Wall Street again coming under pressure as doubts about the overall health of the US banking sector again emerging, traders are again shifting assets into the euro. Expect euro strength to continue for the next several weeks excluding some news, which could alter market sentiment.

 

The yen continues to remain weak against the US$ despite overall bearish sentiment surrounding the US economy. It seems that an emerging set of circumstances in Japan has traders very cautious surrounding holding yen positions. Minutes released overnight from the Bank of Japan’s May meeting revealed that policy makers feel the economy “faces considerable downside risks.” This language all but guarantees that Japanese rates will remain steady through the remainder of the year, if not suggesting that there could be some minimal rate cut later this summer. With Japanese rates remaining the lowest amongst the G8 nations, the appeal of the “carry trade” will remain in place for some time. This will almost certainly continue to weigh on the yen in the coming months.

 

The pound fell modestly overnight after the minutes released from the Bank of England’s June 4^th policy meeting showed that members did not think that a rate hike “was urgently needed.” This has helped reduce the belief of some hawks in the market that the Central Bank would soon be hiking rates to fight inflation pressures. However, with a slowing UK economy countered by rising prices, it is highly unlikely that the BOE will alter policy any time soon. The result is likely sterling being relegated to wide ranges for the foreseeable future. 

US$ Consolidates on Worst Housing Starts Number in 17 Years

The US$ traded in steady ranges overnight against the euro and yen, while gaining against the pound ahead of US economic data slated for release today. With the G8’s failure this past weekend to issue any significant commentary about the US$, traders remain disappointed and hesitant to buy the greenback. This has led the market to focus on interest rate expectations and the prospect that the US economic slowdown has bottomed. However, reports overnight in both the Wall Street Journal and Financial Times suggest that the Fed will leave rates unchanged for the remainder of this year. Similar comments were echoed by Moody’s Investor Services and ABN Amro yesterday, who both suggested that rates will remain low as the Fed attempts to stave off further declines in housing. Currently futures markets have predicted a 69.0% chance that interest rates gain at least 25 basis points at the Bank’s August meeting. Before this meeting, traders will likely watch the flow of US data for inflation pressures and the strength of the overall economy. This morning the US released its Current Account Balance figures showing a widening deficit of $176.4 billion. In addition, PPI was released at a higher than expected 1.4% month on month vs. expectations of a 1.0% reading. Year on Year PPI registered a gain of 7.2% vs. expectations of a 6.8% reading. This data, inflationary in nature will likely continue to support the Fed’s new “hawkish” tone. In addition, Housing Starts were released at a lower than expected annual pace of 975,00 vs. expectations of a 980,000 reading. At 9:15 a.m. Industrial production expected to gain 0.1% and Capacity Utilization expected to register 79.7% are to be released. Expect ranges to prevail through the day, with an ultimate downward bias to the greenback steering trade.

 

The euro continues to remain firm as interest rate expectations continue to steer trade in the common currency. With it all but certain that the ECB will hike rates at its meeting on July 3^rd, traders continue to favor the common currency. This interest rate supported bias has now gained further momentum as the prospect of rate hikes from the Fed is now diminished. This euro strength comes despite signs that the Eurozone economies are beginning to slow. The Zew Center for European Economic Research reported a sharp decline in German investor confidence, dropping to a 15-year low this month. The survey fell to –52.4 in June from a reading of –41.4 in May. As investors continue to get battered throughout Europe due to elevated energy and food prices and a strong euro, it is likely only a matter of time before the common currency comes under some pressure.

 

The yen remains weak as traders are again flocking into the “carry trade” to finance positions across a broad range of asset classes. As equity markets appear set to rally today after the release of much better than expected earnings from Goldman Sachs, the yen will likely remain under renewed pressure today. Goldman announced second quarter earnings of $4.58 per share vs. expectations of $3.42, far better than forecast. This news should spur a renewed rally in equities, particularly financial stocks, further helping traders shift into short yen financed positions. Within this background, expect the yen to remain under pressure throughout the day.

 

The pound fell overnight as traders focused on the likelihood of a slowing UK economy in the coming months. Overnight, data was released showing that inflation accelerated at the quickest pace in over a decade. Consumer prices rose 3.3% in May from a year earlier forcing BOE Chief Mervyn King to state that he believes that inflation will breach 4.0% this year. Such readings are far above the BOE’s acceptable 2.0% ceiling and could force the BOE to soon hike rates to target these rising price pressures. Within this environment of rising price pressures and slowing growth the BOE finds itself pigeon holed and unable to make any significant policy shifts. The result has been a weakened pound. 

