Can the US dollar Continue to Rally Even if the Economy Slows?

Daily Forex Fundamentals | Written by Global Forex Trading | Aug 29 08 22:05 GMT |

Today's Biggest Percentage Movers CAD/JPY( -180 pips or -1.71%) USD/CAD( +118 pips or 1.13%) EUR/CAD( +155 pips or 1.00%) THE STORIES IN THE CURRENCY MARKET USD:CAN THE US DOLLAR CONTINUE TO RALLY EVEN IF THE ECONOMY SLOWS? EUR:DON'T EXPECT THE ECB TO CHANGE RATES, BUT EXPECT HAWKISH COMMENTS GBP: SHORT POSITIONS HIT A NEW RECORD CAD: CANADA AVERTS RECESSION, BUT GROWTH REMAINS SLOW AUD: WILL THE RESERVE BANK CUT INTEREST RATES? NZD:RECESSION RISKS JPY: HOPE FOR JAPAN EXPECTATIONS FOR THE NEXT FED MEETING (9/16/08) CURRENT FED INTEREST RATE:2.00% CURRENT 1 WEEK AGO 1 MONTH AGO NO CHANGE 78.8% 75.6% 58.6% RAISE 25BP 11.6% 15.2% 17.8% RAISE 50BP 3.2% 1.3% 11.0% CUT 25BP 4.7% 7.9% 7.0% ** PERCENTAGES MAY NOT ADD UP TO 100% BECAUSE OF THE PROBABILITY OF LARGER OR SMALLER MOVES BEYOND THOSE SHOWN ON THIS TABLE CAN THE US DOLLAR CONTINUE TO RALLY EVEN IF THE ECONOMY SLOWS? The US dollar has been quietly trended higher since the European trading session.The EUR/USD hit a high of 1.4768 shortly after the London open but ended the US session near its daily lows.Although this strength was also seen against many of the other major currencies, the dollar failed to rally against the Japanese Yen.This weakness was primarily due to the move in US equities which dropped over 170 points in the US session.Oil also reversed sharply, ending the day slightly under $116 a barrel, after having hit an intraday high of 118.76. August has been a very good month for the dollar with the currency seeing its strongest 1 month rally in more than 15 years.Although the US economy remains weak, the price action in the dollar indicates that the currency can rally even if the economy slows.Trading the currency market is oftentimes an expectations game.Since July, the market's expectations for growth have shifted dramatically.Over the past month, it has become increasingly clear that traders have underestimated US growth and overestimated growth outside of the US.GDP growth in the second quarter was 3.3 percent, far above everyone's estimates.Since April, the trade deficit has also narrowed, adding fuel to the dollar's rally.Looking ahead, the question is can the dollar's rally continue?The answer is a qualified yes.The rally can continue but certainly not at the pace that we have seen over the past month.Four central banks are meeting to decide on monetary policy next week, one of which is expected to lower interest rates. Don't expect this central bank to be the last.The Federal Reserve has already done its work and rates are low enough that they will not be decreased again in this monetary policy cycle.Everyone else on the other with the exception of the Bank of Japan still have plenty of room to cut rates. The dollar's weakness in the first half of the year helped to support corporate earnings and M&A flow.The recovery in the dollar since then strips away the foreign exchange contributions which could have a negative impact on earnings in the remainder of the year. The US data released this morning was mixed with personal spending rising slightly but personal income dropping by 0.7 percent.The Chicago PMI and University of Michigan consumer confidence numbers were both better than expected. The US markets are closed on Monday for Labor Day (there will be no commentary), but the shortened trading week only means a busier one.Service and manufacturing ISM are due for release along with the Fed's Beige Book report and non-farm payrolls.The US economy is expected to see its eighth consecutive month of negative job growth. DON'T EXPECT THE ECB TO CHANGE RATES, BUT DO EXPECT HAWKISH COMMENTS The Euro spent most of this week trading near its five month lows.Recent economic data indicates that both growth and inflation is slowing.The Eurozone consumer price estimate eased from 4.1 to 3.8 percent in the month of August while consumer and business confidence remained weak.However ECB officials continue to remind us that inflation is a big problem. Earlier this week, ECB Weber said that interest rate cuts are not on the table and this morning Liebscher added that inflation “demands the ECB's attention.”These are strong comments ahead of the European Central Bank's interest rate decision next week.Although rates are not expected to be changed, the ECB is telling us that they will remain hawkish.Eventually, they will have to temper their tone on monetary policy, but with the recent volatility in oil prices, they are not expected to do so anytime soon. Looking ahead, German retail sales are due for release on Monday.Although this number is usually market moving, the US holiday could limit