Dollar Dragged by Stern's Comments, Real Rates Weigh

Daily Forex Fundamentals | Written by CMC Markets NY | Jul 28 08 14:20 GMT |

The dollar drops off its multi-week highs following comments from Minneapolis Fed president Gary Stern to the Financial Times overnight indicating that the US credit squeeze is likely to persist for many months and might even get worse. Stern argued that 2% Fed funds rate enable the Fed to cope with any negative surprises on growth, but do not enable it as well in dealing with negative surprises on inflation. Stern concluded that either inflation expectations needed to decline, or the Fed will have to increase rates, or both, in order to achieve lift real interest rates. Note that Stern's comments indicate the deterioration in the credit crunch with more certainty than they do regarding increased inflation. The remarks are rather dovish from Mr. Stern who is known to be among the most hawkish members of the FOMC during the Greenspan days in the late 1990s.

Negative real interest rates in the US (nominal rates minus inflation) are as low as -2.3% compared to +0.25% in the Eurozone, +0.45% in Japan and +1.2% in the UK . Low rate rates in the US are the main reason why neither the US Treasury nor the Federal Reserve can step up their strong-dollar rhetoric beyond the usual mantra of a strong dollar being in the US interest. Currency traders are well aware that as long as such unfavorable interest rates persist in the US , the only way for policymakers to effectively lift the dollar is by following up with an actual increase in interest rates instead of rhetoric. Considering the deterioration in the credit crisis as well as the prolonged weakness in housing and employment, the Fed remains not only handicapped in raising interest rates but at risk of prolonging the credit slump and prompting a contraction of economic growth.

Tuesday's consumer confidence figures from the US should be scrutinized beyond their headline number, with a detailed look at the “jobs sentiment ratio”, which indicates jobs hard to find vs jobs being plentiful. The S&P/Case Schiller Home Price Index is also due at on Tuesday.

Euro to Edge Higher Ahead of Eurozone CPI , US Reports

Last week's euro decline was more modest than we had predicted, as the combination of weak US housing figures and surging jobless claims provided the currency with solid support against the dollar. Euro pushed up above $1.5750 due to rising oil prices resulting from militant attacks targeting Royal Dutch Shell pipelines in the Niger delta region. The euro managed to shrug bigger than expected declines in Germany 's GfK consumer confidence and record lows in Spain 's GfK index.

Wednesday's string of Eurozone manufacturing PMI is likely to stress the deteriorating state of the sector in the region, but markets will remain reluctant to drive down the currency below the $1.56 figure ahead of the crucial US GDP and employment report in the subsequent two days. Thursday's release of Eurozone advanced July CPI estimates will be crucial in determining the hawkish foundation of the single currency. Conesus forecasts expect a new record high of 4.1% following June's 4.0% increase. EURUSD faces interim upside at $1.5780, but is unlikely to extend gains beyond $1.5840 before Thursday's CPI. A figure below 4.0% will likely remain supported at 1.5640.

USDJPY's Persistent Failure

USDJPY's persistent failure to breach above the 108 figure is a result of ongoing concerns with the US credit squeeze and negative macroeconomic figures, which continue to take turn in acting as catalysts to the pair's downside. The fact that the yen has fared lower than was penciled in by most Japanese corporate forecasts in last quarter is a positive to their operations, thus, signifies medium term upside for the currency. Friday's Japanese June CPI figures showing a 1.9% annual increase, and a 1.5% rise in the core, may provide an added boost for the currency via rising bond yields.

From a risk appetite point of view, the week will be shaped by US GDP and non farm payrolls, but care is urged on the earnings front. Although the pair continues to trade above its 200-day MA for the 5th straight day, the inability to regain 108 is prominent on the daily chart. Even in the event of a breach above 108, the dollar remains unattractive at 108.40. Interim downside stands at 107.15, backed by intermediate support at 106.80 .

Sterling's Downtrend Affirmed

Another day passes and another report showing new lows in UK house prices. The 1.2% July decline in Hometrack's house price index translated into a 4.4% annual decline, the biggest since the survey began in 2001. The report follow last week's preliminary Q2 GDP figures showing a 1.6% increase, the lowest since 2005. Although real interest rates in the UK of 1.2% are the highest in the G7, they represent the Bank of England's policy bind, which we expect to be ultimately unraveled by renewed easing later this year by two 25-bp rate cuts. GBPUSD targets 1.9830, followed by 1.9800. The 200-day MA of $1.9930 remains stacked with accumulating sell orders as reported by dealers.

Ashraf Laidi
CMC Markets Plc
http://www.cmcmarkets.com/usfx