US$ Struggles as G8 Fails to Mention Necessity of Strong Dollar

The US$ fell overnight after the G8 failed to explicitly mention the US$ in its communiqué after its meetings ended this past weekend. While the G8 stated that the “world economy continues to face uncertainty and downside risks persist,” and that “elevated commodity prices, especially of oil and food, pose a serious challenge,” they failed to offer any remedy to the weak US$ issue at hand. As the G8 was trying to send the market a firm warning about inflation dangers, it distinctly failed to mention currencies. This led to a selloff in the greenback. However, immediately following the G8 meeting, US Treasury Secretary Paulson stated “a strong dollar remains in the best interests of the U.S.” While these comments helped reassure the market, they did little to rally the US$. Also helping weigh on the greenback this morning was an article in the Washington Post by columnist Robert Novak. Novak stated that despite Bernanke’s hawkish comments last week about interest rate policy, the Fed Chief has no intention of raising US interest rates at any time in the near future. While these comments had little effect on the interest rate future markets, they did position the specter of steady US policy for some time. Another set of news released this week, also had surprising little effect on the greenback. The Saudis announced that they would increase daily oil production some 500,000 barrels. Some in the market had expected such an announced increase in production and thus there was little effect on trade. The market will be monitoring the flow of US economic data this week, to determine the state of the US economic turnaround. At 9:00 a.m. today, the TICs report measuring foreign investment in the US economy is to be released expected to register $63.3 billion. Tomorrow sees the release of the Current Account Balance, PPI, Housing Starts, Industrial Production and Capacity Utilization. Thursday yields the Philly fed Survey, Leading indicators and Weekly Claims. There is no other major data slated for release this week. While the G8 failed to mention the US$ traders, will likely initially sell the greenback earlier this week as they aim to get some reaction from Central Bankers and global finance ministers. Expect US$ weakness to prevail modestly until that time.

 

The euro gained overnight after the G8 failed to openly support the US$ at its weekend meeting and rather embraced the need to fight the inflation pressures troubling the world economies. These anti-inflationary comments all but reinforce the view that the ECB will hike rates at next month’s meeting. The inflation rate in the Eurozone rose to 3.7% in May, the highest since June of 1992. These elevated rates of inflation not only support the probability of rate hike from the ECB next month but also suggest that rates could continue to rise throughout the year. This view continues to support the euro, and will likely continue to drive the currency higher in the coming weeks.

 

The yen remains under significant, as it appears that the Japanese economy will continue to weaken. This perceived economic slowdown in Japan could lead the Bank of Japan to reduce borrowing costs later this summer as the Bank takes aim at reinvigorating economic growth. Should rates remain at current levels, or push lower, as some speculate, the appeal of the “carry trade,” will almost certainly increase. In this trade investors short the yen and opt to invest in higher yielding assets, exerting further downward pressure on the currency.

 

The pound rallied overnight following the lack of US$ supportive comments from the G8 and as inflation worries escalate in the UK. Economist forecast that levels of CPI will accelerate above 3.2% this month, prompting the Bank of England Governor Mervyn King to write a letter to the UK government’s Chancellor of the Exchequer explaining policy steps that will be enacted to push inflation back below the Bank’s 2.0% target. These rising inflation readings will all but guarantee that the BOE will be forced to push rates higher in the near term. However, this interest rate bias has its downside, as the recent fallout in housing and consumer spending, should push the Bank to a more accommodative posture. These conflicting factors will ultimately relegate sterling to broad ranges.  

US$ Rises on US Retail Gain and Expectations Ahead of G8 Summit

The US$ rose across the board overnight as traders adjust positions ahead of this weekend’s G8 meeting in Japan. There is a growing consensus in the market that the Group of Industrialized nations will issue a communiqué with extremely strong words supporting the US$. This could very likely be the beginning of the turning point for the greenback as there is an emergency oil meeting scheduled on June 22^nd in Saudia Arabia concerning the recent spike in oil prices. A growing belief on the street is that the Saudis will be willing to increase oil production, albeit only if the West begins to push the US$ higher. Further helping the US$ higher has been the continued shift in hawkish rhetoric at the US Fed. Yesterday, Fed Vice-Chairman Kohn stated that he believed it to be of paramount importance that the Central Bank maintain a hawkish bias to keep prices stable. These comments all but suggest that US rates will be pushing higher in the coming months. This view is being reflected in the futures markets, which have now predicted with a  75.0% probability that rates will push higher by the Fed’s September 5^th meeting. As a final push to the greenback, InBev announced that it was making an offer of $65 billion to acquire Anheuser Busch. $46.3 billion of this deal would be brokered with cash. In addition, the release of significantly better than expected retail sales data this morning pushed the US$ higher. Retail Sales rose 1.0% vs. a forecast of a 0.5% gain, excluding autos, the number rose 1.2%. Expect this trend of US$ strength to continue throughout the day.