any big moves.For the rest of the week, the primary Eurozone releases that we are expecting aside from the ECB interest rate decision are Eurozone producer prices and second quarter GDP. BRITISH POUND: SHORT POSITIONS HIT A NEW RECORD HIGH Currency traders remain extremely bearish British pounds.The latest round of selling in the GBP/USD started in the beginning of the US trading session.The currency dropped to a new 2 year low against the US dollar around 12 noon ET. Since then it has recovered marginally. According to the Commitment of Traders report released today, futures traders continued to add to their short positions.Non-commercial net short position rose to the highest level on record for the second week in a row.To put the latest move into perspective, August was the worst month for the British pound since George Soros broke the Bank of England in 1992. There was no UK economic data released today, but expect some more action in the British pound next week with service sector PMI, manufacturing PMI and the Bank of England interest rate decision on the calendar.With 8 out of the 9 monetary policy members favoring unchanged or higher interest rates at the last meeting, the BoE is not expected to alter interest rates.When no changes are made, no statement is released which means that the rate decision itself could be a non-event.Given the proximity of the psychologically important 1.80 price level, the GBP/USD could continue to weaken, but the net short positioning in the GBP/USD has hit a new record high, which means that everyone who wants to be short is probably already short, increasing the chances of a sharp reversal in the GBP/USD on the first sign of positive UK data. AUSTRALIA AND CANADA HAVE INTEREST RATE DECISIONS, WHO IS EXPECTED TO CUT RATES? The Canadian, Australian and New Zealand dollars fell against the greenback and the biggest move was in the Canadian dollar.The loonie quietly consolidated ahead of the GDP numbers and was trading around 1.0500, but once the weaker number was released, the currency began declining and ended the day at 1.06 against the US dollar. The Canadian economy grew by 0.3 percent in the second quarter.Even though two consecutive quarters of negative GDP growth was averted, the rebound was much weaker than the market expected.There is no technical recession, which is defined by two negative quarters of growth, but the Canadian economy remains weak.Next week, the Bank of Canada will make an interest rate decision.Although rates are not expected to be decreased, the BoC should be paving the way for a rate cut in the near future.The market is currently pricing in 50bp of easing over the next 12 months.The Reserve Bank of Australia on the other hand is expected to cut interest rates by 25bp. We do not think that a rate cut is a done deal, but the minutes from the most recent monetary policy meeting suggests that an easing cycle is about to begin. Aside from the 2 interest rate decisions in the week ahead, there are a number of other economic data expected from Canada and Australia (New Zealand's economic calendar is devoid of any market moving releases).The big numbers that we are watching include second quarter GDP in Australia, the trade balance, Canadian employment numbers and IVEY PMI. HOPE FOR JAPAN: NEW STIMULUS PACKAGE The 170 point drop in the Dow drove the Japanese Yen crosses lower throughout the US trading session.News that the Bank of China will be cutting its holdings of Fannie Mae and Freddie Mac has everyone in the equity markets nervous.Economic data from Japan was stronger than expected with retail sales, consumer prices, manufacturing PMI and the jobless rate beating expectations. The big news today however was Japan's new 10 trillion yen stimulus plan.With the economy deteriorating and the Bank of Japan not able to cut interest rates to support growth, this new plan gives hope to Japan.Although there has been a lot of criticism about this package being too small, something is better than nothing. Looking ahead, there are no major economic releases on the Japanese economic calendar next week. GBP/USD:Currency Pair in Play Over the Next 24 Hours Monday is Labor Day in the US, so the currency markets should be extremely quiet.However UK manufacturing PMI is due for release at 8:30 GMT. We are watching the GBP/USD which is trading in the sell zone on both the daily and weekly charts.We determine the buy and zones using Bollinger Bands.1.8620 is a key Fibonacci Resistance level, but near term resistance is 1.8400, which is the first standard deviation Bollinger band on the daily chart.If the GBP/USD closes above 1.8400, we could see a more meaningful recovery.As for support, 1.8090 is the June 2006 low. Kathy Lien http://www.gftforex.com