 

The euro fell overnight, as the Anheuser Busch news circulated through the market, suggesting that there will be significant euro sales to hit the market should this deal close.  Also weighing on the euro is the prospect that Irish voters could reject a new European Union treaty governing the latitude of the ECB. Should they reject this treaty today, it will likely put further pressure on the euro, as it could lead to a change in the ECB’s mandate in setting policy. Amidst this euro negative news, the common currency will ultimately be supported by the continued strong inflation fighting rhetoric from ECB officials. Overnight, ECB Council Member Axel Weber stated that the “Bank is in a period of heightened awareness” and “ready to act to curb inflation.” These comments all but echo those of ECB Chief Trichet last week who stated that rates would likely be rising at the Central Bank’s July meeting. Ultimately, expect ranges to prevail with downward pressures on the common currency.

 

The yen fell overnight, as equity markets appear poised to rally this morning following the news about the proposed takeover of Anheuser Busch by InBev. This news has helped spark renewed confidence in the overall equity markets leading traders to again adopt the “carry trade.” With this trade as a significant backdrop in the market, the yen continues to act as a proxy for market risk. Expect this trend to continue for some time, with an overall negative bias weighing on the yen, as confidence in Japan wanes and an improving US economy appears to be surfacing.

 

The pound continues to weaken against the US$ as traders remain focused on the likelihood of a modest US recovery coupled with higher rates in the US. Further hurting the pound is the continued weakness in the housing market and its ultimate effect on consumer spending. This weakness should prompt the BOE to lower rates to jumpstart growth. However, with rising inflation pressures, it is unlikely that the UK Central Bank will be able to lower rates. This will likely keep the UK economy under continued pressure, leading to sterling declines.

US$ Consolidates on FED's Shift Towards Hawkish Stance on Rates

The US$ weakened within recent ranges overnight as traders continue to gauge the overall global interest rate outlook. Yesterday, the US$ continued to gain following comments from US Treasury Secretary Paulson. Paulson further refined his comments from last week, stating that intervention in currency markets remains a tool for policy makers. Paulson further stated that he will stress to his G8 counterparts that US fundamentals should be reflected in the value of the US$. These comments take on additional viability approaching this weekend’s G8 meeting in Japan. It is almost certain finance ministers and Central Bankers will affirm the need for further US$ strength and a pullback in oil prices. Likely to further assist the US$ higher in the coming days is the apparent revival of hawkish rhetoric from the US Fed. Yesterday, Fed Chief Bernanke signaled to the market his intent to hike rates sooner rather than later as inflation pressures are surfacing within the US. At 11:30 a.m. today, Fed Vice Chairman Donald Kohn and St. Louis Fed President Jim Bullard are scheduled to speak about the risks of inflation. Should they signal a more overtly hawkish interest rate tone, the US$ is almost certainly to gain. Currently futures markets have priced in a 43.8% probability that rates will gain 25 basis points by the August 5^th policy meeting, with a 97.1% probability assigned to the likelihood that rates will be higher by year-end. The US released Mortgage Application data, rising a surprising 10.9% after a decline of some 15.3% last month. At 2:00 p.m., the Fed releases its Beige Book survey. Should this report reveal signs that the US economy has nearly bottomed the US$ could enjoy further gains. 

The euro gained overnight after another ECB official verified Trichet’s comments from last week, suggesting an ECB rate hike could be forthcoming at next month’s meeting. ECB Executive Board Member Juergen Stark stated that markets “understood the Bank’s signal to raise rates next month.” However, he stated that this would not be the signal of a series of rate hikes, but rather a “one off” event. While these comments helped push the euro higher, they further reinforce the timing and posture differences between the ECB and Fed. While the Eurozone Central Bank remains steadfast in “maintaining price stability,” the Fed has delayed shifting to such a hawkish bias. This will ultimately delay any significant and prolonged US$ gains, keeping the currency relegated to recent ranges. 

The yen continues to come under pressure as traders again introduce risk to their portfolios through the “carry trade” and after the market has digested news about currency interventions by several Asian Central Banks. As global equity markets, appear to again be achieving some solid footing, traders are again favoring the low yielding yen as a preferred financing mechanism for these equity positions. With calm returning to markets, the yen is almost certain to remain under pressure. Surprisingly, the yen continues to remain weak despite the news that Bank of Thailand intervened in currency markets, buying Bhat  to “create stability.” Furthermore, South Korea’s Finance Minister announced that they had sold some $500 million to support the won yesterday in an effort to create some level of market dynamic to keep its currency firm. These Central Bankers will aim to maintain strong currencies as a hedge to combat inflation. However, these interventions are likely to have minimal effect as the US$ should ultimately gain against all Asian currencies, excluding China. 

The pound gained modestly overnight as traders pushed the UK currency within recent ranges as some modest profit taking took hold. Sterling will likely continue to remain under pressure, as a housing slump and the credit market squeeze will likely curb economic growth. Also likely leading sterling lower was the news that Merrill Lynch had downgraded British homebuilders Galliford Try Plc and Barrat Developments, citing declines in home prices that could lead to write downs in land values. With a slumping housing market leading to declines in consumer spending, it is likely that the pound will remain under pressure for some time.

Paulson and Bernanke Boost the US$

The US$ gained overnight following comments from both US Fed Chief Bernanke and Treasury Secretary Hank Paulson suggesting that the US government has shifted both its interest stance and US$ policy. Overnight, in addressing a conference in Boston, Bernanke stated that the risks to the economy’s downside have eased and that he would “strongly resist” any waning of public confidence in stable prices. These comments seemed to suggest that the US Central Bank is prepared to hike rates sooner rather than later as it aims to tackle the growing problem of global inflation. Further helping boost the US$ were comments yesterday from Treasury Secretary Paulson suggesting that that a new policy was being initiated by the US government. Yesterday Paulson stated that he would “never” rule out currency intervention to prop the US$. These comments to the market seem to signal a warning, that further US$ declines will not be tolerated. Also helping the US$ push higher was the announcement by the largest oil producing nation in the world, Saudia Arabia, that it was calling an emergency meeting of OPEC nations and consumer nations. They further stated that the current price of oil remains too high and that this needs to be addressed. Within this backdrop of a shift in US$ policy and the suggestion that US interest rates could push higher, the G8 is preparing to meet this weekend in Japan and it is almost certain that they will consider some level of joint action to deflate the price of oil and bolster the US$. With the price of oil so tightly correlated to the direction of the US$ it seems almost certain that global finance ministers will respond to these market deficiencies. At 8:30 this morning trade Balance figures were released revealing a defict in line with expectations of $60.9 billion. This data will likely have little effect on trade as the market shifts its attention to larger more fundamental policy shifts.

The euro continues to seesaw in wide ranges looking for some definitive direction as traders aim to determine the ongoing policy shifts between the ECB and Fed and US Treasury. Last week ECB Chief Trichet suggested that Eurozone interest rates could rise as early as next month as the Central Bank aimed to tackle ongoing inflation pressures. This view was reinforced overnight following the release of an article in the Spanish publication La Gaceta de los Negocios. Trichet stated that it is essential to control inflation to support growth and maintain job creation. While these comments helped reinforce the view that Eurozone rates will like move higher in the coming months, the market’s attention now seems to rest squarely on commentary from both the Fed and US Treasury. Bernanke’s comments yesterday suggested that the Fed is quickly shifting into an inflation fighting posture, signaling higher rates, while Treasury is finally backing a string US$. These combating sets of commentary will likely continue to weigh on the euro until some equilibrium price level is found.

The yen continues to come under pressure, weakening to the lowest levels in four months, as traders focus on a slowing Japanese economy and continue to use the low yielding currency in the “carry trade.” With global Central Bankers now suggesting that interest rates will begin to gain, it seems most likely that Japan will not follow suit. With signs that Japan’s economy is again tumbling toward recession, rates will likely remain at current levels for some time. This environment of low rates will continue to support the “carry trade” as traders use the Japanese currency to inject risk into their portfolios. Look for yen weakness to persist for some time within this current environment.

The pound fell overnight as data continues to paint a gloomy picture for the UK housing market. An industry report released overnight showed that the recent credit crunch has eased mortgage lending, leading to the largest drop in UK housing prices in close to three decades. However, within this backdrop of declines in housing, the Bank of England finds itself in a difficult situation. Rising inflationary pressures will likely soon force the BOE to hike rates, even as the economy slips into recession. This policy posture will likely only worsen any economic slowdown, contributing ultimately to further sterling declines.